Mr. Douglas Izard
Dean
IRS School of Taxation
M:CD:TX
2221 S. Clark Street
Arlington, VA 22202
Re: Revised Internal Revenue Service Worker Classification Training Manual entitled "Employee or Independent Contractor"
Dear Dean Izard:
The Office of Advocacy of the Small Business Administration was requested by the delegates to the White House Conference on Small Business to monitor the implementation of the recommendations and report on any progress made by the Administration or Congress. Also, it is our statutory responsibility(1) to advise the Administration and Congress on the impact of tax related proposals on small business. We are pleased to comment on this proposed training manual and to commend the Internal Revenue Service for its serious attention to this important area.
In June of 1995, two thousand delegates to the White House Conference on Small Business gathered in Washington DC. The delegates represented every state and most every industry classification in the country. Tens of thousands of businesses representing the nation's 20 million small businesses had previously taken part in the year long preparation for this national conference by holding preliminary conferences in every state and region. At the national conference, the delegates reviewed hundreds of proposed recommendations that had been winnowed and perfected after months of debate.
After a thorough discussion every imaginable topic of concern to small business owners, the White House Conference delegates voted worker re-classification clarification their top recommendation for action to the President and the Congress.
There is no mystery about why this one area was the most important to the small business owner. Worker classification has an impact on all small businesses. At some point, they all must hire an independent contractor, even if it is only to install their computer or keep their books. Also, business owners must compete every day with other businesses which hire independent contractors. The principle motivation, however, is fear. Businesses that have employed independent contractors have cause to wonder how their actions will be viewed by the Internal Revenue Service (IRS). Every small business owner has heard that an adverse decision could bankrupt them, taking everything they have worked for. It is this fear that caused the delegates to take worker classification so seriously and it is fear which serves, however unfairly, to undermine their confidence in the government.
We believe that there are two distinct tasks required to clarify the current law. First, the clarification of the underlying law itself; altering and simplifying 20 part common law test and restating the safe harbors, to make them certain and useful. This will require Congress to pass legislation.
The second task is to ensure that enforcement is uniform, straightforward and considerate of the businesses which struggle to understand the law. We applaud the IRS decision to proceed to undertake the second part of this test. While it is true that Congress has worker clarification proposals under active consideration(2), we agree with the IRS that the magnitude of the feeling for this problem makes quick action desirable. Such an approach shows good faith on the part of the IRS and goes a long way toward earning the confidence of small businesses.
The Revised Internal Revenue Service Worker Classification Training Manual entitled "Employee or Independent Contractor" (hereafter called the Manual) captures the appropriate tone at the outset in paraphrasing Commissioner Richardson: "Either worker classification -- independent contractor or employee--can be a valid and appropriate business choice." Small businesses sometimes are made to feel that the hiring of independent contractors has made them targets to be singled out and harassed. Our biggest objections to the manual, and there are very few, are those places where the manual deviates from this spirit.
The Office of Advocacy feels that the materials are presented well. The course is broken down into 3 sections, each section laying out a roadmap of territory to be covered and then filling in the scenery with instruction, supporting and contrary(3) case law, examples, summaries and finally case studies. Areas where questions remain are highlighted and the trainee is often reminded to keep all elements in mind and not fall into the trap of fixing on one element to make the classification(4). We feel this is important.
An effort has also been made to incorporate the changing standards necessitated by changing methods of businesses. For example, it is pointed out that the wearing of uniforms may not have the same implications it once had.(5) We also think it is important to emphasize the element of risk of profit and loss that exists for an independent contractor.
The Sections (called 'lessons') seem aptly chosen and cover: 1) the regular classification process, 2) statutory employees and non-employees, and finally, 3) the troublesome IRC §530 Safe Harbors.
One general comment on the entire effort. The difficulty in drafting the Manual for an issue such as worker re-classification is that the existing controversy and long history of contentiousness makes it almost impossible to draw lines upon which the trainees and the businesses they review can depend. Each time lists of evidence or criteria are enumerated, the trainee is again properly warned that no one fact controls. It remains up to the subjective judgement of the examiner whether the matter has risen to a level that requires reclassification and referral. The best help for the taxpayer is the ability to work with the examiner to solve the problem. This is an excellent example of why the IRS Classification Settlement Program and the Early Referral Appeals Program are absolutely essential companions for the Manual in the successful overhaul of the Worker Classification Procedure. It speaks well of the Service's changing attitude to concentrate on correcting well intentioned small businesses instead of confronting and punishing them.
The most contentious area covered by the Manual is IRC §530 safe harbors. One comment we have relates to the interpretation of "reasonable reliance on a long standing, recognized practice of a significant segment of the industry in which the individual was engaged." In this area, notwithstanding the well taken reminders to trainees, the IRS appears to set the standard for proof to claim protection under the section far higher than Congress intended. In order to meet the standard, the taxpaying business owner must return to the inception of the business and prove that there was a reasonable reliance that led to the classification decision.
Businesses indicate that the "decision process" when such classifications are made is generally based on the accumulated knowledge of the business owner based on his experience and informal research in the field. To prove one's in the manner the IRS recommends would seem to require a survey of similar industries, minutes from meetings where hiring was discussed, or dated letters from trade associations and business consultants advising the owner of the industry practice all done at the time independent contractors are hired. We think it is unrealistic to expect a small business owner to meet the burden the proof requirement set out in the training materials. We do not believe that the law or the cases require such proof.
Also, it seems odd that the classification by a predecessor of workers as employees will weigh against an owner seeking IRC §530 protection for substantive consistency purposes(6) yet the issuance of a Private Letter Ruling to a predecessor does not provide proof of reliance for the purposes of section §530 protection where the successor carries on the classification(7). In this area, in spite of Congressional intent to the contrary, it seems the trainees learn that all ties favor the IRS.(8)
Finally, the materials place strong emphasis, perhaps too strong, on the timely filing of past required reports. The IRS decision to cling strictly to the letter of the law in this area by requiring timely filing of all documents each year or lose §530 protection, will create problems.(9) This is especially true where the business has a history which establishes an earnest effort to file the correct reports on time as opposed to a pattern of obfuscation and abuse. In this area, the agent should be allowed to base his decision on a reading of the entire record.
All in all the Internal Revenue Service has lived up to the commitment made by the Commissioner to the White House Conference on Small Business to review the area very carefully and take the necessary administrative actions, pending further legislation, to make this difficult and contentious area less intimidating to taxpaying small businesses. Thank you for accepting our comments.
Very sincerely,
Jere W. Glover
Chief Counsel for Advocacy
Russ Orban
Tax Advocate
END NOTES
1. 15 USC §634b(4)
2. In the House, HR 1972 The Independent Contractor Tax Simplification Act and a similar bill, S 1610 in the Senate.
3. We feel that the Manual does a good job of ensuring that the trainee knows there are two sides to the story by pointing out contrary cases and/or places where the IRS has nonacquiesed.
4. On page 1-8 for example, where trainees are about to be told what evidence substantiates the right to direct or control details and means by which a worker performs required services, they are reminded that one fact should not be singled out and that ALL elements must be considered.
5. See page 1-11.
6. See p. 3-12 citing Rev. Proc. 85-18.
7. See p. 3-21.
8. See pages 3-15 for the Congressional history.
9. See example 3 on p. 3-8