Information contained in this publication is intended for informational purposes only and does not constitute legal advice or opinion, nor is it a substitute for the professional judgment of an attorney.
On December 14, 2022, the U.S. Department of Labor (DOL) and the Internal Revenue Service (IRS) signed and published a Memorandum of Understanding for Employment Tax Referrals (the “MOU”). The MOU establishes a system for referrals from the DOL’s Wage & Hour Division (WHD) to the Small Business/Self Employed Specialty Employment Tax unit (“SB/SE”). The stated goal is: “To share information between the SB/SE and WHD to assist in the identification of emerging and ongoing employment tax compliance issues related to misclassification,”1 but its practical effect is to streamline the process for investigating and penalizing businesses that allegedly misclassify their employees as independent contractors. This is the latest memorandum of understanding between federal agencies focusing on perceived widespread worker misclassification in the labor market.2 Businesses should take this coordinated focus on worker classification as an opportunity to assess their workers’ classifications and mitigate the risk of tax penalties resulting from misclassification.
While the main body of the MOU sets forth the terms of the agencies’ cooperation, Appendix B, titled “U.S. Department of Labor Standardized Referral Form and DOL/IRS Decision Tree,” refers to the partnership established by the MOU as the Joint Worker Misclassification Initiative. It sets forth a “standardized form and decision tree [that] was created to assist in outlining the necessary key information fields needed to standardize the terms, types, and quantities of information provided to establish a viable referral.”3
The MOU makes clear that the IRS will target businesses that lack a good-faith basis for worker misclassification, and which are thus more likely to be on the hook for substantial penalties. For example, the decision tree for referrals to the IRS begins with this statement: “At this time, the IRS does not want referrals that do not involve a determination of worker status.”4 Further criteria for referral to the IRS include that the business is still operating and its “annual dollar volume of sales” exceeds $500,000. The “annual dollar volume of sales” of a business (or an establishment, where applicable) is defined as the gross receipts from all sales of goods or services by the business (or establishment) during a 12-month period.5 Assuming those criteria are met, the decision tree classifies as a “Tier 1 IRS referral” those business that would not qualify for protection under Section 530 of the Revenue Act of 1978.
Section 530 is a relief provision that terminates a taxpayer’s employment tax liability with respect to an individual not treated as an employee if three statutory requirements are met: 1) reporting consistency; 2) substantive consistency; and 3) reasonable basis. Section 530 does not extend to the worker, who may still be liable for the employee share of FICA, not self-employment tax. Section 530 provides a permanent cure for a business’s employment tax liabilities relating to a particular group, or groups, of workers. “Reporting consistency” means the business must have timely filed the returns consistent with its treatment of the worker as a non-employee. “Substantive consistency” means the business has not previously treated the worker, or any worker holding a substantially similar position, as an employee. “Reasonable basis” means the business reasonably relied on one of several bases including: 1) prior audit by the IRS; 2) judicial precedent; 3) industry practice; or 4) other common law bases.
The IRS’s stated aim in excluding potential Section 530 candidates is fiscal: the “IRS will not have to devote resources to address the Section 530 issue,” and “the likelihood of a Federal Tax adjustment is enhanced.”6 This is in keeping with a statement, earlier in the decision tree, that “Given scarce IRS resources, the focus is where there is a likely source of collection.”7
Businesses are advised to respond to this increase in coordinated government action by conducting internal assessments of their workforce classification and continuing to do so on a periodic basis, including determining whether the requirements of Section 530 could be satisfied. Classifications that might have posed little risk of a misclassification finding under prior government administrations may not pass muster today. Worker reclassification, where appropriate, will mitigate any future claims related to misclassification, but may also trigger an IRS audit. As a result, businesses undertaking worker reclassification should consult counsel to best navigate important wage-and-hour and tax considerations of making such transitions.
1 MOU at 2.
2 See, e.g., “Memorandum Of Understanding Between The Federal Trade Commission (FTC) And The National Labor Relations Board (NLRB) Regarding Information Sharing, Cross-Agency Training, And Outreach In Areas Of Common Regulatory Interest”, (available at https://www.nlrb.gov/sites/default/files/attachments/pages/node-7857/ftcnlrb-mou-71922.pdf). See Littler’s prior coverage of this Memorandum of Understanding.
3 MOU at 11.
4 MOU at 12.
5 29 C.F.R. § 779.342.
6 MOU at 12.