Status Quotient

Controversy Abounds

As noted above, the worker is considered an independent contractor if the company controls only the results. The worker is an employee if the company also controls how the work is done. So much controversy has arisen over these definitions that Congress passed a "safe haven" law. This prevents the IRS from forcing employee status if the company meets the following three requirements:

The company . . .

*Did not treat workers in a similar position as employees for employment tax purposes

  • Has filed Form 1099, when required, with the IRS as if the worker was an independent contractor, and

  • Has reasonable basis for treating the worker as an independent contractor.

Ah, that word--"reasonable"-- is the cause of so many tax battles. Examples from Congress and court cases shed some light on the problem. "Reasonable" basis can be claimed by an employer who . . .

  • Relies on court cases, IRS rulings, or the advice of an accountant or attorney familiar with the law and the facts,

  • Had a previous audit and the IRS didn't challenge the status, or

  • Was following long-standing industry practice.

Of these, "industry practice" creates the most controversy. The IRS is stubborn about allowing this exception, even when the taxpayer has strong evidence supporting its position. One company, whose workers were appraisers, commissioned a survey of the industry which showed that 75 percent of all survey respondents treated their appraisers as independents. The IRS, unconvinced, challenged the status. A court reversed the IRS' decision and agreed with the company.

In another case, a court didn't require an independent survey, but accepted one performed by the company itself. The IRS had challenged Paul D. McClellan, of Sterling Floors and Kitchens in Detroit, over the status of floor installers. Posing as an unemployed installer, McClellan called 41 competitors and found that 40 of them classified workers as independent contractors. The IRS still disagreed. But when the case went to court, the judge stated that Congress had passed the safe haven law to curb overzealous enforcement in just such situations. He added that the IRS' obstinacy bordered on bureaucratic arrogance. McClellan not only won his case, but the court nailed the IRS for legal fees and court costs.

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This article was originally published in the May 1997 print edition of Entrepreneur with the headline: Status Quotient.

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