EMPLOYEE OR INDEPENDENT CONTRACTOR: IS THE 20 FACTOR TEST DEAD?
By Deborah J. Muhlbauer
In late 1996, the Internal Revenue Service released the final version of its new materials for worker classification training. These materials were prepared for revenue officers and employment tax specialists and are comprised of three lessons: Employee or Independent Contractor (Common Law), Statutory Employees and Statutory Non-Employees, and Section 530 of Revenue Reconciliation Act of 1978. This article will focus on Lesson 1 because it articulates the evidence that a revenue officer must consider when determining a worker's status and the effect of the 20 Factor Test on said determination.
The new materials resulted from a pledge made by the Commissioner during the White House Conference on Small Business in 1995 that the Service would emphasize in its worker classification training the principle that the interest of the Service is to assure that both businesses and workers, whether under the withholding rules or under the rules governing the self-employed, pay the proper amount of tax. In honor of this pledge made by the Commissioner, these new training materials demonstrate a “kinder gentler” approach by the IRS to the issue of worker classification. Evidence of this gentler approach is found in the Introduction to Lesson 1 which states, in bold, “either worker classification, employee or independent contractor, can be a valid and appropriate business choice.”
In the past, the IRS trained revenue officers and examiners to look at the relationship between the worker and the business in terms of 20 different factors. In recent years this approach has come under severe scrutiny by the public because the Service's piecemealing of the various facets of the relationship often resulted in the revenue officer's recommendation of reclassification. Lesson 1 clearly identifies for revenue officers the distinction between the common law standard that applies to determinations of worker status and the IRS's 20 Factor Test. The materials explain that the common law standard is a legal test applied by the courts to make appropriate determinations to worker classification issues. In contrast, the 20 Factor Test is an analytical tool created by the Service to be used as a means for predicting what would be the outcome of a legal proceeding.
When addressing the issue of worker status, the new training materials instruct revenue officers to gain a general understanding of the way a business operates. Revenue officers must examine what the business does, how the business gets done, and the relationship between the business and its customers. This more global or holistic approach requires the examiner to examine the facts in terms of three relevant types or categories of evidence.
BEHAVIORAL CONTROL
FINANCIAL CONTROL
RELATIONSHIP OF THE PARTIES
FACTS OF LESSER IMPORTANCE
WEIGHING THE EVIDENCE
So is the 20 Factor Test dead? The answer is probably no. The Service's new approach incorporates many of the factors from the 20 Factor Test. However, the new “categories of evidence” approach is more holistic, with an emphasis on evidence rather than presumption. The new training materials also address controversial issues associated with many of the incorporated factors and designate those factors which are to be given little or no weight given current social realities and business practices.
In closing, however, practitioners must remember that these materials are new, and as such, not all revenue officers will be aware of the provisions contained therein. For those that are, it may take time for some to digest and accept the changes or modifications to the Service's past approach to this issue. Thus, practitioners facing an employment tax audit will serve their clients well by being aware of the provisions of these new training materials, and by reminding examiners, when necessary, of the provisions relevant and beneficial to their client's case.
Deborah J. Muhlbauer is a partner with the law firm of Bluestein & Muhlbauer, P.C. specializing in tax controversies and estate planning and is an adjunct professor of tax practice and procedure at the State University of New York at Buffalo, School of Law.
Bluestein & Muhlbauer, P.C.
333 International Drive
Williamsville, NY 14221
716.633.3200
