Classification Settlement Program

The Classification Settlement Program or "CSP" establishes new procedures under an optional classification settlement program that will allow businesses and tax examiners to resolve worker classification cases as early in the administrative process as possible, thereby reducing taxpayer burden. The procedures will also ensure that the taxpayer relief provisions under section 530 of the Revenue Act of 1978 are properly applied. Under the CSP, Internal Revenue Service (IRS) examiners will be able to offer businesses under examination a worker classification settlement using a standard closing agreement.

Background

Section 3121 (d)(2) of the Internal Revenue Code (IRC) requires that the issue of worker classification be resolved using the common-law standard. This requires the IRS to examine facts and circumstances to determine whether a business has the right to direct and control the details of the performance of its workers.

If an IRS examiner determines that a business has misclassified a worker as an independent contractor, the examiner then must determine whether the business is entitled to relief from retroactive and prospective liability for employment taxes under section 530 of the Revenue Act of 1978. To qualify for relief, the business must meet three requirements:

1. Reporting Consistency: All Federal tax returns (including information returns) required to be filed by the taxpayer with respect to the individual for the period, must have been filed by the business on a basis consistent with the business' treatment of the individual as not being an employee.

2. Substantive Consistency: The business must have consistently treated similarly situated workers as independent contractors. That is, if the business treated a similarly situated worker as an employee, there is no section 530 relief.

3. The business must have had some reasonable basis for not treating the worker as an employee. This may consist of reasonable reliance on: a judicial precedent, a published ruling, a private letter ruling or technical advice memorandum issued to the taxpayer; the results of a past audit of the taxpayer; or a long-standing recognized practice of a significant segment of the industry. Any other reasonable basis will also suffice.

Because IRS administrative procedures do not permit examiners to weight chances of success in court when proposing adjustments, businesses seeking to negotiate a settlement of the issue, including relief under section 530 will generally take their cases to IRS Appeals or to the courts. This increases costs for both taxpayers and the government.

Description of the Classification Settlement Program

Where it appears that a business may have erroneously treated a worker as an independent contractor rather than an employee, the examiner will develop the issue, including the business' eligibility for relief under section 530, for that year (Under general employment tax procedures, examiners initiate a single-year examination when opening a case. If the business is not entitled to a CSP settlement offer, or if the business rejects such an offer, the examiner will continue with traditional examination procedures under the Internal Revenue Manual, pursuant to which the examination is generally expanded to include other open tax years.) and gather the facts necessary to determine whether improper classification has occurred and, if so, the business' eligibility for a CSP offer.

The examiner will then consult with the examination group manager. After thoroughly reviewing the facts and circumstances of the case, the group manager will confirm the business' eligibility for a CSP settlement offer. If an offer is made and accepted by the business, the parties will sign a CSP closing agreement based on a standard closing agreement provided by the National Office.

Under the CSP, a series of graduated settlement offers will be available. If the business meets the section 530 reporting consistency requirement but either clearly does not meet the section 530 substantive consistency requirement or clearly cannot meet the section 530 reasonable basis test, the offer will be a full employment tax assessment for the one taxable year under examination computed using IRC section 3509, if applicable. If the business meets the reporting consistency requirement and has a colorable argument that it meets the substantive consistency requirement and the reasonable basis test, the offer will be an assessment of 25 percent of the employment tax liability for the audit year, computed using section 3509, if applicable. In each instance, the business will agree to properly classify its workers prospectively, thus ensuring future compliance.

In cases where the business clearly meets the reporting and substantive consistency requirements and satisfies the reasonable basis test the requirements of section 530 are fully met. As a result, no assessment will be made and the business may choose to continue treating its workers as independent contractors.

Some businesses, however, may prefer to treat their workers as employees. In this case, an agreement for prospective treatment will be made available. A business that enters into such an agreement may begin treating the workers as employees currently or at the beginning of the next year. By doing so, the business will not give up its claim to section 530 relief for Prior years

A business may qualify for more than one CSP offer if several classes of workers are at issue. For example, a business may receive an offer based on 25 percent of its one-year liability for one class of workers and an offer based on the full one-year liability for another class. On another class of workers, the same business may not qualify for any CSP offer. On yet another class, the business may be in full compliance with section 530 and would therefore be permitted to continue to treat the workers as independent contractors.

The graduated settlement offers comprising CSP are intended to simulate the results that would be obtained under current law, if the businesses accepting those offers had instead exercised their right to an administrative and/or judicial appeal.

Taxpayer participation in the CSP will be entirely voluntary, and a taxpayer may accept a CSP settlement offer at any time during the examination process. A taxpayer's rejection of a CSP offer will in no way affect the outcome of the examination. Moreover, a taxpayer declining to accept a settlement offer under the CSP will retain all rights to administrative appeal that exist under the IRS' current policies and procedures, and all existing rights to judicial review.

Examination

Every CSP offer will be based on a full examination of the facts and circumstances for the year under examination. Only through an examination can the IRS explore whether a worker should be treated as an employee or an independent contractor. An examination also enables the examiner to analyze the extent to which a business meets the requirements for section 530 relief, which is critical to determining whether the business can continue current classification practices or the appropriate nature of the offer the business will receive under the CSP.

Full examinations and the attendant review should ensure that all businesses are provided appropriate settlement offers under the CSP and thus should ensure the consistency and uniformity of the CSP.

Two Year Period

The CSP will be implemented on a two-year basis, beginning on March 5, 1996. This will allow enough time to determine the success of the program. Statistical information will be utilized to identify trends in case closures, both within and without CSP offers, and compliance by businesses that have entered into CSP agreements can be tracked. Businesses and their representatives are invited and encouraged during the two-year period to provide feedback on the program and its usefulness.

Eligible Cases

The CSP will be available to businesses with an open case in either Examination or Appeals on March 5, 1996. Any cases initiated during the two year period will also qualify for the program. Businesses that have not filed the required information returns are not entitled to participate in the CSP. (This rule applies only to information returns required by law. Whether or not information returns are provided when not required by law, such as when reporting payments are made to corporations or that total less than $600, will have no effect on the availability of the CSP.) Instead, the IRS will follow traditional methods of seeking compliance, and these businesses will be able to use the traditional administrative and judicial appeal processes.

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