I — Publication 963

cases, workers may be defined as “statutory employees” or “statutory nonemployees” because specific laws address the occupation (see Publication 15-A for more information on these workers). In general, however, the determination of worker status is made by applying an established common-law standard that addresses the facts and circumstances concerning how the work is performed. Whether workers are employees has significant consequences for tax liability and reporting.

Generally, when workers are employees, the government entity that employs them must withhold and pay employment taxes and file employment tax returns. Employment taxes consist of federal income tax withholding, Old-Age, Survivors and Disability Insurance (OASDI or Social Security) tax and the Hospital Insurance (Medicare) tax. The Social Security and Medicare tax make up the Federal Insurance Contributions Act (FICA) contributions, which are paid through employer and employee shares. State and local governments generally pay the Social Security tax on employees covered under Section 218 Agreements and on employees not covered by a public retirement system (mandatory coverage), and generally pay the Medicare portion on all employees hired after March 31, 1986. Wages paid by state and local governments are not subject to taxes under the Federal Unemployment Tax Act (FUTA), but state unemployment taxes may apply.

When workers are independent contractors, the governmental entity may have information-reporting and backup withholding responsibilities, but it is not required to withhold and pay employment taxes on behalf of those workers.

This chapter deals with the general rules for determining whether workers are employees, and the laws that apply to different categories of public employment.

Workers Covered Under Section 218 Agreements

As discussed in Chapter 1, states can enter into agreements with SSA to provide Social Security and Medicare coverage for their employees pursuant to Section 218 of the Social Security Act (Section 218 Agreements). If a position is covered by a Section 218 Agreement, then anyone holding that position is an employee. Therefore, the first question for a government to ask about a worker’s status is whether the worker is in a position covered under a Section 218 Agreement. If Section 218 Agreement coverage applies, this fact takes precedence over other considerations, including the common law tests discussed below and the mandatory coverage rules.

If you aren’t sure whether the Section 218 Agreement covers a specific position, contact your State Social Security Administrator (see NCSSA for a listing by state), or the SSA Regional Office for assistance. If a group of workers is covered under a Section 218 Agreement, the Agreement cannot be terminated or modified to exclude that coverage group.

Employees who are not covered under a Section 218 Agreement are generally subject to Social Security and Medicare unless they participate in a public retirement system that serves as a FICA replacement plan, discussed in Chapter 6. However, Medicare taxes generally apply to wages of all state and local government employees hired after March 31, 1986. See Chapter 5 for further information.

See IRC Section 7871 for information on the treatment of Indian tribes as governments. Indian tribal governments are not treated as states for purposes of Section 218. However, the Tribal Social Security Fairness Act of 2018 provides information about Indian tribes wishing to offer Social Security coverage to tribal council members under Section 218A of the Social Security Act. For more information about Social Security coverage, Medicare and tribal governments, see the IRS Indian Tribal Governments website.

Common-Law Standard - Employee for Employment Taxes (FICA and Income Tax Withholding)

For employment tax purposes, an employee is defined by IRC Section 3121(d)(2) as “any individual who, under the usual common law rules applicable in determining the employer-employee relationship, has the status of an employee.” The common law test for determining whether a worker is an employee is whether the service recipient (the government entity) has the right to direct and control the worker as to the manner and means of the worker’s job performance. In other words, does the entity have the right to tell the worker not only what will be done, but how it will be done? See Treas. Reg. Sections 31.3121(d)-1(c)(1) and 31.3401(c)-1(a).

In determining whether the person providing service is an employee or an independent contractor, all information that provides evidence of the degree of control and independence must be considered.

Facts that provide evidence of the degree of control and independence fall into three categories:

1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does their job?

2. Financial: Are the business aspects of the worker’s job controlled by the payer? (These include things like how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, and so on.)

3. Type of Relationship: Are there written contracts or employee type benefits (for example, retirement plan, insurance, vacation pay)? Will the relationship continue and is the work performed a key aspect of the business?

All these factors must be weighed when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors that are relevant in one situation may not be relevant in another.

The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.

Behavioral Control

Facts that fall under this category show whether the entity has a right to direct and control how the worker performs the specific task for which they are engaged. Many times, when workers perform their tasks satisfactorily, the entity does not appear to exercise much control. The critical question, however, is whether there is a right to control . If the entity has the right to do so, it isn’t necessary that it actually direct and control the manner in which the services are performed.

The following considerations address the elements of behavioral control with respect to government employees:

Instructions, Training and Required Procedures

An employee is generally subject to the government entity’s instructions about when, where, and how to work. The employer has established policies, which the workers are required to learn and follow. Daily or ongoing instructions about the expected tasks are especially indicative of employee status. Training is a classic means of explaining detailed methods and procedures to be used in performing a task. Periodic or ongoing training about procedures to be followed and methods to be used indicates that the employer wants the services performed in a particular manner. This type of training is strong evidence of an employer-employee relationship. For instance, police officers and firefighters must be trained to comply with departmental rules and regulations. They don’t have the independence characteristic of independent contractors. Other examples of training that indicates employment include a state statute requiring that animal control officers receive state-sponsored training and a statute requiring that inspectors of sanitary facilities be trained and state-certified. These facts are indicative of a right to control. Election workers are trained to follow uniform procedures established for the polling place. They are directed by a supervisor.

Government Identification

Nature of Occupation

Evaluation Systems

Financial Control

These facts suggest they would typically be employees. Government employees often work subject to regulations and manuals, which specify how their jobs are to be done. Teachers are required to receive periodic training in departmental policies. They are required to attend meetings, to follow an established curriculum, to use certain textbooks, to submit lesson plans and to abide by departmental policies concerning professional conduct. However, some types of training or minimal instructions may be provided to either an employee or an independent contractor, including orientation or information sessions about a government entity’s policies and voluntary programs for which there is no compensation.

Government workers may be required to identify themselves by wearing a uniform or driving a marked vehicle. When individuals represent themselves as agents of a government, that gives them an appearance of authority. Wearing a uniform, displaying government identification, or using forms and stationery that indicate one is representing a government are highly indicative of employee status.

The nature of the worker’s occupation affects the degree of direction and control necessary to determine worker status. Highly-trained professionals such as doctors, accountants, lawyers, engineers or computer specialists may require very little, if any, instruction on how to perform their specific services.

Attorneys, doctors and other professionals can, however, be employees. In such cases, the entity may not train the individuals or tell them how to practice their professions, but may retain other kinds of control, such as requiring work to be done at government offices, controlling scheduling, holidays, vacations and other conditions of employment. Again, the government entity should consult state statutes to determine whether a professional position is statutorily created. On the other hand, professionals can be engaged in an independent trade, business or profession in which they offer their services to the public, including work for government entities. In this case, they may be independent contractors and not employees. In analyzing the status of professional workers, evidence of control or autonomy with respect to the financial details is especially important, as is evidence concerning the relationship of the parties as discussed below.

Evaluation systems are used by virtually all government entities to monitor the quality of work performed. This isn’t necessarily an indication of employee status. In analyzing whether a government entity’s evaluation system provides evidence of the right to control work performance, consider how the evaluation system may influence the workers’ behavior in performing the details of the job. If there is a periodic, formal evaluation system that measures compliance with performance standards concerning the details, the system and its enforcement are evidence of control over the workers’ behavior.

This second category includes evidence of whether the entity controls the business and financial aspects of the workers’ activities. Employees do not generally have the risk of incurring a loss in the course of their work, but generally receive a salary for as long as they work. An independent contractor has a genuine possibility of profit or loss. Facts showing possibility of profit or loss include significant investment in equipment, tools or facilities; unreimbursed expenses, including the requirement to provide materials or hiring helpers; working by the day or by the job rather than on a continuous basis; having fixed costs that must be paid regardless of whether the individual works; and payment based on contract price, regardless of what it costs to accomplish the job.

The following considerations address the elements of financial control:

Method of Payment

Offering Services to the Public

Corporate Form of Business

Part-Time Status

The method of payment must be considered. An individual who is paid a contract price, regardless of what it costs to accomplish the job, has a genuine possibility of profit or loss and, therefore, would not generally be considered an employee. An individual who is paid by the hour, week or month is typically an employee. However, this is not always the case; for example, independent contractor attorneys usually bill by the hour. An individual who is paid by the unit of work, such as a court reporter, may or may not be an independent contractor, depending on the facts.

Another factor favoring independent contractor status exists when the individual makes their services available to the public or a relevant segment of the market. Relevant questions that address this issue include:

Does the individual advertise?
Does the individual use a private business logo?
Does the individual maintain a visible workplace?
Does the individual work for more than one entity?

If the individual is incorporated and observes corporate formalities associated with this status, this makes it unlikely that they are an employee of the government entity. (A corporate officer will be an employee of the corporation.) The mere fact of incorporation or use of a corporate name, however, does not transform an employee into an independent contractor. The corporation must serve an intended business function or purpose, or be engaged in business.

The fact that workers work on a part-time or temporary basis, or work for more than one entity, does not make them independent contractors. A part-time, temporary or seasonal worker may be an employee or an independent contractor under the common-law rules.

Relationship of the Parties The third category used to determine worker status is evidence of the relationship between the parties, including how they view their relationship. The relationship of the parties is generally evidenced by examining the parties’ agreements and actions with respect to each other, paying close attention to those facts that show not only how they perceive their relationship, but also how they represent their relationship to others.

For example, the intent of how the parties perceive their relationship may be expressed in a written contract. A written agreement describing the worker as an independent contractor is evidence of the parties’ intent, and in situations where it is unclear whether a worker is an independent contractor or employee, the intent of the parties, as reflected in the contract, may resolve the issue.

However, a contractual designation, in and of itself, is not sufficient evidence for determining worker status. The facts and circumstances under which a worker performs services are determinative. The substance of the relationship, not the label, governs the worker’s status (Treas. Reg. 31.3121(d)-1(a)(3)). The following items may reflect the intent of the parties:

Filing a Form W-2 or withholding payroll taxes for an individual indicates the entity’s belief that the worker is an employee.
A worker doing business in corporate form, with observance of corporate formalities, indicates the worker is not an employee of the government entity.
Providing employee benefits, such as paid vacation, sick days and health insurance, is evidence that the entity regards the individual as an employee. The evidence is strongest if the worker is provided with benefits under a tax-qualified retirement plan, Section 403(b) annuity or cafeteria plan because, by statute, these benefits can be provided only to employees.

The following are other considerations in evaluating the elements involving the relationship of the parties:

Discharge or Termination

Termination of Contracts

Nonperformance of Employees

The circumstances under which a business and a worker can terminate their relationship have traditionally been considered useful evidence concerning the status of the worker. However, business practices and legal standards governing worker termination have changed since these general principles developed. Under a traditional analysis, a government entity’s ability to terminate the work relationship at will, without penalty, provided a highly effective method to control the worker. The ability to fire at will is indicative of employee status. In the traditional independent contractor relationship, the government entity could terminate the relationship only if the worker failed to provide the intended product or service, thus indicating that the business did not have the right to control how the work was performed. In the current environment, however, a government entity rarely has complete flexibility in discharging employees. The reasons a government entity can terminate an employee may be limited by law, by contract, or by its own practices. Consequently, inability to freely discharge a worker, by itself, no longer constitutes persuasive evidence that the worker is an independent contractor.

Historically, a worker’s ability to terminate work at will was considered to illustrate that the worker merely provided labor and tended to indicate an employer-employee relationship. In contrast, if the worker terminated work, and payment could be refused, or the worker could be sued for nonperformance, this traditionally tended to indicate an independent contractor relationship. Today, however, it is more common that independent contractors may enter short-term contracts for which nonperformance remedies are inappropriate, or may negotiate limits on their liability for nonperformance. For example, professionals, such as doctors and attorneys, are typically able to terminate their contractual relationship without penalty. Accordingly, the worker’s protection from liability for terminating the relationship does not necessarily indicate employee status.

Employers may successfully sue employees for substantial damages resulting from their failure to perform the services for which they were engaged. As a result, the presence or absence of limits on a worker’s ability to terminate the relationship, by itself, is less relevant in determining worker status. On the other hand, a government entity’s ability to refuse payment for unsatisfactory work continues to be characteristic of an independent contractor relationship. Because the meaning of the right to discharge or terminate is so often unclear, and depends primarily on contract and labor law, these facts should be viewed with great caution.

Permanency The permanency of the relationship between the worker and service recipient is somewhat relevant to determining whether there is an employer-employee relationship. If a worker is engaged with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is generally considered evidence of intent to create an employment relationship. However, a longterm relationship may also exist between a government entity and an independent contractor. There may be a long-term contract, or contracts may be renewed regularly due to superior service, competitive costs or lack of alternative service providers. Part-time, seasonal or temporary workers may also be employees under the common law. The fact that workers do not have full-time, permanent status is irrelevant to their classification.

Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding

In difficult cases, the IRS can provide a determination as to whether a worker is an employee or an independent contractor. To obtain a determination from the IRS, file Form SS-8. Either a governmental entity or a worker may submit Form SS-8. The IRS will acknowledge receipt of the form and will request information from the other party. If a contract has been executed between the worker and the entity, a copy of the contract should be submitted with Form SS-8. In some cases, the State Social Security Administrator may help determine whether the entity and position are covered by a Section 218 Agreement. The IRS will generally issue a formal determination to the entity and will send a copy to the worker.

Note: The SS-8 determination is not an examination. It does not reopen a closed examination or change the findings for years previously examined.

Classification Issues Involving Government Employees

The following discussion addresses some special worker classification situations involving governmental employees.

Elected Officials and Officers

Under IRC Section 3401(c), an officer, employee or elected official of a state or local government is an employee for income tax withholding purposes. Thus, by federal statute, public officers are specifically included within the term “employee” for income tax withholding purposes (and conversely are not “independent contractors” for income tax withholding purposes). Treas. Reg. 31.3401(c)-1(a) clarifies the officers or employees can either be elected or appointed.

For Social Security and Medicare purposes, elected officials (also referred to as individuals in elective positions) are subject to a degree of control that typically makes them employees under the common law, and therefore subject to these taxes. Elected officials are responsible to the public, which has the power to vote them out of office. Elected officials may also be subject to recall by the public or a superior official. Very few elected officials have sufficient independence to be considered independent contractors.

Public Officer or Official

The term “public officer” refers to someone who has authority to exercise the power of the government and does so as an agent and employee of the government. The Internal Revenue Code does not define the term “public officer,” but Treas. Reg. Section 1402(c)-2(b), addressing self-employment tax, provides that holders of “public office” are not in a trade or business and are therefore not subject to self-employment tax. Rather, an individual recognized as a “public officer” is an employee.

An exception to this rule applies for certain public officials paid solely on a fee basis (see Chapter 5).

The Treas. Reg. give the following examples of positions that constitute “public office”:

Governor
Mayor
Member of a legislature or elected representative (elective office)
County commissioner
State or local judge, or justice of the peace
County or city attorney
Marshal, sheriff, constable
Registrar of deeds
Tax collector or tax assessor
Road commissioners
Members of boards and commissions, such as school boards, utility districts, zoning boards and boards of health

It may not always be clear whether a worker holds public office. In Metcalf & Eddy v. Mitchell, 269 U.S. 514 (1926), the U.S. Supreme Court addressed the definition of an officer. The Court ruled that an office is a public station conferred by the appointment of a government. The term “officer” includes the idea of tenure, duration, emolument and duties fixed by law, and where an office is created, the law usually determines its term, duties and compensation. In Buckley v. Valeo, 424 U.S. 1 (1975), the Supreme Court stated that anyone who exercises significant authority pursuant to the laws of the United States is an officer. The term “officers” embraces all appointed officials exercising responsibility under the public laws of the nation. Officers perform a significant governmental duty exercised pursuant to a public law and administer and enforce the public law.

If there is some question as to whether a worker is a public officer and employee, a critical factor to consider is whether there is a provision of the state constitution or a statute establishing the position. State statutes should be reviewed to determine whether they establish enough control for the individual to be classified as an employee under the commonlaw test. A statute may state that a specific position is that of a public official, in which case there is likely to be a right to control sufficient to make the individual an employee. Statutes may also specify the duties of a public office and generally establish the officer’s superiors and subordinates, if any. Statutes establish an official’s term of office and sometimes the compensation. They may require that a public official take an oath of office. Statutes often establish general and specific penalties for dereliction of duty. For instance, members of boards who are paid for each meeting they attend may face termination if they fail to attend a certain number of meetings.

Example: State A establishes the position of city attorney by statute and indicates that the position holder is an officer and an employee. This statute defines the duties of the position. The city attorney is required to direct all litigation in which the city is a party, including prosecution of criminal cases; to represent the city in all legal matters in which the city or a city officer is a party; to attend meetings of the commissioners, advise commissioners, mayors, and so on on all legal questions; and approve all contracts and legal documents. A city manager appoints, supervises and controls the work of the city attorney. The city attorney must take an oath of office. These facts show the importance of state statutes in establishing a right of direction and control over a public official and thus classifying the individual as a common-law employee.

Home Care Service Recipients

A home care service recipient (HCSR) is an individual who receives home care services while enrolled in a program administered by a federal, state or local government agency that provides funding for that individual’s home care services. Home care services include health care and personal attendant care services rendered to the HCSR. Generally, the HCSR is considered the employer of the service provider under the common-law rules. The provision of home care services generally constitutes household employment.

The HCSR may request that the IRS authorize, under Section 3504, an agent to act on their behalf to withhold, report and pay the federal employment taxes for the workers who provide home care services. See Revenue Procedure 2013-39 and Form 2678, Employer/Payer Appointment of Agent. Special rules apply when a state or local government agency acts as the Section 3504 agent. A state or local government agency acting as a Section 3504 agent on behalf of an HCSR files an aggregate Form 941 and aggregate Form 940, attaching Schedule R (Form 941), Allocation Schedule for Aggregate Form 941 Filers, and Schedule R (Form 940), Allocation Schedule for Aggregate Form 940 Filers. Agencies must have an employer identification number separate from the one used to report taxes of its own employees for this purpose. The state agent may engage a reporting agent or subagent to perform the reporting and payment of employment taxes that the state agent would otherwise perform on behalf of the service recipient.

Volunteer Firefighters

Compensation paid in an employer-employee relationship is taxable wages (unless an exclusion applies), regardless of whether the workers are termed “volunteers.” In some cases, rather than receive salaries, firefighters may receive amounts intended to reimburse them for expenses. They may also receive other cash or in-kind benefits that may be wages. Unless these reimbursements are paid under an accountable plan, discussed in Chapter 3, these reimbursements are taxable as wages.

Amounts that are termed “reimbursements” but are not paid under an accountable plan are treated as wages and subject to income, Social Security and Medicare taxes.

Therefore, a per diem or fixed amount paid to a firefighter (or other worker), that does not reimburse actual, documented expenses, is includible in income and subject to income tax withholding, Social Security and Medicare.

The services of volunteers are generally not eligible for the exclusion from FICA for emergency workers, discussed in Chapter 5. IRC Section 3121(b)(7)(F)(iii) provides that services performed by employees on a temporary basis in the case of fire, storm, snow, earthquake, flood or other similar emergency are exempt from employment. Firefighters who are on call and work part-time or intermittently do not qualify for the emergency worker exclusion. This exception applies only for temporary workers who are hired because of an unforeseen emergency.

Medical Residents

Medical residents are generally common-law employees of the hospitals for which they work, and therefore are subject to Social Security and Medicare taxes (unless they are excepted by a Section 218 Agreement). IRC Section 3121(b)(10) provides an exception for students employed by a school, college or university (SCU) who are enrolled and regularly attending classes at the SCU. However, this exception is not available to full-time employees. Under Treas. Reg. Section 31.3121(b)(10)-2(d)(3)(iii), an employee whose normal work schedule is 40 hours or more per week is always considered a full-time employee. Therefore, medical residents generally do not qualify to exclude payments for their services from Social Security and Medicare taxes.

Identity of the Employer for Tax Purposes

In certain cases, it is clear that the work in question is performed by employees, but it may not be clear which of two or more entities, organizations or individuals is the employer. This situation may arise when workers are supplied or paid by one entity but work under the direction of another (for example, leased workers).

The term “employer” is defined in IRC Section 3401(d), for income tax withholding and reporting purposes, as the person for whom an individual performs any service, of whatever nature, as an employee. However, an exception is provided if the person for whom the individual performs the services does not have control of the payment of the wages. In this situation, the term “employer” means the person having legal control of the payment of the wages except for purposes of the definition of wages under Section 3401(a) (IRC Section 3401(d)(1) and Treas. Reg. Section 31.3401(d)-1(f)). In the situation where there is an employer under Section 3401(d)(1), there are three parties for employment tax purposes: (1) the employee, (2) the employer under Section 3401(d)(1) (also known as a Section 3401(d)(1) employer) and (3) the employer under the common law rules (the common law employer).

When a question is raised about the identity of the employer, all facts relating to the employment must be considered. If there is any provision in a statute or ordinance that authorizes the employment by a government entity of the individual, and the individual is hired under this authority, the individual is generally an employee under the common law rules of that governmental entity. Any statutory provisions relating to the relationship should be reviewed. If there is no statutory authority, the identity of the employer must be determined under the common law control test.

If an entity is a Section 3401(d)(1) employer with respect to payments of wages to an employee, that employer under Section 3401(d)(1) is liable for the payment of employment taxes on the wages. However, the determination of whether the remuneration paid the employee is wages under Section 3121(a) for Social Security or Medicare purposes and wages under Section 3401(a) for income tax withholding purposes is made with respect to the common law employer. Thus, for example, a Section 3401(d) employer who is paying wages to employees on behalf of two or more common law employers cannot aggregate employees’ wages for purposes of calculating the wage base for taxes under FICA and FUTA. See Cencast Services, L.P. v. United States, 729 F.3d 1352 (Fed. Cir. 2013).

Employee Status for Other Purposes

A state or federal agency may make determinations of employee status for workers’ compensation, minimum wage or other purposes. The state or federal agency may apply different standards from those used to determine worker classification for federal employment tax purposes. Characterizations of individuals as employees based on state or nontax laws should be weighed with caution, and in some cases disregarded, because the laws or regulations involved may use different definitions of an employee for their purposes.

Independent Contractor Reporting Responsibilities

Independent contractors are subject to the taxes imposed under the Self-Employment Contributions Act (SECA). Taxes imposed under the SECA are usually referred to as self-employment tax, or SECA tax, to distinguish from the Social Security taxes and Medicare taxes under the FICA that apply in the case of employment. Generally, payments to independent contractors of $600 or more during a calendar year must be reported on Form 1099-NEC. Independent contractors are required to provide a taxpayer identification number to the entity that pays them. Form W-9 contains the required certification and can be used for this purpose.

For more information about requirements for information reporting to independent contractors, see the Instructions for Form 1099-MISC and 1099-NEC. Workers who have been treated as independent contractors but are later determined to be employees will need to file amended returns if they reported income on Form 1040, Schedule C, and calculated selfemployment tax (SECA) on Schedule SE. A worker in this situation should use Form 8919, Uncollected Social Security and Medicare Tax on Wages, to figure and report the employee share of Social Security and Medicare taxes imposed under the FICA. Entities that misclassify employees as independent contractors may be held liable for back taxes, penalties and interest.

Worker Providing Services as an Employee and as an Independent Contractor

Individuals who are employees for some services may not be employees for other services they provide. For example, a teacher may be retained to remove snow from school property. This individual may be an employee as a teacher but an independent contractor for the snow-removal activity. Apply the common law rules separately to each activity to establish whether it is an independent trade or business.

Revenue Ruling 58-505 explains that for an individual to work in two capacities (employee and contractor), the services must not be interrelated. Stated differently, an individual does not work in two capacities when the same type of work, such as legal services, is divided into two components, one in an employee capacity and one in an independent contractor capacity. The services and remuneration for the two activities must be separate.

Section 530 Relief

State and local government entities under examination by the IRS may be entitled to relief from employment tax for certain workers under Section 530 of the Revenue Act of 1978 (Section 530). If applicable, Section 530 terminates an entity’s federal employment taxes, including Social Security and Medicare, income tax withholding and any penalties attributable to the liability. See Revenue Procedure 85-18. This relief is not available for services covered by a Section 218 Agreement.

If the requirements for Section 530 relief are met, but the services are covered by a Section 218 Agreement, the entity may obtain relief from liability for income tax withholding for prior years. However, Section 530 relief from income tax withholding will not apply with respect to wages paid after the date on which the entity is advised that the workers are covered under a Section 218 Agreement. This is because the entity would have begun withholding FICA taxes, which constitutes treatment of the workers as employees. See Revenue Procedure 85-18, section 3.03(C) and 3.04.

Section 530 provides relief for an entity that treated workers as nonemployees if the entity had a reasonable basis for the classification and acted consistently on that basis. To qualify for Section 530 relief, the entity must have a reasonable basis for treating the worker as an independent contractor. Section 530 provides three safe harbors for satisfying the reasonable basis requirement:

Published ruling or judicial precedent;
Prior IRS examination of the taxpayer (if after 1996, the examination must have included a review of worker classification); or
Longstanding recognized practice of a significant segment of the industry. Alternatively, an entity may establish some other reasonable basis. For more information, see Revenue Procedure 85-18.

In addition, the entity must:

Have filed all federal tax returns (including information returns) on a basis consistent with treatment of the worker as a nonemployee; and
Not have treated the worker, or any other worker in a substantially similar position, as an employee.

For more information about the requirements for Section 530 relief, see Publication 1976, Do You Qualify for Relief Under Section 530?

Note: Section 530 is not part of the Internal Revenue Code. It was originally intended as an interim relief measure but was extended indefinitely in 1982.

Tax Consequences for Workers

In some cases, a government entity may be entitled to relief under Section 530, but workers find, through a determination letter or some other means, that they have been misclassified and are employees under the common law. Section 530 does not extend employment tax liability relief to workers. It does not convert them from employees to independent contractors. Misclassified employees remain liable for the employee share of Social Security and Medicare taxes rather than for SECA (self-employment) tax. (See Form 8919 for this computation.) If the workers have been filing income tax returns as independent contractors, they should file amended returns for years for which the statute of limitations is open. As employees, they are not entitled to deduct unreimbursed business expenses on Schedule C. Because these Section 530 relieved employers are entitled to continue treating these workers as independent contractors, the workers will not be subject to income tax, Social Security or Medicare withholding and will generally have to make estimated tax payments to cover their tax liabilities. Information provided in Notice 989, Commonly Asked Questions When IRS Determines Your Work Status is “Employee”, although not written specifically to Section 530 employees, provides information for filing their income tax returns or amended returns. Please note, however, that not all references of Notice 989 are applicable, for example, the Section 530 employer will not be liable to provide a corrected Form W-2 in in this situation.

Frequently Asked Questions

1. What are the consequences of misclassifying a worker? Generally, when an employer erroneously classifies an employee as an independent contractor and does not withhold federal payroll taxes, the employer is liable for the employer and employee shares of all applicable federal payroll taxes, as well as penalties and interest. [IRS]

2. What do you do if you cannot determine whether a worker is an employee? The state or local entity or the worker can request a formal determination by submitting to the IRS Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. The IRS will review the facts and circumstances and officially determine the worker’s status. [IRS]

3. Are volunteers considered employees? The common law tests apply to determining the status of individuals regardless of whether they are deemed “volunteers.” If an individual considered a volunteer meets the common law tests, any form of compensation or benefit they receive is considered wages, unless a specific exception applies.

[IRS]

4. What effect does the presence of a Section 218 Agreement have on worker status? If an existing Section 218 Agreement classifies a position as that of an employee covered by the Agreement then an individual in that position is an employee, subject to FICA and income tax withholding; the common law tests are not considered. Positions not covered by a Section 218 Agreement should be evaluated under the common law tests. [SSA/IRS]

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