Section 530 Relief

The IRS recently provided new guidance on how it will apply Section 530 Relief to Employment Tax Audits.  The IRS issued Rev. Proc. 2025-10 which announced the IRS’ updated positions on Section 530 relief available to taxpayers in Employment tax audits who were found to have misclassified workers as independent contractors.  The new IRS guidelines may be potentially helpful for taxpayers found to have misclassified workers during an employment tax audit. 

 Back in 1978, there was a “new trend” of IRS employment tax audits finding businesses misclassified employees as independent contractors.  In response, Congress originally enacted Section 530 as a form of temporary relief for businesses being “surprised” by employment tax audits findings of misclassified employees.  Congress eventually made Section 530 permanent. Although misclassification has been a big issue in employment tax audit for decades, Section 530 remains in effect to this day even though misclassification issues are hardly a “new trend” catching well informed business owners off guard. 

Section 530 relief is available to business owners that meet three requirements.  Businesses must have met (1) the reporting consistency requirement, (2) the substantive consistency requirement, and (3) must have had a reasonable basis for treating the misclassified worker as an independent contractor.

The reporting consistency requirement is met if the taxpayer files all tax returns consistently treating the misclassified worker as an independent contractor.  This generally means the taxpayer will issue only 1099 returns to the misclassified worker (as opposed to W-2 returns).  Many businesses found to misclassify workers often meet this requirement.

The substantive consistency requirement means all workers who are substantially similar to the misclassified worker were also treated as independent contractors.  To give an example, this requirement may be met if a business treats its entire sales force as independent contractors and is later found to have misclassified its sales force as independent contractors.  This requirement would not be met if a business treated some members of the sales force as employees and other members of the sales force as independent contractors.  Many businesses found to misclassify workers often meet this requirement as well.

The third basis is the so-called reasonable basis requirement.  This is perhaps the toughest requirement to meet for most businesses.  A reasonable basis requires (a) some sort of judicial precedent or other published ruling, (b) favorable treatment in a prior audit, (c) a long-standing recognized practice of a significant segment of the Taxpayer’s industry or (d) some other basis of classification.  The first two grounds for relief are often unavailable to many taxpayers so taxpayers often rely on a long-standing and recognized practice in their industry or “some other basis” to get Section 530 relief.    

Many taxpayers seeking Section 530 relief will argue they were following a long-standing recognized practice of a significant segment of their industry or argue they had some other basis for relief.    A significant segment of the industry typically requires at least 25% of the industry follows the practice and the practice is at least 10 years old.  Many taxpayers may have difficulty establishing a long-standing recognized practice in their industry because it may be difficult to prove what the prevalent practices within their industry. 

The recent IRS guidance provides both hope and concern for an employer found to have misclassified employees in its definition of what “some other basis” for the reasonable basis requirement can be.  On one hand, the IRS guidance provides there cannot be reasonable cause when a taxpayer has “negligence, intentional disregard of rules and regulations, or fraud.”  The IRS may argue taxpayers were negligent when they treated workers as independent contractors without seeking appropriate professional advice. 

On the other hand, the IRS guidance states the “some other basis” standard is met when the taxpayer considers the misclassified employee as an employee for other purposes.  Such other purposes would include providing workers’ compensation insurance to the worker and adhering to overtime rules.  Most taxpayers found to misclassify employees typically treat the misclassified workers as independent contractors across the board, i.e., they typically do not get workers’ compensation benefits for their independent contractors or take on other burdens associated with the employer-employee relationship for their independent contractors.  This requirement may be difficult to meet for many employers.

RJS LAW has decades of combined experience helping taxpayers face IRS and EDD employment tax audits.  Please feel free to contact us if you have any questions about employment tax audits.  We can be reached at 619-595-1655 and are always available to help.    

Written by Joseph Cole, Esq., LL.M.