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IRS Updates Guidance on Section 530 Employment Tax Liability Relief

Ed Zollars, CPA

Revenue Ruling 2025-3 and Revenue Procedure 2025-10 provide updated guidance regarding Section 530 of the Revenue Act of 1978, which addresses controversies involving whether individuals are employees for purposes of employment taxes.

Revenue Procedure 2025-10

  • Purpose and Updates: This revenue procedure updates and supersedes Revenue Procedure 85-18. It clarifies the definition of an employee, the requirement for filing necessary returns under Section 530, and the reasonable basis safe harbor rules. Additionally, it expands on the guidelines in section 3.03 of Rev. Proc. 85-18, which interprets the term “treat” in determining if a taxpayer did not treat an individual as an employee for Section 530(a) purposes. It includes new provisions reflecting statutory changes to Section 530 since 1986, which added sections 530(d), (e), and (f). The provisions in Rev. Proc. 85-18 regarding refunds, credits, abatements, and handling of claims for taxpayers under audit at the time of Section 530’s enactment have been removed.
  • Section 530 Background: Section 530 was initially a temporary measure to provide relief for taxpayers in employment status disputes with the IRS. It was later extended indefinitely and is not part of the Internal Revenue Code. Section 530 can relieve a taxpayer from federal employment tax liability if certain requirements are met. This relief applies to the taxpayer, not the individual worker, and covers FICA, RRTA, FUTA taxes, and income tax withholding.
  • Key Provisions of Section 530(a): If a taxpayer did not treat an individual as an employee, that individual will be deemed not to be an employee, unless there was no reasonable basis for not treating them as such. For periods after December 31, 1978, relief requires that all federal tax returns are filed consistently with the taxpayer’s treatment of the individual as a non-employee and that the taxpayer has not treated any individual holding a substantially similar position as an employee.
  • Application of Section 530 Relief: Section 530 applies exclusively to taxpayers involved in employment status disputes with the IRS, preventing the IRS from reclassifying independent contractors as employees. Relief is available if the taxpayer did not treat the individual as an employee for federal employment tax purposes and meets the reporting consistency, substantive consistency, and reasonable basis requirements.
  • Reasonable Basis: A taxpayer can have a reasonable basis if their treatment was based on judicial precedent, past IRS audits, long-standing industry practice, or some other reasonable basis.
  • Prohibition of Regulations: The Department of Treasury is prohibited from publishing regulations or revenue rulings regarding the employment status of any individual for employment tax purposes, and this revenue procedure does not violate that prohibition.
  • Definition of Employee: The term “employee” includes corporate officers, individuals under common law rules, statutory employees, individuals under Section 218 or 218A agreements of the Social Security Act, and state or local government officials.
  • “Treatment” of an Individual: The IRS uses specific guidelines to determine if an individual was “treated” as an employee. This includes withholding taxes, filing employment tax returns, filing Schedule H, issuing Form W-2s, or contracting with a third party to perform employer acts. However, returns prepared by the IRS or those filed due to IRS compliance procedures do not indicate “treatment” of the individual as an employee for that period.
  • IRS Procedures: The IRS will provide written notice of Section 530 availability before or at the start of an employment tax audit. The IRS will first consider if the taxpayer meets the requirements of Section 530 before determining if the individuals are employees.
  • Limitations of Section 530 Relief: Section 530 applies only to the status of an individual as an employee or non-employee and does not apply to the characterization of payments. It does not apply to whether a payment is wages or whether services constitute employment.
  • Dual Status Workers: The revenue procedure addresses situations where individuals may perform services for a taxpayer in separate capacities, with the application of Section 530 considered separately for each relationship.
  • Technical Personnel: Section 530 does not apply to technical service workers, such as engineers, designers, drafters, and programmers, whose employment status is determined under common law rules.
  • Test Room Supervisors and Proctors: For periods after December 31, 2006, Section 530 relief can apply to test proctors or room supervisors assisting with college entrance or placement exams for a tax-exempt organization, irrespective of past treatment of similar workers as employees.
  • Federal Agencies: Section 530 relief is not available to federal agencies.
  • Abatement and Refund: If Section 530 relief is granted, the IRS will abate any assessed liability and refund any payments, including penalties and interest.
  • Reporting Consistency: To obtain relief, taxpayers must file all required federal tax returns consistent with treating the individual as a non-employee. Reporting consistency is applied on a period-by-period and individual-by-individual basis. Good faith mistakes in filing the wrong type of information return or reporting an inaccurate amount will not cause the taxpayer to fail the reporting consistency requirement.
  • Substantive Consistency: Taxpayers must not have treated an individual or anyone in a substantially similar position as an employee after December 31, 1977. The determination of a substantially similar position includes considering the relationship between the taxpayer and the individual.
  • Reasonable Basis Requirement: Taxpayers must demonstrate that they reasonably relied on one of the safe harbors or had another reasonable basis for treating the individual as a non-employee. The IRS considers judicial precedent, past IRS audits, and industry practices when determining reasonable reliance on a safe harbor. The legislative history of Section 530 states the reasonable basis requirement should be construed liberally in favor of the taxpayer. A taxpayer is not considered to have a reasonable basis for treating individuals as non-employees if the facts and circumstances indicate negligence, intentional disregard of rules and regulations, or fraud. The IRS may consider if a taxpayer treated the individual as an employee for other purposes, such as claiming tax deductions or credits, complying with labor laws, and participating in benefit plans.
  • Burden of Proof: If a taxpayer establishes a prima facie case of a reasonable basis and cooperates with the IRS, the burden of proof shifts to the IRS. This shift does not apply if the taxpayer relied on some other reasonable basis.
  • Status of Individuals: Section 530 does not change the status of the individual, and they remain liable for their personal employment taxes. If a taxpayer receives Section 530 relief, the worker remains liable for their employee share of FICA tax.

Revenue Ruling 2025-3

  • Situations Addressed: This ruling examines whether Section 530 or the reduced rates of § 3509 of the Internal Revenue Code (the Code) apply in five different scenarios. It also addresses whether the IRS will issue a Notice of Employment Tax Determination Under IRC § 7436 (§ 7436 Notice) in those situations.
  • Fact Situations: The ruling presents five fact situations involving various payment and reporting practices, focusing on the treatment of bonuses, fixed payments, and third-party payment arrangements.
  • Application of Law: The ruling discusses the employer’s liability for federal employment taxes on wages paid to employees, including FICA, RRTA, FUTA taxes, and income tax withholding. It reviews the definition of “wages” and “employment” for FICA, FUTA, and income tax withholding purposes and the common law rules for determining if a worker is an employee. It explains that Section 530 relief is available to a taxpayer, not the individual worker, if specific requirements are met.
  • Section 530 Requirements: Section 530 relief requires that a taxpayer did not treat an individual as an employee, filed all required returns consistently, did not treat similar individuals as employees, and had a reasonable basis for not treating the individual as an employee.
  • Limitations of Section 530: Section 530 relief applies to controversies involving whether individuals are employees or non-employees, not to whether particular payments constitute wages.
  • Section 3509 Relief: If Section 530 relief does not apply, an employer may be eligible for relief under § 3509 of the Code, which provides reduced rates if the employer did not withhold income tax or the employee share of FICA tax because they treated the employee as a non-employee. Similar to section 530, § 3509 does not apply when the employer treated the worker as an employee and there is a dispute over the characterization of payments.
  • Section 7436 Notice: The ruling addresses the issuance of a § 7436 Notice, which is required to obtain Tax Court review for certain employment tax determinations. The IRS will issue a § 7436 Notice if there is a disagreement between the IRS and the taxpayer regarding employment status or if the taxpayer does not meet requirements for Section 530 relief, and there was an examination in connection with an audit.
  • Holdings: The ruling provides specific holdings for each of the five fact situations, determining the applicability of Section 530, § 3509, and the issuance of a § 7436 Notice based on the facts presented. In situations where the taxpayer treated the individual as an employee, but mischaracterized additional payments to them as something other than wages, neither section 530 nor 3509 apply.

Key Updates and Implications

  • Clarification of “Treatment”: Both the revenue procedure and ruling emphasize the importance of how a taxpayer “treats” an individual for employment tax purposes, clarifying what actions constitute treating an individual as an employee or a non-employee.
  • Distinction Between Worker Classification and Payment Characterization: Both documents make it clear that Section 530 is intended for worker classification issues (employee vs. non-employee) and not for disputes about whether payments made to an employee are considered wages.
  • Application of Section 3509: The ruling clarifies the application of reduced rates under § 3509 of the Code, which is applicable to cases where a worker was treated as a non-employee but was reclassified by the IRS as an employee, and where the employer failed to withhold taxes, but does not apply to disputes over the characterization of payments.
  • Burden of Proof: The revenue procedure reinforces the idea that a taxpayer has the burden of showing they meet the requirements for Section 530 relief, but if they establish a prima facie case and cooperate with the IRS, the burden of proof will shift to the IRS.
  • Emphasis on Consistency: Both documents stress the importance of reporting and substantive consistency in claiming Section 530 relief, ensuring that taxpayers have acted in good faith.

Five Fact Situations in Revenue Ruling 2025-3

Revenue Ruling 2025-3 presents five fact situations regarding the application of Section 530 of the Revenue Act of 1978 and the reduced rates of § 3509 of the Internal Revenue Code (the Code), as well as whether the IRS will issue a Notice of Employment Tax Determination Under IRC § 7436 (§ 7436 Notice) in each situation.

Situation 1:

  • A taxpayer (TP) hires individuals and pays them a weekly fixed amount and a weekly bonus. TP does not withhold or pay federal employment taxes, and reports the total payments on Form 1099-NEC as nonemployee compensation.
  • During an IRS audit, it’s determined that TP doesn’t qualify for Section 530 relief and the individuals are employees. The IRS proposes to assess federal employment taxes on the payments, which should have been reported as wages on Form 941 and Forms W-2. TP claims it satisfies the requirements for section 530 relief.
  • Guidance: Section 530 is applicable because the IRS is reclassifying the individuals as employees. Whether TP is entitled to relief depends on whether the TP satisfies the substantive consistency, reporting consistency, and reasonable basis requirements. If section 530 does not apply, § 3509 of the Code may be applicable because the TP treated the individuals as non-employees and did not deduct and withhold federal employment taxes. The IRS will issue a § 7436 Notice because the IRS determined the individuals were employees and TP was not entitled to section 530 relief and there is a disagreement between the IRS and TP about the employment status of the workers.

Situation 2:

  • TP employs individuals and treats them as employees, paying a weekly salary and a weekly bonus. TP treats the salary as wages for federal employment tax purposes, and withholds and pays employment taxes. However, TP does not treat the bonus as wages and reports the bonus amounts on Forms 1099-NEC without withholding or paying any federal employment taxes.
  • During an IRS audit, the IRS concludes that the bonus amounts are wages, and proposes to assess federal employment taxes on the bonus payments. TP claims it satisfies the statutory requirements for section 530 relief with respect to the bonus amounts and does not agree that the bonus amounts are wages.
  • Guidance: Section 530 is not applicable because the IRS is not reclassifying the individuals as employees. TP treated the individuals as employees and paid additional wages in the form of bonuses. The reduced rates under § 3509 are not applicable for the same reason. The IRS will issue TP a § 7436 Notice because there was an audit, a determination was made that TP was not entitled to relief under section 530 with respect to the bonuses, and the IRS and TP disagree on whether the statutory requirements for section 530 relief have been met.

Situation 3:

  • Same facts as Situation 2, except TP does not report the weekly bonus amounts on Forms 1099-NEC or any other information return.
  • Guidance: Section 530 and § 3509 of the Code are not applicable for the same reasons as in Situation 2. The IRS will issue a § 7436 Notice at the conclusion of the audit because there was an examination, a determination was made that TP was not entitled to relief under section 530 with respect to the bonuses, and the IRS and TP disagree on whether the statutory requirements for section 530 relief have been met.

Situation 4:

  • Same facts as Situation 2, except TP does not report the weekly bonus amounts on Forms 1099-NEC or any other information return, and TP does not claim it satisfies the statutory requirements for section 530 relief with respect to the bonus amounts.
  • Guidance: Section 530 and § 3509 of the Code are not applicable for the same reasons stated in Holding 2. The IRS will not issue a § 7436 Notice because TP did not claim that TP was entitled to relief under section 530, and there is no controversy over whether the individuals are employees or independent contractors.

Situation 5:

  • TP employs individuals and contracts with a third party (3P) to pay the individuals’ weekly salary, withhold and pay federal employment taxes, and file federal employment tax returns. 3P fulfills these obligations using its own employer identification number (EIN). TP pays a year-end bonus directly to the individuals without treating it as wages, withholding, or reporting the bonus amounts on any information return.
  • During an audit, the IRS concludes the bonus amounts are wages and proposes to assess federal employment taxes on those amounts. TP claims it satisfies the statutory requirements for section 530 relief with respect to the bonus amounts and does not agree the bonus amounts are wages.
  • Guidance: Section 530 is not applicable because the IRS is not reclassifying the individuals as employees. The year-end bonus amounts are additional wages for services performed by individuals who were treated as employees by TP. The reduced rates under § 3509 are not applicable for the same reason. The IRS will issue a § 7436 Notice because there was an audit, a determination was made that TP was not entitled to relief under section 530 with respect to the year-end bonus amounts, and the IRS and TP disagree on whether the statutory requirements for section 530 relief have been met.

In summary, these situations illustrate different scenarios where a taxpayer may try to argue that certain payments made to workers are not wages subject to employment tax. The IRS guidance indicates that section 530 relief is only available when a taxpayer has treated a worker as a non-employee and the IRS is proposing to reclassify the worker as an employee. If a taxpayer treats a worker as an employee, but fails to classify certain payments to the worker as wages, section 530 relief is not available. In some cases, the reduced rates under § 3509 of the Code may apply, and in some cases a § 7436 notice will be issued allowing the taxpayer to seek Tax Court review.

Source Documents

https://www.irs.gov/pub/irs-drop/rr-25-03.pdf

https://www.irs.gov/pub/irs-drop/rp-25-10.pdf