Friday, September 30, 2011

Employee v. Independent Contractor

New IRS Voluntary Compliance Initiative

(What A Great Deal!)

In my Fairleigh Dickinson Tax Research class, one of the student projects is preparing a Protest involving the classification of workers. Those of you who have taken the class may remember my “Quickie” problem where the student must determine the proper classification of the “worker.” Employee v. Independent Contractor issue is a reoccurring one and important to practitioners.

Whether a worker is an independent contractor or employee generally is determined by whether the enterprise he works for has the right to control and direct him regarding the job he is to do and how he is to do it. Under the common law rules (so-called because they originate from court cases rather than from the Code), multiple factors are used to determine if an individual is a common law employee.

Section 3121(d) provides that the term "employee" means any individual who, under the usual common-law rules applicable in determining the employer employee relationship, has the status of an employee. Under the treasury regulations the term "employer" means any person for whom and individual performs or performed any service, of whatever nature, as the employee of such person.

Rev. Rul. 87 – 41 provides the guidelines for determining whether a particular worker is an employee or independent contractor. In this ruling the IRS determined that many factors are considered in evaluating whether a worker is an employee or independent contractor. No single factor or the absence of a factor is conclusive. The ruling outlined 20 factors to consider.

Section 530 of the '78 Revenue Act (as amended) provides retroactive and prospective relief from employment tax liability for employers who misclassified workers as independent contractors using the common law facts and circumstances standards. Section 530 applies only if:

(1) the taxpayer does not treat an individual as an employee for any period, and does not treat any other individual holding a substantially similar position as an employee for purposes of employment tax for any period—the substantive consistency requirement;

(2) for post-'78 periods, “all federal returns (including information returns) required to be filed by the taxpayer” with respect to the individual for such period “are filed on a basis consistent with the taxpayer's treatment” of the individual as a nonemployee—the reporting consistency requirement; and

(3) the taxpayer had a “reasonable basis” for not treating the worker as an employee (judicial precedent or IRS rulings, a past IRS audit, or a long-standing practice of a significant segment of the relevant industry)—the reasonable basis requirement.

Under IRS's pre-existing Worker Classification Settlement Program (CSP), which applies only for taxpayers under audit, the examiner first determines if the taxpayer is entitled to Section 530 relief (and if it is, there is no assessment). If the taxpayer is not entitled to this relief, a series of two graduated CSP settlement offers can occur.

If the service recipient has met the reporting consistency requirement of Section 530but either can't meet the reasonable basis requirement or can't meet the reporting consistency requirement, the offer is a full employment tax assessment under IRC 3509 (which sets forth the employer's liability for employment tax because of its treating an employee as not being an employee) for one tax year (with the employer agreeing to reclassify the workers as employees on a prospective basis).

If the service recipient has met the reporting consistency requirement and can reasonably argue that it met the reasonable basis and substantive consistency requirements, the offer will be an assessment of 25% of the employment tax liability for the audit year under IRC 3509 (with the employer agreeing to reclassify the workers as employees on a prospective basis).

If workers are recharacterized under the CSP, no interest will be due on the additional liability arising as a result of the recharacterization if certain conditions are met.

New IRS Voluntary Compliance Initiative

The IRS has determined that it would be beneficial to create a program that allows for voluntary reclassification of workers as employees outside of the examination context and without the need to go through normal administrative correction procedures applicable to employment taxes. The IRS reasons that the program will facilitate voluntary resolution of worker classification issues and achieve the resulting benefits of increased tax compliance and certainty for all parties involved.

Who's eligible?

The voluntary classification settlement program (VCSP) is available to taxpayers who are currently treating their workers (or a class or group of workers) as independent contractors or other non-employees and want to prospectively (presently and in the future) treat the workers as employees. Ann. 2011-64, 2011-41 IRB , provides that the program is open to businesses, tax-exempt organizations, and government entities.

To be eligible:

• A taxpayer must have consistently treated the workers as non-employees;
• A taxpayer must have filed all required Forms 1099 for the workers for the previous three years. The Instructions for Form 8952, Application for Voluntary Classification Settlement Program (VCSP), clarify that this requirement must be satisfied for each of the affected workers for the three preceding calendar years ending before the date Form 8952 is filed.
• The taxpayer cannot currently be under audit by IRS, or currently under audit concerning the classification of the workers by the Department of Labor (DOL) or by a state government agency.
Notwithstanding a taxpayer that was previously audited by IRS or DOL about the classification of the workers will only be eligible if it has complied with the results of that audit.

Terms of the offer

A taxpayer who applies for and is accepted into the VCSP will agree to prospectively treat the class of workers as employees for future tax periods and in exchange:
(A) Will pay 10% of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year, determined under the reduced rates of IRC 3509;
(B) Will not be liable for any interest and penalties on the liability;
(C) Will not be subject to an employment tax audit for the worker classification of the workers for prior years; and
(D) Will agree to extend the period of limitations on assessment of employment taxes for three years for the first, second and third calendar years beginning after the date on which the taxpayer has agreed under the VCSP closing agreement to begin treating the workers as employees.

Application process

Taxpayers will have to apply on Form 8952 for participation in the VCSP, and provide the name of a contact or an authorized representative with a valid Power of Attorney (Form 2848). The Instructions to Form 8952 provide that although Form 8952 can be filed at any time, it should be filed at least 60 days before the date a service recipient wants to begin treating the class or classes of workers as employees. IRS will contact the taxpayer or authorized representative to complete the process once it has reviewed the application and verified the taxpayer's eligibility. IRS retains discretion as to whether to accept a VCSP application. Those who are accepted will enter into a closing agreement with IRS to finalize the terms of the VCSP and will simultaneously make full and complete payment of any amount due under the closing agreement.

Thursday, September 15, 2011

Property Inherited in 2010: Carryover (Step-Up) Basis Rules

The federal estate tax has undergone several changes in recent years. We had an estate tax in 2009, and none in 2010. In December of 2010, Congress retroactively enacted an estate tax for 2010, but gave executors options to determine basis of assets inherited from a decedent.
In a legislative compromise at the end of 2010, congress retroactively reinstated the estate tax to apply to decedents who died in 2010. However, an important feature of the law that revived the estate tax is that it gave executors of estates of decedents who died in 2010 a choice. The executor can either:
(a) have the new estate tax rules ($5 million exemption, with a flat rate of 35% imposed on all transfers over that amount) apply to the estate, in which case the traditional stepped-up basis rules (which provide that the basis of assets received from a decedent is equal to the value of such assets on the date of the decedent's death) would apply in determining the basis of property acquired from the decedent; OR
(b) elect not to be subject to the estate tax, meaning that the estate would pass to the heirs free from estate tax, but the modified carryover basis rules (discussed below) would apply in determining the basis of property acquired from the decedent.
Modified Carryover Basis Rules
Under the modified carryover basis rules IRC Sec. 1022, the basis of property acquired from an individual dying in 2010, in the hands of the person acquiring it, generally is the lower of the fair market value on the date of the decedent's death or the adjusted basis of the property immediately before the death of the decedent.

For example, the decedent died on Jan. 1, 2010, owning 200 shares of Corporation Y stock having a fair market value of $40,000. His adjusted basis in the stock immediately before his death was $30,000, which was the amount he paid for the 200 shares several years ago. Absent from a permitted basis increase for the stock, the basis of the Corporation Y stock in the hands of the person acquiring it from the decedent is $30,000. Now, assume the stock is worth $20,000 on the date of decedent's death. Under the modified basis rule, the basis in the hands of the person acquiring or receiving it would be $20,000.
The basis of property determined under the modified basis rule (i.e., the lesser of adjusted basis or fair market value) is increased by a general basis increase amount of $1.3 million. In other words, each estate receives a $1.3 million of basis plus more (depending on marital status at time of death and other circumstances) to be added to the carryover basis of any one or more of the assets held at death. However, no addition to basis can increase the new basis of any asset above its fair market value on the date of death.
The allocations of the general basis increase and other increases must be made by the executor, or other person in possession of a decedent's property, and must be reported to IRS and the property recipients.
Generally, if an estate is less than or equal to $5,000,000 ($10,000,000 for a married couple), the likely choice will be to apply the retroactive estate tax and remain subject to the estate tax rules (and receive the step-up in basis to date-of-death fair market value). However, in many cases, the circumstances will be more complex and will require careful analysis to determine whether or not to elect out of the default estate tax rules. For these situations, other specific factors will be considered and decisions will depend on each person’s specific circumstances.
By way of an announcement on September 13, 2011, the IRS pushed back the due date of these estate tax returns. The returns are now due March 19, 2012.
Please contact Frank Brunetti with any concerns or help that you may need with any of the aforementioned issues.
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