New IRS Guidance on Employee Misclassification
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APPLIES TO All Employers |
EFFECTIVE January 8, 2025 |
QUESTIONS? Contact HR On-Call |
Quick Look
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Discussion:
The Internal Revenue Service (IRS) issued Revenue Ruling 2025-3 and Revenue Procedure 2025-10 to address the application of Sections 530, 3509, and 7346 of the Internal Revenue Code. These three sections address employment misclassification disputes, and the Revenue Ruling examines their treatment under five separate scenarios.
Section 530
If an employer failed to pay employment taxes for a worker the IRS determined to be an employee rather than an independent contractor, Section 530 allows the employer to avoid employment tax liability by meeting specific requirements:
- The employer timely filed all required federal tax returns related to the belief the worker was an independent contractor (e.g., filed Forms 1099-NEC).
- The employer did not treat the worker, or those holding a substantially similar position, as an employee at any time after December 31, 1977.
- The employer had a reasonable basis for not treating the worker as an employee due to the reliance of one of the following safe harbors:
- A prior audit showed there were no employment taxes attributable to the worker;
- The employer relied on industry practice that the worker was not an employee;
- The employer relied on judicial precedent, a published ruling, or a letter ruling to treat the worker as an independent contractor.
Advice of legal counsel, favorable state decisions, or reasonable application of common law can also be relied on if the above safe harbors do not apply.
Section 3509
If the employer cannot meet the requirements of Section 530, Section 3509 allows the employer to remit unpaid taxes at a reduced rate because of the belief the worker was not an employee. Employers cannot use this section if the worker was treated as an employee and the dispute is only towards the characterization of the tax payments.
Section 7436
Section 7436 allows the United States Tax Court to review tax determinations made by the IRS. Tax Court review requires the following:
- The IRS conducted an examination in connection with an audit;
- The audit determination found:
- One or more individuals performing services are employees; or
- The employer is not entitled to relief under Section 530;
- An actual controversy exists involving the determination as a part of an examination; and
- An appropriate pleading is filed in the Tax Court.
When the first three elements are met, the IRS will issue a Section 7436 Notice. The employer must meet the fourth element by filing a timely petition with the Tax Court.
New Guidance Scenarios
The following are summaries of the factual scenarios the IRS provides in its new guidance. Review the Revenue Ruling in its entirety for additional application of the scenarios.
Scenario 1. The employer treated a worker as an independent contractor and did not withhold or pay federal employment taxes and reported total payments on Form 1099-NEC. The IRS determines the worker is an employee, and the employer does not qualify for relief under Section 530. Under the new guidance, the employer is eligible for Section 530 relief if the statutory requirements are met. If not, then the employer could be eligible for reduced rate relief under Section 3509. Under this scenario, a Section 7436 Notice would also be issued.
Scenario 2. The employer pays a worker a weekly fixed amount and bonus and withholds and pays employment taxes. However, the bonus is reported on Form 1099-NEC. The IRS finds the bonus amount to be wages and assesses federal employment taxes on the payments. Under the new guidance, Sections 530 and 3509 do not apply because the IRS is not reclassifying the worker as an employee. A Section 7436 Notice will be issued at the conclusion of the audit or appeals if no agreement is reached between the parties.
Scenario 3. The facts are the same as Scenario 2, but the employer does report the bonus on Form 1099-NEC. Under the new guidance, Sections 530 and 3509 do not apply because the IRS is not reclassifying the worker as an employee. A Section 7436 Notice will be issued at the conclusion of the audit or appeals if no agreement is reached between the parties.
Scenario 4. The facts are the same as Scenario 2, but the employer does report the bonus on Form 1099-NEC and does not claim they satisfied Section 530. Under the new guidance, Sections 530 and 3509 do not apply because the IRS is not reclassifying the worker as an employee. A Section 7436 Notice will not be issued at the conclusion of the audit or appeals if no agreement is reached between the parties because the employer did not claim it was entitled to relief under Section 530. As such, there is no controversy between the parties.
Scenario 5. The employer enters into a contract with a worker to pay weekly salary and withhold and pay federal taxes in addition to filing tax returns. A bonus amount is issued but the employer does not withhold or pay federal employment taxes or report the amounts. The IRS determines the bonus amounts are wages and proposes to assess taxes. The employer claims it satisfies the requirements for Section 530 relief. Under the new guidance, Sections 530 and 3509 do not apply because the IRS is not reclassifying the worker as an employee. A Section 7436 Notice will be issued at the conclusion of the audit or appeals if no agreement is reached between the parties.
Additional Information
Revenue Procedure 2025-10 clarifies the definition of an employee. “Employee” now 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.
It also expands the guidelines under which an employer can “treat” a worker in determining if they are an employee. This includes, but is not limited to, withholding taxes, filing employment tax returns, filing Schedule H, issuing Form W-2s, or contracting with a third party to perform employer acts.
The guidance also clarifies that 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.
The purpose of the Revenue Ruling and Revenue Procedure is to make it more difficult for employers to apply these safe harbor provisions in the event of misclassification. Employers should prioritize auditing their workers for misclassification issues and preparing for corrections with advice of their legal counsel and tax professional.
Action Items
- Review the Revenue Ruling here and Revenue Procedure here.
- Audit independent contractors for potential misclassification.
- Consult with a tax professional and legal counsel to address any misclassifications.
Disclaimer: This document is designed to provide general information and guidance concerning employment-related issues. It is presented with the understanding that ManagEase is not engaged in rendering any legal opinions. If a legal opinion is needed, please contact the services of your own legal adviser. © 2025 ManagEase