IRS Issues Guidance on the Tax Court’s Review of Employment Status Determinations

The IRS issued Notice 2022-13, effective February 7, 2022, regarding the Tax Court's review of an IRS determination as to whether a worker is properly classified as an employee or an independent contractor. The new guidance modified and superseded Notice 2002-5 and Rev. Rul. 2009-39 so that formal IRS notice under section 7346 is no longer a requirement for a taxpayer to petition the Tax Court for review of an IRS’s worker reclassification determination.¹

Worker Classification Background

Worker classification is generally determined under common law rules and is based on the circumstances of each case. Employers are not required to withhold income tax or pay employment taxes on payments to workers classified as independent contractors. The IRS typically makes a worker reclassification determination when it concludes that a taxpayer misclassified an individual as an independent contractor. Employers can be liable for employment taxes plus additional penalties and interest if they classify a worker as an independent contractor without a reasonable basis.

Section 530 of the Revenue Act of 1978 provides relief for employers who acted in good faith to classify their workers as independent contractors. Section 530 prevents the IRS from retroactively reclassifying workers if the employer meets certain tests.² This prohibition against retroactive reclassification can relieve employers of past employment tax liability for independent contractors reclassified as employees.³

Section 7436 provides for Tax Court review of two types of employment tax determinations made by the IRS: (a) worker reclassification, and (b) section 530 relief determinations, and it allows the court to ascertain the proper amount of employment tax, penalties, and additions to tax resulting from those determinations. The IRS will issue a section 7436 Notice only after the IRS has determined that: (a) one or more individuals performing services for the taxpayer are employees for purposes of subtitle C, and (b) the taxpayer is not entitled to section 530 relief.

A section 7436 Notice also informs the taxpayer of the taxes or penalties owed as well as the opportunity to seek the Tax Court’s review.⁴ If a petition is filed in the Tax Court, the court can review both a worker reclassification determination and a section 530 relief determination.⁵

The Tax Court petition can only be filed by "the person for whom the services are performed" and cannot be filed by an individual worker to challenge their classification.⁶

Tax Court Jurisdiction

Previous IRS guidance, Notice 2002-5, interpreted the statute to require a taxpayer to receive a section 7436 Notice as a prerequisite to Tax Court review of an IRS determination regarding worker reclassification, similar to the jurisdictional requirement of the issuance of a notice of deficiency in an income tax case.⁷ Notice 2022-13 supersedes and modifies Notice 2002-5. The section 7436 Notice will continue to be the IRS’s formal documentation informing a taxpayer of a determination regarding worker reclassification or section 530 relief, but issuance of the 7436 Notice determination is no longer a prerequisite for Tax Court jurisdiction.⁸ Accordingly, even without a formal section 7436 Notice, a taxpayer can petition the Tax Court to review an IRS worker reclassification determination or section 530 relief determination as long as four requirements are met.⁹

• The IRS conducts an examination in connection with an audit;
• As part of the audit, the IRS determines that a worker is reclassified as an employee or section 530 relief is not provided;
• There is an actual controversy involving the determination as part of the examination; and
• An appropriate pleading was filed in the Tax Court.¹⁰

An "actual controversy" exists if (1) the taxpayer did not treat an individual as an employee, (2) the IRS reclassifies the individual as an employee and proposes to assess employment tax, and (3) no agreement is reached during the examination process.¹¹ No "actual controversy" regarding worker reclassification will exist if the taxpayer agrees the amounts were paid in connection with an employee-employer relationship but that the withholding provisions are not considered wages or that the services do not constitute employment.¹² Moreover, an actual controversy for section 530 relief exists if (1) the taxpayer alleges that it is entitled to relief, (2) the IRS determines that section 530 is not applicable or the taxpayer has not satisfied the statutory requirements, and (3) no agreement is reached during the examination process.¹³

Endnotes

¹ See 26 U.S.C. §7436; see also Notice 2022-13 at 9-10 (January 19, 2022), available at https://www.irs.gov/pub/irs-drop/rp-22-13.pdf.

² See Revenue Act of 1978, P.L. 95-600 (1978), Section 530.

³ Rev. Proc. 1985-18.

⁴ Notice 2022-13 at 10 (January 19, 2022), available at https://www.irs.gov/pub/irs-drop/rp-22-13.pdf.

⁵ 26 U.S.C. § 7436(a).

⁶ 26 U.S.C. § 7436(b)(1).

⁷ However, two recent Tax Court decisions have held that receiving a section 7436 Notice is not a jurisdictional requirement to for Tax Court review. See SECC Corp v. Commissioner, 142 T.C. 225 (2014); American Airlines, Inc. v. Commissioner, 144 T.C. 24 (2015).

⁸ Notice 2022-13

⁹ Id.

¹⁰ Id. at 4.

¹¹ Id. at 7.

¹² Id.

¹³ Id. at 8.