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Understanding Eligibility for Section 530 Relief: What Employers Need to Know

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In 1982, Congress enacted a relief provision, Section 530 of the Revenue Act of 1978, designed to give employers relief from back taxes and penalties when they misclassified employees as independent contractors. This provision limits a taxpayer’s employment tax liability for individuals not classified as employees if three requirements are met:

  1. Reporting consistency 
  2. Substantive consistency  
  3. Reasonable basis 

These rules established a good faith standard and considered long-standing industry practices. Now, the IRS has issued Rev. Proc. 2025-3 and Rev. Proc. 2025-10 to clarify the reasonable basis rules and explain how Section 530 relief applies in five different situations. While this new guidance provides more certainty on how to qualify for the safe harbor, it also narrows eligibility for relief in the future. 

Three Requirements for Worker Classification Relief

To understand the new scenarios, it’s helpful to revisit the three requirements for Section 530 relief. The provision provides a permanent resolution for an audited business’ employment tax liabilities for a specified group of workers.  

  1. Reporting Consistency: The employer must have timely filed required information returns, like 1099s, consistent with its treatment of the workers as non-employees.  
  2. Substantive Consistency: The employer or predecessor must not have treated the workers, or any workers holding a “substantially similar position,” as employees after December 31, 1977. 
  3. Reasonable Basis: The employer must have reasonably relied on one of the following three “safe harbors”: 1) prior audit with no challenge to classification based on substantially similar positions; 2) judicial precedent from relevant case law; 3) standard industry practice. Note that the employer must have relied on the authority at the time the employment decisions were being made.  

If these three criteria are not met, employers have another avenue to seek relief if the employer can demonstrate that it relied on another reasonable basis for treating the individual as a non-employee, such as professional advice. The IRS notes in its guidance that Congress intended the reasonable basis requirement to “be construed liberally in favor of the taxpayer.” 

Employers also can get relief under IRC Section 3509, which allows employers to remit unpaid taxes at reduced rates in some reclassification cases. The reduced rates only apply to the employee’s share of FICA tax on wages paid to the employee. This relief is available as long as the employer filed required returns when the worker was treated as a non-employee.  

Employers also can have their worker classification dispute and proposed penalties reviewed by the U.S. Tax Court in some situations as described in Rev. Proc. 2025-3. The IRS files a Section 7436 Notice to inform employers of penalties owed and their opportunity to seek Tax Court review.  

IRS Offers Five Examples of Worker Status Relief 

Situation 1

Facts: Taxpayer, the employer, hires individuals and pays them a weekly fixed amount and a weekly bonus. Taxpayer does not withhold or pay federal employment taxes and reports the total payments on Form 1099-NEC as nonemployee compensation. During audit, the IRS determines that the workers are employees, and Taxpayer does not qualify for Section 530 relief. The IRS intends to assess federal employment taxes. Taxpayer claims it is entitled to Section 530 relief. 

Analysis: Section 530 applies and will be available to Taxpayer because the IRS is reclassifying workers as employees. The employer must meet the three requirements for relief. If Section 530 does not apply, Taxpayer may be eligible for reduced tax payments. Also, Taxpayer can get review by Tax Court because there is a disagreement between the IRS and Taxpayer about the employment status of the workers.  

Situation 2

Facts: Taxpayer employs individuals who perform services and treats them as employees. For those services, Taxpayer pays each individual a weekly salary and a weekly bonus. Taxpayer treats the weekly salary as wages and withholds and pays federal employment taxes but does not treat the weekly bonus amounts as wages. Instead, the employer reports the bonus amounts on Forms 1099-NEC. The IRS says the bonus amounts are wages and proposes to assess federal employment taxes. Taxpayer claims it satisfies the statutory requirements for Section 530 relief for the bonus amounts and does not agree that the bonus amounts are wages.  

Analysis: Section 530 is not applicable because the IRS is not reclassifying the individuals as employees. Taxpayer also cannot get reduced taxes because Section 3509 relief does not apply to recharacterization of payments but only to worker classification disputes. Taxpayer is entitled to review by the Tax Court because there was an audit, and the IRS and Taxpayer disagree on the applicability of Section 530 and the resolution.  

Situation 3

Facts: Same facts as situation 2 except Taxpayer does not report the weekly bonus on Forms 1099-NEC or any other information return.  

Analysis: Section 530 relief and reduced tax payments are both not applicable because the IRS seeks to reclassify payments, not workers. Taxpayer is entitled to review by the Tax Court because there was an audit, and the IRS and Taxpayer disagree the applicability of Section 530 and the resolution.  

Situation 4

Facts: Same facts as situation 2 except Taxpayer does not report the weekly bonus on Forms 1099-NEC or any other information return and does not claim Section 530 relief for the bonus.  

Analysis: Section 530 relief and reduced tax payments are both not applicable because the IRS seeks to reclassify payments, not workers. However, the IRS will not issue a Section 7436 Notice seeking Tax Court review because Taxpayer did not claim that it was entitled to relief under Section 530 for the bonuses, and there is no controversy over whether the individuals are employees or independent contractors. 

Situation 5

Facts: Taxpayer employs individuals who perform services during the year and enters into a contract with a third party to pay them a weekly salary, withhold and pay federal employment taxes and file federal employment tax returns. The third party does so. In December of that year, Taxpayer pays a year-end bonus directly to the workers for their services during the year but does not treat the bonuses as wages. Taxpayer does not withhold or pay any federal employment taxes or report the bonus amounts on any information return. During an audit, the IRS concludes that the bonuses are wages. The IRS proposes assessment of federal employment taxes on the bonus amounts. Taxpayer claims it satisfies the requirements for Section 530 relief for the bonus amounts and does not agree the bonus amounts are wages.  

Analysis: Section 530 is not applicable because the IRS is not reclassifying the employees. The year-end bonus amounts are additional wages, and the reduced rates on back taxes are not allowed. The Tax Court may review the case because there was an audit, and the IRS and Taxpayer disagree on whether the requirements for Section 530 relief have been met. 

Navigating Section 530 Relief and Worker Classification 

The situations covered in the revenue procedure show that Section 530 relief is only available when there is a dispute with the IRS as to whether workers are employees or independent contractors. The mischaracterization of wages, such as bonuses, is not covered by the relief provision. It is always best to get out ahead of worker classification disputes with the IRS. For this reason, employers should consult with a trusted tax advisor, such as Frazier & Deeter, when deciding to treat groups of workers as non-employees.   

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