A tax issue that often arises for businesses in general is whether the IRS will recognize the status of workers who have been hired as “independent contractors.” For employment tax purposes, independent contractors pay their own taxes in the form of self-employment taxes. However, the IRS may assert that such workers are actually employees, for whom the employer is liable for a share of the social security taxes and also has income tax withholding responsibility.
Hawley Troxell recently assisted a hospital that had been audited by the IRS on this issue. The auditor suggested that certain doctors who worked in the emergency room were employees, even though they had signed contracts as independent contractors. Unfortunately, the fact that the parties have such a contract is not a guarantee that the IRS will recognize it for tax purposes. The IRS will focus on the substance of the arrangement, and if the relationship appears to be closer to an employer-employee situation than one involving a contractor who is truly independent, it will assert employment tax liability.
We were successful in this case in persuading the IRS that no employment tax was due in connection with the emergency room doctors. There were two arguments used to accomplish this goal. The first involved the examination of the usual principles applied in determining independent contractor status. These principles focus on the degree of independent control exercised by the worker over the performance of his or her duties. The following factors supported the conclusion that these doctors were independent contractors:
- These doctors were contracted for with the use of a specific written agreement that recognized their special and unique status as doctors.
- Like most independent contractors, these doctors could perform their duties based on their own opinions concerning the proper medical care of the patient, and based on their experience and training. They were not subject to the control of the hospital with respect to the methods of such care. They had control over the hospital employees they worked with in providing such care.
- The doctors effectively set their own hours by providing to a supervising doctor the hours or shifts they were willing to work.
- The doctors were free to engage in private practice outside the hospital.
- The hospital did not pay employment benefits to the doctors with respect to their emergency room services.
The foregoing factors were consistent with independent contractor status according to the usual tests for determining such status. However, there is a second argument that is available to hospitals. Section 530 of the Revenue Act of 1978 provides a “safe harbor” for employers who in good faith have established a practice of treating certain classes of workers as independent contractors. Even if workers would not otherwise meet the tests for independent contractor status, this Act protects employers who have satisfied its requirements. The legislative history of the Act states that the Act is to be liberally applied in favor of independent contractor status.
The Act requires that an employer has consistently treated these types of workers as independent contractors for tax purposes, including employment tax filings. That was the case for this hospital.
Second, the Act requires that the employer had a reasonable basis for treating the workers as independent contractors. There are several means by which this may be accomplished, but the one that was most applicable in this case was that the employer is entitled to rely on a long-standing practice of a significant segment of the industry. The hospital in this case was able to point to its reliance on the fact that all the surrounding hospitals have similar practices with respect to emergency room doctors. This also appears to be a national practice. In a 2003 Tax Court case dealing with emergency room doctors, the Court observed that the parties had agreed (including the IRS) that the taxpayer had relied on “a longstanding, recognized practice of the emergency medicine industry” in treating its doctors as independent contractors.
In summary, a hospital may establish independent contractor status either by pointing to facts that support the independent nature of the doctor’s services (setting own hours, etc.), or by using the “safe harbor” of the Revenue Act of 1978.