Co-Employment in IRS Section 1706

Tuesday, April 10, 2007

It's tax season, and for busy HR professionals that means reviewing the hiring practices and management of temps and other contingent workers over the past year. Most importantly, these detailed reviews focus on exposure to and instances of "co-employment".

According to ContingentLaw.com, co-employment is "a legal doctrine which applies when two businesses exert some control over an employee's work or working conditions. Relationships between temporary staffing agencies and business clients are typical examples and consequently, easy targets for lawsuits initiated by temporary or other contingent workers."

Contingent staffing can be costly to organizations that do not handle it carefully and correctly. Any company or agency that hires, refers, or manages temporary or contract workers can face costly legal battles as a co-employer of temporary, contract, or other contingent workers. Complex legal requirements and federal statues are dramatically transforming the risks and potential liabilities involved in the hiring and managing of contingent workers. In a co-employment lawsuit, your company and the other co-employer will be equally liable even if there was no wrong-doing on the part of your company. Among many other workforce management issues, risk mitigation with regard to co-employment been pushed up the priority list because of the devastating effects it can inflict upon unsuspecting employers.

Compounding the complex issue of co-employment is IRS Section 1706 of the Tax Reform Act of 1986 (1986–3, Vol. 1, C.B. 698) (TRA '86) . Section 1706 places strict limits on who can be classed as a contractor in technical services industries. This can eliminate independent contracting as an option in many situations where it would be ideal. Having the flexibility to bring in an outside contractor is of crucial importance for many businesses, especially in the technical field. Many IT professionals also view the right to be self-employed as essential to their livelihoods.

Yet section 1706 amended section 530 by adding subsection (d). "Section 530(d) provides that relief under section 530(a) is not available in the case of a worker who, pursuant to an arrangement between the business and a client, provides services for that client as any of the following: engineer, designer, drafter, computer programmer, systems analyst, and other similarly skilled worker engaged in a similar line of work. Section 1706 of TRA '86 applies only to the business in a three-party situation, namely, the business providing workers to a client. The fact that the worker is incorporated is immaterial. The intent of Congress was to classify, under the common law rules, workers retained by businesses to provide technical services, without regard to section 530 of the Revenue Act of 1978. Section 1706 does not change anyone from an independent contractor to an employee. The examiner must still look at the common law rules. Section 1706 applies to remuneration paid and services rendered after December 31, 1986."

The potential harm caused by Section 1706 is that with only the common law employment test to prove a worker's status to the IRS, many high-tech firms will not hire independent contractors in order to avoid an IRS audit. The time and expenses to contest the IRS would outweigh the benefit, even if the audit is favorable. For independent contractors, this means less employment opportunities.

Alternatively, employers may choose to avoid co-employment risks by using risk mitigation services such as payrolling. nextSource, Inc. offers payroll and benefits administration services to afford employers the flexibility to engage independent contractors (1099s). nextSource payrolling entails adding your non-agency represented contingent workers to the nextSource payroll, thus minimizing co-employment risks and eliminating paperwork associated with benefits, payroll and related tax issues.