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Nannygate Reconsidered:

Nannygate may have vanished from the front pages, but it has caused unnecessary concern — even panic — among government officials and our citizens. What originally was a violation of immigration law by Zoe Baird has evolved into a White House inquisition into the hiring practices of household workers, regardless of immigration status. Many citizens are concerned that by hiring a neighbor’s teenager as a baby-sitter or by using a housekeeper on a part-time basis, they were required to file the federal information return (Form 942) and pay Social Security and Medicare taxes on their “employees.” Contrary to the position taken by both the IRS and numerous tax commentators, the vast majority of part-time domestic workers are independent contractors; therefore, taxpayers are under no obligation to file tax returns and pay taxes on them.

In reality, the tax issue is straightforward: Is a household worker an “employee” or an “independent contractor?” Unfortunately, the answer is buried deep within the caverns of our tax laws, and involves a federal statute curiously omitted from the tax code and never mentioned in the Form 942 instructions. In recent years, Congress and the courts have radically redefined the law with respect to whether a worker is an independent contractor or an employee. The traditional common-law test, still embraced by the IRS and those tax commentators who have written on Nannygate, involves the issue of worker control: Are the services of the household worker subject to the taxpayer’s will and control over what must be done and how it must be done? In Revenue Ruling 87-41, 1987-1 CB 296, the IRS developed 20 factors used to determine whether a worker is an independent contractor under the common-law test.

The IRS’s conventional approach, however, has been clearly superseded by Federal statute and recent court interpretations. Now, the proper inquiry is not the degree of taxpayer control over the worker, but rather, has the taxpayer consistently treated the worker as an independent contractor, and did the taxpayer have any reasonable basis” for such treatment? If the answers are yes, then the IRS is prevented from reclassifying the worker as an employee.

Section 530

In 1978, responding to aggressive attempts by the IRS to reclassify workers from independent contractors to employees, Congress enacted Section 530 of the Revenue Act of 1978 (26 USC Sec. 3401 note). Under Section 530, the IRS is bound by the taxpayer’s classification, provided the taxpayer (1) filed all necessary tax and information returns; (2) consistently treated the worker as an independent contractor and (3) had “any reasonable basis” in determining that the worker was an independent contractor. Congress directed that the reasonable basis standard should be “construed liberally in favor of the taxpayer.” General Investment Corporation, 823 F. 2d 337 (CA-9, 1987). Although there are no reported cases involving household workers and Section 530, the IRS in Rev Proc. 85-18, 1985-1 CB 518, has acknowledged the validity of Section 530 in general and, specifically, its application to all taxes imposed on an employer — including IRC Sec. 3111 Medicare and Social Security taxes involving household employees.

But Section 530 contains a major hurdle: to qualify for relief, taxpayers must not have “treated” household workers as employees, something done by filing Form 942. Because Section 530 does not permit an employee to be later reclassified as an independent contractor, those who may have panicked and innocently filed Form 942 have probably done themselves irreparable damage by irreversibly classifying a worker as an employee.

Section 530 states that the “any reasonable basis” standard may be satisfied by meeting any of three statutory “safe havens.” These safe havens are, in general: (1) judicial precedent and published IRS rulings, whether or not they relate to the particular industry or business in which the taxpayer is engaged; (2) a past IRS audit of the taxpayer where no assessment was made regarding employment taxes of workers holding positions substantially similar to the position held by the worker whose status is at issue; and (3) a long-standing recognized practice of a significant segment of the industry in which the worker was engaged — although the practice need not be uniform throughout the entire industry.

These safe havens are not exclusive; the taxpayer may demonstrate a reasonable basis in some other manner. As the following cases demonstrate, the courts have liberally construed Section 530 in favor of taxpayers; in fact, taxpayers have won every case under Section 530 in which a legitimate controversy existed! In Queensgate Dental Family Practice v. U.S., 91-2 USTC 50,536 (DC-PA, 1991), a corporation relied on a Pennsylvania Dental Board decision that it could not legally treat its licensed dentists as employees; the court found that such reliance was reasonable under Section 530. The court stated that the inquiry was simply whether the taxpayer’s beliefs and decisions regarding his treatment of individuals as either employees or independent contractors were reasonable and made in good faith. Similarly, in Darrell Harris, Inc., 770 F. Supp 1492 (DC-Okla, 1991), the court stated that the “any reasonable basis” test under Section 530 was met by a taxpayer’s good faith showing in determining whether its workers were independent contractors. The Queensgate court also stated that Section 530 was enacted explicitly to eliminate the need for courts to engage in the traditional common-law practice of balancing complex factual issues in deciding whether an individual is an independent contractor or employee. The threshold inquiry is whether the taxpayer is entitled to relief under Section 530. If Section 530 applies, then the court need not apply the 20-factor test set forth in Revenue Ruling 87-41, supra, to determine worker control under the common-law. If Section 530 is unavailable — because the taxpayer either: (1) failed to consistently treat the worker as an independent contractor; (2) had no reasonable basis for treating the worker as an independent contractor; or (3) failed to file all necessary tax returns — then the taxpayer must prove its case under the common law approach taken by the IRS.

In Critical Care Registered Nursing Inc. v. U.S., 91-2 USTC 50,481 (DC-PA, 1991), the taxpayer supplied specialist registered nurses to hospitals for temporary additional staffing and treated the nurses as independent contractors. The court held that the taxpayer could apply the traditional worker control tests to establish that it had a reasonable basis for treating the workers as independent contractors. The taxpayer did not have to prove by a preponderance of the evidence that its workers were independent contractors; it only needed to show that it had a “reasonable basis” for treating the workers as independent contractors under the traditional common law tests for worker control. This decision greatly expanded the application of Section 530 and severely undercut the IRS’s ability to prevail in independent contractor controversies.

In REAG, Inc., 801 F. Supp 494 (DC-Okla, 1992) the court held that under Section 530, the taxpayer need only show a “substantial rational basis” to meet its burden of proof for its decision to treat a worker as an independent contractor. This new standard fell somewhere between the usual taxpayer standard for prevailing under the preponderance of the evidence burden of proof and the usual IRS burden of proof of a prima facie showing of correctness. The string of pro-taxpayer decisions has continued. In the recent case of Apollo Drywall, Inc. v U.S., 1993 U.S. Dist. Lexis 5611 (April 6, 1993), the court ruled that the IRS’s interpretation of Section 530 was not “substantially justified” and awarded attorney fees and costs to the taxpayer under 26 USC Section 7430. The decisions in Critical Care Registered Nursing, Inc. and REAG, Inc., which constitute judicial precedent under the first safe-harbor above, provide the legal justification for classifying most part-time baby-sitters, housekeepers, gardeners, and other household workers as independent contractors. Some common-law tests applicable to a part-time household worker may include whether the worker: (1) works part-time for any one person; (2) works for one or more unrelated persons at the same time; (3) negotiates dates, times and hours for the work; (4) is paid on a per-job basis; (5) is free to accept or decline assignments; (6) offers his or her services to the public (such as through advertising or classified ads); (7) works in teams, uses helpers or delegates the work to someone else; (8) uses his or her own tools and equipment; (9) is hired to produce a certain result (a clean house, a well-groomed garden) and is not given step-by-step instructions for accomplishing the task; (10) is not trained to perform the services in a particular manner by the person hiring the worker; and (11) does not have a continuing relationship with the person hiring the worker. Remember, the taxpayer’s burden of proof has been substantially lowered — if several of these factors demonstrate independent contractor status, that should be enough to satisfy the “any reasonable basis test” under Section 530.

In fact, taxpayers with full-time household workers may still obtain relief — under the second or third safe haven above. Also, Rev. Ruling 77-279, 1977-2 IRB 12, held that even an individual providing full-time child-care services was engaged in an independent trade or business. This constitutes a published ruling under the “judicial precedent and published IRS ruling” safe haven described above, and thus it may be applicable to full-time or part-time child care and baby-sitters. Although the worker in Rev. Ruling 77-279 provided child care in the worker’s own home, this was not a factor in the IRS ruling.


Before a taxpayer files Form 942, he or she must consider whether Sec. 530 and the subsequent court cases offer a “reasonable basis” for treating his or her household workers as independent contractors. The confusion of Nannygate (compounded by the illegal work status issues) should not trap taxpayers into an irreversible filing. Section 530 was enacted to protect taxpayers from the IRS on these issues — they should use it.

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