November 19, 2020

Q: What is the IRS Reasonable Basis Test for Worker Classification?

Understand what the Reasonable Basis test is and how it is used to classify workers.

Q: What is the IRS Reasonable Basis Test for Worker Classification?

Compliance Ask Liquid Finance and Accounting

The reasonable basis test is part of the relief from federal employment tax obligations provided to employers by Section 530 of the Revenue Act of 1978. Section 530 is also referred to as a safe harbor provision. In order to be eligible for relief, an employer must meet three statutory requirements. 

  1. Exhibit reporting consistency by filing the requisite forms and returns for the worker (such as Form 1099) for all taxable years.
  2. Demonstrate substantive consistency by treating the worker and any similar workers as independent contractors.
  3. Establish a reasonable basis for treating the worker as an independent contractor.

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A business can establish a reasonable basis for independent contractor through any of the following methods: 

  1. A prior IRS audit of employment taxes during a period that included similar workers treated as independent contractors
  2. Precedent through a court case or IRS ruling regarding similar workers
  3. Industry practice (by a significant segment of your industry) demonstrates that similar workers are also classified as independent contractors
  4. Or other reasonable basis such as the advice of a business lawyer

As an alternative to the reasonable basis test, the IRS created a “20 Factor” common law test for employers to evaluate whether a worker should be classified as a W2 employee or an independent contractor.

Need more guidance on classifying workers? Our W2 Employee Versus 1099 Independent Contractor Checklist helps make it easier to navigate the differences between types of workers and classify them correctly. In addition, our Freelancer Compliance Risk Checklist can help you assess your compliance risk level. And using Liquid provides you with access to features that help you with independent contractor compliance, including reporting consistency.

Ready to pay your vendors, freelancers, and suppliers? Try Liquid today

Category: Compliance Ask Liquid Finance and Accounting

Updated: November 19, 2020

Quick note: This is not to be taken as tax advice or legal advice or payroll advice. Since tax rules and laws change over time and can vary by location and industry, consult a CPA / tax advisor and/or attorney for specific guidance.

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