May 4, 2021
Re: § 58.1-1821 Application: Withholding Tax
Dear *****:
This will respond to your letter in which you seek correction of the withholding tax assessments issued to ***** (the “Taxpayer”), for the taxable periods January 2014 through December 2019.
FACTS
The Taxpayer operated a roofing and construction business in Virginia. For withholding tax purposes, the Taxpayer was a quarterly filer for the taxable periods from January 2014 through December 2015 and a monthly filer thereafter. The Department audited the Taxpayer for the periods January 2014 through December 2019. The Department concluded that a number of workers whom the Taxpayer had considered independent contractors and to whom it had issued Form 1099s should have been classified as employees and had income tax withheld from their wages. As a result, assessments were issued for withholding tax due. The Taxpayer appealed, contending the workers in question were independent contractors. The Taxpayer also contends that the audit sample did not take into account the seasonality of its business and that the statute of limitations on assessments barred the Department from assessing tax for a portion of the period at issue.
DETERMINATION
Employee vs. Independent Contractor
Virginia Code § 58.1-460 defines “employee” as “an individual, whether a resident or a nonresident of the Commonwealth, who performs or performed any service in the Commonwealth for wages....” The Code of Virginia does not define “independent contractor” for income tax withholding purposes. Under Title 23 of the Virginia Administrative Code (VAC) 10-140-10 the relationship between an employer and employee or independent contractor is determined in accordance with the test set forth in Treas. Reg. § 31.3401(c)-1. In Public Document (P.D.) 96-280 (10/10/1996), the Tax Commissioner found that the factors enumerated in Treas. Reg. § 31.3121(d)-1 should be used as a guideline for determining whether a worker is an employee or an independent contractor.
In its appeal, the Taxpayer refers to the twenty factors cited above and asserts that nearly every such factor in its case supports its position that the workers were independent contractors. Previously, the IRS set forth twenty factors to help differentiate between employees and independent contractors. See Rev. Rul. 87-41 . The Internal Revenue Manual (IRM) § 4.23.5.7.1 now states that although the 20 factor test may still be used for reference purposes, the primary method is to consider every piece of information in a case that helps decide the extent to which the taxpayer does or does not retain the right to control the worker. This evidence tends to fall into three categories: behavioral control, financial control, and the type of relationship of the parties. See also IRS Publication 15-A, Employer’s Supplemental Tax Guide (2020). It is important to note that not all factors have to exist on one side or the other. It is also important to note that every factor might not be relevant in each case, and depending on the specific circumstances of the case, some factors may be more relevant than others. Typically, an employee relationship will exist when the worker is subject to the will and control of the employer not only as to what will be done but how it will be done. On the other hand, an independent contractor is normally only subject to the control and direction of another as to the result of the work, but not as to the means and methods of accomplishing it. See Treas. Reg. § 31.3121(d)-1.
The audit staff requested documentation from the Taxpayer to support treating the workers as independent contractors. The Taxpayer provided copies of contracts it had with the workers, but the auditor found this documentation to be insufficient. The Taxpayer was then asked for additional support and given a list of documentation that was acceptable, namely invoices for the jobs, business cards, business licenses and proof of liability insurance. When the Taxpayer was unable to produce these items, the audit was concluded and assessments were issued.
While documentation such as invoices, business cards, business licenses and proof of liability insurance may support a conclusion that workers are independent contractors operating their own businesses, the absence of such documentation or the inability of a taxpayer to produce such documentation does not mean that an independent contractor relationship could not have existed. Determinations in cases such as these must rest on an analysis of the factors establishing the extent of control over the workers in question.
Sampling
The Taxpayer also contends that the Department should have taken into account the seasonality of its business when extrapolating the audit sample to determine the Taxpayer’s total liability for the audit period. According to the audit staff, however, the audit was based on the Taxpayer’s issued Form 1099s for the years in question, and no sampling was done. As such, there does not appear to have been an extrapolation that could have been distorted because of the seasonality of the business.
Statute of Limitations
Virginia Code § 58.1-1812 allows the Department to assess omitted taxes within three years of the latter of the due date of the return or the actual date that the return was filed. Under Virginia Code § 58.1-312 A, the Department may assess underreported tax at any time when a taxpayer fails to file a return or files a false or fraudulent return with the intent to evade tax.
The Taxpayer was a quarterly filer for the taxable periods from January 2014 through December 2015 and a monthly filer thereafter. Under Virginia Code § 58.1-472 2, monthly filers must file their returns before the 25th day of the following month. Based on the Taxpayer’s filing history, the monthly February 2017 period was the last return within the three year limitations period because that return was filed on March 27, 2017, and the assessments were issued on March 27, 2020. In order for the Department to have assessed withholding taxes for periods prior to such date, the Taxpayer either would have to have failed to file returns or filed them falsely or fraudulently with the intent to evade payment of the tax. Based on a review of the record, there is insufficient information in this case on which to base a claim that returns were filed falsely or fraudulently with such intent. Therefore, the three year statute of limitations applied.
CONCLUSION
Because insufficient information exists to support a conclusion that the Taxpayer filed withholding tax returns falsely or fraudulently with the intent to evade tax, the three year statute of limitations applied under Virginia Code § 58.1-302. Accordingly, the audit was limited to the tax periods beginning February 2017. Any tax liability assessed for periods prior to that month will be abated.
Under the provisions of Virginia Code § 58.1-205, an assessment of a tax by the Department is deemed prima facie correct. As such, the burden of proof is on the Taxpayer to show the Department’s assessment is incorrect. The Department’s regulations, however, require an evaluation an employer’s records to determine if its workers are employees or independent contractors pursuant to the factors enumerated in Treas. Reg. § 31.3121(d)-1 and as further described in Rev. Rul. 87-41 and more recently in IRS Publication 15-A. The Department’s audit staff, therefore, must give taxpayers a full opportunity to present information and evidence concerning their relationships with workers. Such evidence may take the form of written documentation, including, but not limited to, any contracts that existed between the taxpayer and the individuals in question. The evidence may also include, but again not be limited to, written or oral testimonials from individuals with knowledge of the relationships, including members of management or the individuals themselves whom the Department is trying to determine were employees or independent contractors. Once a taxpayer has had a full opportunity to present such information, the audit staff should undertake a complete evaluation of such evidence and fully document its analysis in reaching its audit conclusions.
Accordingly, the case will be returned to the audit staff to conduct a complete examination of the relationships at issue in accordance with the procedures outlined above. The Taxpayer, in turn, must provide sufficient information to support its contention that its workers were independent contractors during the tax periods at issue. In particular, the Taxpayer and the audit staff should review IRS Publication 15-A for a discussion of the different categories of factors at issue. In addition, the Taxpayer will be given an opportunity to present information and evidence concerning the seasonality of its business, if it wishes. Once the examination is completed, the audit staff is directed to prepare a revised audit report and communicate the result of the examination to the Taxpayer in writing. The report should fully analyze any information the Taxpayer is able to provide concerning the factors described above. Should the Taxpayer wish to appeal the result of the revised audit, it will have 90 days from the date the audit staff communicates the audit result in writing in which to appeal.
The Code of Virginia sections, regulation and public document cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department’s web site. If you have any questions regarding this determination, you may contact ***** in the Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/3451.M