Document Number
24-42
Tax Type
Withholding Taxes
Description
Administration: Audit - Standards of Review, Evaluation of Factors, Taxpayer Records
Topic
Appeals
Date Issued
03-29-2024

March 29, 2024

Re: § 58.1-1821 Application: Withholding Tax

Dear *****:

This will reply to your letter in which you seek correction of the withholding tax assessments issued to ***** (the “Taxpayer”) for the taxable periods January 2021 through June 2022.

FACTS

The Taxpayer, a corporation that operated a drywall business in Virginia, was audited for the taxable periods at issue. The Department concluded that the Taxpayer’s workers who were classified as independent contractors should have been classified as employees. As a result, assessments were issued for withholding tax due, as well as applicable civil penalties. The Taxpayer filed an application for correction, contending that the workers in question were independent contractors. 

DETERMINATION

Employee Defined

Effective January 1, 2021, under legislation enacted by the 2020 General Assembly (Chapters 681 and 682 of the 2020 Acts of Assembly), Virginia added Chapter 19 to Title 58.1, relating to misclassification of employees as independent contractors. Virginia Code § 58.1-1900 A provides that:

For the purposes of this title and Title 40.1, Title 60.2, and Title 65.2, if an individual performs services for an employer for remuneration, that individual shall be considered an employee of the party that pays that remuneration unless such individual or his employer demonstrates that such individual is an independent contractor. The Department shall determine whether an individual is an independent contractor by applying Internal Revenue Service [IRS] guidelines.

Pursuant to IRS guidelines, the Department adopted the common-law analysis to determine whether an individual is an employee or an independent contractor. See Public Document (P.D.) 99-143 (6/11/1999) and P.D. 21-56 (5/4/2021). Generally, “an employee is subject to the will and control of the employer not only as to what shall be done but how it will be done.”  Treas. Reg. § 31-3401(c)-1. Consistent with the IRS, the Department will consider all information regarding the relationship between the worker and the business that provides evidence of the degree of control and the degree of independence that existed. See Internal Revenue Code (IRC) § 3121(d)(2) and Treas. Reg. § 31.3121(d)-1. In IRS Publication 15-A, the IRS explains that facts providing this evidence fall into three categories:  behavioral control, financial control, and the type of relationship of the parties. 

In making such a determination, the Department will examine all evidence regarding a worker’s classification, including, but not limited to, any contracts that existed between the taxpayer and the individuals in question, and written or oral testimonials from individuals with knowledge of the relationships, including members of management or the individuals themselves. Such evidence may also include the types of documents used to evidence worker classification under the 20-factor test enumerated in Rev. Rul. 87-41, 1987-1 C.B. 296.

Behavioral Control

Under this test, a determination must be made as to whether the business has the right to direct and control how the worker does the task for which they were hired. This includes an examination of the instructions given to the worker and the training provided by the business. An employee generally must follow instructions given by the business regarding, among other things, when and where to work, what tools or equipment to use, what workers to hire or assist with the work, where to purchase supplies and services, and what order to follow in performing the work. Because the amount of instruction needed may vary according to the complexity of the work and the skill of the worker, it is not required that the business actually give instructions, but rather that the business retains the right to issue such instructions. Further, providing training to the worker regarding how to perform a task in a particular manner would be indicative of an employee relationship. An independent contractor would typically use their own methods for performing tasks.

The Department’s auditor determined that the behavioral control test in this case tended to indicate an employee relationship existed because the Taxpayer controlled the work and instructed the workers where to report for the job assignments. The audit did not explain, however, how the Taxpayer controlled the work. Merely communicating to a worker about where a job is to be performed is insufficient by itself to support a conclusion that a company exercised an employer level of control over that worker.

According to the Taxpayer, the workers provided their own tools and equipment and decided how and when to complete the work. The workers were also free to retain their own assistants. In addition, the Taxpayer did not provide any training to the workers. 

Financial Control

To evaluate this test, the extent to which a business controls the business aspects of the worker’s job must be analyzed. This involves looking at the extent to which the worker has unreimbursed business expenses, the extent of the worker’s investment, and the extent to which the worker makes his services available to others. In addition, how the business pays the worker and whether the worker can realize a profit or loss are other factors to consider.

The auditor determined that the Taxpayer exercised a degree of financial control over the workers in question that would indicate an employee relationship existed. As evidence, the audit pointed to the fact that, because the workers did not carry their own liability insurance, the Taxpayer carried the risk of the work. The audit also indicated that many workers were paid on a weekly or continual basis and that none of the workers could realize a profit or loss from their work.

Although insurance may cover the cost of a liability a worker might incur as a result of their work, the fact that a worker does not have insurance does not necessarily mean that the worker did not at least share in the risk of loss. An uninsured contractor, for example, can still be sued for damages even if they do not have liability insurance. 

While being paid on a regular basis would normally be a factor in favor of finding an employee relationship existed, it is certainly not the determinative factor. Construction jobs could unfold over days, weeks, or even months, and workers may have an expectation of being paid on a regular basis as the work is completed, regardless of whether an independent contractor or employee relationship exists. 

In addition, the audit did not explain how the workers at issue could not have realized a profit or loss from their work. To the extent that they may have had unreimbursed business expenses such as, for example, transportation costs in getting to a job site, costs in providing their own tools, or costs incurred in hiring assistants, it was possible the workers could have incurred losses, or it was at least possible that some projects would be more profitable than others. Further, according to the Taxpayer, the workers did not have an exclusive relationship with the Taxpayer and were free to seek and accept projects either on their own or from other contractors. 

Type of Relationship

The analysis of a business’s relationship with a worker includes examining any written contracts describing the parties’ intent and whether the worker is provided typical employee benefits such as health care, vacation and pension plans. In addition, the permanency of the relationship and the extent to which the worker’s services are a key aspect of the regular activities of the business can be indicative of the type of relationship between the parties. 

The auditor acknowledged that the workers had no written agreements with the Taxpayer and that benefits were not offered. Rather, the audit report emphasized that the workers continually performed jobs for the Taxpayer over the length of the audit period, but failed to identify any other factor as to the type of relationship on which to base a finding that an employee relationship existed. 

The Taxpayer, on the other hand, indicates that many of the workers were only used for one project, or at least irregularly. To the extent that was true, a permanent employment relationship, though possible, would be questionable. A review of the payment details in the audit report confirms that some workers were used more regularly than others. The Taxpayer also explains that when required, it provided the workers with Forms 1099 each year, indicating it viewed the workers as independent contractors rather than employees. 

CONCLUSION

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. In addition, Virginia Code § 58.1-1900 provides a presumption that an individual who performs services for remuneration is an employee. The Department’s regulations, however, require an evaluation of a business’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 auditor determined that the workers were employees rather than independent contractors in part because the workers did not have business liability insurance, or other documentation to show that they were independent contractors, and they did not file a federal Form Schedule C. While documentation such as invoices, business cards, business licenses, and proof of liability insurance may be an indication that workers are independent contractors operating their own businesses, the absence of such documentation or the inability of a taxpayer to produce such documentation is not conclusive evidence that an employee relationship existed. Determinations of worker misclassification must evidence a thorough analysis of the factors establishing the extent of control over the workers in question. See P.D. 21-56. 

In this case, simple statements in the audit report concerning direction and control that the Taxpayer told workers where the work was to be performed could be said about many types of workers, including contractors, repair service providers, and equipment installers, that might be hired to complete a task. A more complete examination and analysis of the facts of the underlying relationship between the Taxpayer and its workers was required to make an accurate determination. 

Therefore, after a careful review, I have determined that the Taxpayer properly characterized the workers at issue as independent contractors. Accordingly, the assessments will be abated. 

While the Department concedes that the Taxpayer’s workers should not be considered employees for the periods at issue, the Taxpayer should be aware that the Department has the authority to conduct similar worker classification audits in subsequent years. Virginia Code § 58.1-102 requires taxpayers to maintain suitable records that substantiate information required by the Department. 

As discussed above, documentation showing a worker’s status can vary and the Department’s auditors must examine the entire relationship as evidenced by documentation and oral testimony. To assist the Department’s auditors in making an accurate determination, proprietors should strive to maintain sufficient records, including contemporaneous notes, worker agreements, training and guidance materials, federal identification numbers, residency documentation, and address or other documentation, as applicable, evidencing the relationship with a worker. In addition, proprietors should refrain from engaging individuals who refuse or are unable to provide sufficient documentation in order to issue a Form 1099 or W-2, if appropriate.

Worker misclassification cannot be determined by a confined list of evidence or documentation. An examination of the entire relationship as evidenced by all relevant documentation that a proprietor or worker may possess, any written or verbal explanations of the proprietor’s relationship with its workers, or any other relevant information that shows how the parties treated the relationship must be conducted in order to appropriately classify a worker as an independent contractor or an employee. 

On an application for correction, the Department will continue to be flexible with regard to documentation presented to determine a worker’s classification. However, as audit processes are refined over time, the Department may find that a proprietor’s failure to keep accurate and contemporaneous records as to the activities of its workers and the relationship it has with those workers may become a significant factor in favor of upholding assessments. See Virginia Code § 58.1-102. Keeping such records will assist audit staff in making timely and accurate determinations.

The Code of Virginia sections 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 response, you may contact ***** in the Office of Tax Policy, Appeals and Rulings, at (804) *****.

Sincerely,

 

Craig M. Burns
Tax Commissioner                  

                        

AR/4446.X

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Last Updated 05/15/2024 16:05