Rulings of the Tax Commissioner

March 29, 2024

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 your client, ***** (the “Taxpayer”), for the taxable periods January 2021 through June 2022.  

FACTS

The Taxpayer, a limited liability company that operated a construction business in Virginia, was audited for the periods January 2021 through June 2022. The Department concluded that eleven of the Taxpayer’s workers who were treated 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 appealed, contending that eight of the workers in question were independent contractors and one individual was not a worker. 

Based on information provided with the application for correction, the auditor agreed that five of the workers were independent contractors and would be removed from the audit. This determination, therefore, will be limited to the remaining four workers.

DETERMINATION

Employee Defined

Effective January 1, 2021, under legislation enacted by the 2020 General Assembly (House Bill 1407, Chapter 681, 2020 Acts of Assembly, and Senate Bill 744, Chapter 682, 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 requires 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 him 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 his own methods for performing tasks.

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.

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.

Worker 1

The auditor concluded that the Taxpayer exercised behavioral control over ***** (Worker 1) because the Owner instructed him where to report for job assignments and that this was indicative of an employee relationship. The audit report did not address any other factors as to behavioral control. 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, Worker 1 was a subcontractor who was contracted to work on specific discrete projects. He completed his jobs with no direct supervision or training from the Owner. He provided his own equipment, and his work was self-directed. He was also free to retain his own assistants. 
 
The auditor also determined that the Taxpayer exercised a degree of financial control over Worker 1 that would indicate an employee relationship existed. As evidence, the audit pointed to the fact that because Worker 1 did not carry his own liability insurance. The audit also indicated that Worker 1 was paid on a weekly or continual basis and that he could not realize a profit or loss from his 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 report did not explain why Worker 1 could not have realized a profit or loss from his work. To the extent that he may have had unreimbursed business expenses such as transportation costs, costs in providing his own tools, or costs incurred in hiring assistants, it would have been possible for Worker 1 to have incurred profits or losses. 

According to the Taxpayer, Worker 1 was paid upon completion of his projects and provided his own equipment. Further, Worker 1 did not have an exclusive relationship with the Taxpayer and was free to seek and accept projects either on his own or from other contractors. 

The auditor acknowledged Worker 1 was not offered typical employee benefits. Rather, the audit report emphasized that the Worker continually performed jobs for the Taxpayer over the audit period. The audit report did not point to any other factor as to the type of relationship on which to base a finding that an employee relationship existed. 

When required, the Taxpayer provided Worker 1 with a Form 1099 each year, indicating that it viewed him as an independent contractor rather than an employee. While Worker 1 did work for the Taxpayer over an extended period, an analysis of the payments reveals that they were inconsistent both as to amount and frequency. This is not indicative of a permanent employment relationship. 

Worker 2 and Worker 3

The analysis as to Worker 1 also generally applies to the relationship between the Taxpayer and ***** (Worker 2) and ***** (Worker 3). In the case of Worker 2 and Worker 3, however, there was no ongoing relationship between them and the Taxpayer. Both Worker 1 and Worker 2 were retained for only a single project. This fact would raise doubts as to whether an employee relationship existed. The audit report failed to provide an adequate explanation as to why these workers should have been reclassified as employees.

Worker 4

The Taxpayer states that ***** (Worker 4) did not actually work for the Taxpayer. Rather, he was paid a one-time consulting fee for a project he referred to the Taxpayer. Worker 4 owned his own construction company and has confirmed that he received only the single consulting fee. The Taxpayer’s records show one payment to the individual. Under these facts, an employment relationship did not exist between the Taxpayer and Worker 4.

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 Department’s auditor determined that the workers were employees rather than independent contractors 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 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 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.

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 four individuals at issue should not be classified as employees for withholding tax purposes. Based on this determination, the audit will be returned to the audit staff to remove the four aforementioned workers as well as the five workers that the audit unit has previously agreed to remove. After the revision of the audit is complete, the Taxpayer will be issued a revised audit report and revised bill, with interest accrued to date. The Taxpayer should remit the balance due within 30 days of the bill date to avoid the accrual of additional interest and possible collection actions. 

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 determination, you may contact ***** in the Office of Tax Policy, Appeals and Rulings, at (804) *****.

Sincerely,

Craig M. Burns
Tax Commissioner

AR/4499.X