Taxes in your practice: IRS issues guidance on worker classification audits

Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City.

The Internal Revenue Service recently issued a revenue procedure and revenue ruling on controversies involving worker classification that lawyers should know to best advise their clients or handle their own firms’ business.

Revenue Procedure 2025-10 provides updated guidance regarding the implementation of § 530 of the Revenue Act of 1978, which addresses controversies regarding whether individuals are employees for purposes of employment taxes. Revenue Procedure 2025-10 modifies and supersedes Revenue Procedure 85-18, clarifying the definition of employee, whether a taxpayer has treated an individual as an employee, § 530 procedural requirements, and the reasonable basis safe harbor.

The IRS also issued Revenue Ruling 2025-3 providing scenarios where § 530 relief and related Internal Revenue Code provisions may apply. 

Revenue Procedure 2025-10 

Section 530 was enacted to provide relief for taxpayers involved in worker classification disputes with the IRS. Section 530 generally provides that if a taxpayer has not treated an individual as an employee for a tax period, then the individual is deemed not an employee for that period unless the taxpayer had no reasonable basis for their position. Section 530 relief only applies if the taxpayer did not treat the individual as an employee for federal employment tax purposes and meets each of the following requirements for the period in question:

1. The taxpayer filed all required federal tax returns, including information returns, on a basis that is consistent with the taxpayer’s treatment of the individual as not being an employee (reporting consistency requirement).

2. The taxpayer did not treat the individual or any individual holding a substantially similar position as an employee (substantive consistency requirement).

3. The taxpayer had a reasonable basis for not treating the individual as an employee (reasonable basis requirement). A taxpayer shall be treated as having a reasonable basis if the taxpayer’s treatment was in reasonable reliance on any of the following: 

a. judicial precedent, published rulings, technical advice with respect to the taxpayer, or a letter ruling to the taxpayer;

b. a past IRS audit of the taxpayer in which there was no assessment attributable to the treatment (for employment tax purposes) of the individuals holding substantially similar positions; 

c. long-standing recognized practice of a significant segment of the industry in which that individual was engaged; or 

d. the taxpayer had some other reasonable basis for not treating the individual as an employee.

Revenue Procedure 2025-10 confirms the following definition of the term “employee” for purposes of § 530: 

"(1) an officer of a corporation under §§ 3121(d)(1), 3306(i), or 3401(c) of the code;

(2) an individual, who under the common law rules, has the status of an employee under §§ 3121(d)(2) or 3306(i); 

(3) agent-drivers, commission-drivers, full-time life insurance salespersons, home workers or traveling or city salespersons under §§ 3121(d)(3) (statutory employees) or 3306(i); 

(4) an individual who performs services that are included under an agreement pursuant to Section 218 or Section 218A of the Social Security Act (218 Agreement) under § 3121(d)(4) of the Code; and

(5) an officer, employee or elected official of a state, or any political subdivision thereof, or the District of Columbia, or any agency or instrumentality of the foregoing under § 3401(c)."

Revenue Procedure 2025-10 outlines the following guidelines for determining whether there was “treatment” of an individual as an employee for a period for purposes of § 530:

"(1) The withholding of income tax or FICA taxes from any payments made to an individual, whether or not the tax is paid to the IRS, indicates ‘treatment’ of the individual as an employee. 

(2) Except as provided in paragraphs (6) and (7) below, the filing of an original or amended employment tax return (including a Form 940 ‘Employer’s Annual Federal Unemployment Tax Return,’ 941 ‘Employer’s Quarterly Federal Tax Return,’ 943 ‘Employer’s Annual Tax Return for Agricultural Employees,’ or 944 ‘Employer’s ANNUAL Federal Tax Return’), with respect to an individual, whether or not tax was withheld from the payments made to the individual, indicates ‘treatment’ of the individual as an employee.

(3) The filing of Schedule H (Form 1040), Household Employment Taxes, with respect to an individual, whether or not tax was withheld from the payments made to the individual, indicates ‘treatment’ of the individual as an employee. 

(4) The filing of a Form W-2 ‘Wage and Tax Statement’ with respect to an individual, or the furnishing of a Form W-2 to an individual, whether or not tax was withheld from the payments made to the individual, indicates ‘treatment’ of the individual as an employee. 

(5) Contracting with a third party to perform acts required of employers with respect to an individual, whether or not tax is withheld or paid to the IRS or the third party otherwise satisfies the terms of the contract, indicates 'treatment' of the individual as an employee. 

(6) The filing of a delinquent or amended employment tax return for a particular tax period with respect to an individual as a result of IRS collection or examination activities or other compliance procedures, does not indicate ‘treatment’ of the individual as an employee for that period. IRS correspondence that merely advises the taxpayer that no return has been filed and requests information from the taxpayer is not a compliance procedure. However, if the taxpayer takes any of the actions identified in section 3.03 with respect to those individuals in a later period (for example, the taxpayer withholds employment taxes or files employment tax returns with respect to those individuals for the periods following the period audited), those actions indicate ‘treatment’ of the individuals as employees for those later periods. 

(7) A return prepared by the IRS under § 6020(b) for a period is not ‘treatment’ of an individual as an employee for that period."

Revenue Procedure 2025-10 also includes key procedural considerations for application of § 530 in an employment tax audit, including the following:

– “[T]he IRS will provide written notice of the availability of section 530 treatment before or at the start of any employment tax audit inquiry relating to the employment status of one or more individuals who perform services for the taxpayer or when it appears that a determination concerning worker classification will be made.”

– Before analyzing whether individuals are employees in an employment tax audit, the IRS will first consider whether a taxpayer has satisfied the requirements of § 530. 

– Detailed considerations are outlined for the application of the reporting consistency, substantive consistency, and reasonable basis requirements. This includes details regarding how the IRS will apply the reasonable basis safe harbors in § 530(a)(2). 

– If a taxpayer establishes a prima facie case for meeting the reporting consistency requirement, substantive consistency requirement, and one of the reasonable basis safe harbor requirements, and the taxpayer has fully cooperated with reasonable requests from the IRS, then the burden of proof will shift to the IRS with respect to the applicability of § 530.

Revenue Ruling 2025-3 

Revenue Ruling 2025-3 addresses whether § 530 or reduced rates under § 3509 of the Internal Revenue Code apply to five example situations, as well as whether the IRS will issue a Notice of Employment Tax Determination under § 7436 for U.S. Tax Court review. Section 530 rules are outlined in this ruling consistent with Revenue Procedure 2025-10. The ruling also confirms that under § 3509, a taxpayer who does not meet the § 530 requirements may still be eligible to remit unpaid taxes at reduced rates so long as the taxpayer did not intentionally disregard the requirement to withhold and deduct employment taxes. 

Revenue Ruling 2025-3 notes that § 7436 provides for tax court review of certain employment tax determinations by the IRS if the following elements are present: 

"(1) an examination in connection with the audit of any person; 

(2) a determination that – 

(a) one or more individuals performing services for such person are employees of such person for purposes of subtitle C, or 

(b) such person is not entitled to relief under section 530(a) with respect to such an individual; 

(3) an ‘actual controversy’ involving the determination as part of an examination; and 

(4) the filing of an appropriate pleading in the Tax Court."

The five situations and IRS positions are summarized here. 

Situation 1 

The taxpayer hires individuals who provide services during the year and pays each individual a weekly fixed amount and a weekly bonus amount. The taxpayer does not withhold or pay federal employment taxes on any of the payments and reports the total amount of the fixed weekly amounts and the weekly bonus amounts on Form 1099-NEC “Nonemployee Compensation.” 

During an audit, the IRS determines that (1) the taxpayer does not meet the statutory requirements for § 530 relief, and (2) the individuals are employees. The IRS proposes to assess federal employment. The taxpayer claims it satisfies the statutory requirements for § 530 relief and does not agree that the individuals are employees. 

The IRS holds that § 530 is applicable to this situation because the taxpayer did not treat the individuals as employees, and the IRS is reclassifying the individuals as employees. Whether the taxpayer is entitled to § 530 relief depends on the substantive consistency, reporting consistency, and reasonable basis requirements. If § 530 does not apply, § 3509 may be applicable because the taxpayer treated the individuals as non-employees and did not deduct and withhold federal employment taxes from amounts paid to the individuals, and the IRS is reclassifying the individuals as employees. Whether the taxpayer is entitled to § 3509 reduced rates depends on the statutory requirements in § 3509. 

A § 7436 Notice will be issued at the conclusion of the audit or after the IRS appeals the consideration if no agreement is reached. 

Situation 2 

The taxpayer employs individuals who perform services during the year, treats the individuals as employees for the services that they perform, and pays each individual a weekly salary and a weekly bonus amount. The taxpayer treats the weekly salary as wages for federal employment tax purposes and withholds and pays federal employment taxes with respect to the weekly salary. The taxpayer does not treat the weekly bonus amounts as wages for federal employment tax purposes and reports the bonus amounts on Form 1099-NEC. 

During an audit, the IRS concludes the bonus amounts are wages and proposes assessing federal employment taxes on the bonus amounts. The taxpayer claims it satisfies the statutory requirements for § 530 relief with respect to the bonus amounts and does not agree that the bonus amounts are wages. 

The IRS holds § 530 and § 3509 are not applicable to this situation because the IRS is not reclassifying the individuals as employees. The taxpayer treated the individuals as employees, and there is no controversy over whether the individuals are employees or independent contractors with respect to their services. 

A § 7436 Notice will be issued at the conclusion of the audit or after the IRS appeals the consideration if no agreement is reached. 

Situation 3 

Same facts as situation 2 except the taxpayer does not report the weekly bonus amounts on Form 1099-NEC or any other information return. The IRS holds § 530 and § 3509 are not applicable to this situation for the same reasons stated in situation 2, and the IRS will issue a § 7436 Notice at the conclusion of the audit or after appeals consideration if no agreement is reached. 

Situation 4 

Same facts as situation 2 except the taxpayer does not report the weekly bonus amounts on Form 1099-NEC or any other information return and does not claim it satisfies the statutory requirements for § 530 relief with respect to the bonus amounts. The IRS holds § 530 and § 3509 are not applicable to this situation for the same reasons stated in situation 2. 
In situation 4, the IRS will not issue a § 7436 Notice because the taxpayer did not claim relief under § 530 concerning the bonuses, and there is no controversy over whether the individuals are employees or independent contractors. 

Situation 5 

The taxpayer employs individuals who perform services during the year and enters a contract with a third party to pay each individual a weekly salary, withhold and pay federal employment taxes, and file federal employment tax returns. The third party pays the weekly salaries, withholds, pays federal employment taxes, and reports the weekly salaries and taxes on Form 941 and Forms W-2 using the third party’s employer identification number.

In December of that same year, the taxpayer pays a year-end bonus amount directly to each individual for the individual’s services during the year but does not treat the year-end bonus amounts as wages, withhold or pay any federal employment taxes, or report the bonus amounts on any information return. 

During an audit, the IRS concludes that the bonus amounts are wages and proposes to assess federal employment taxes on the bonus amounts. The taxpayer claims it satisfies the statutory requirements for § 530 relief with respect to the bonus amounts and does not agree the bonus amounts are wages. 

The IRS holds § 530 and § 3509 are not applicable to this situation because the IRS is not reclassifying the individuals as employees. The year-end bonus amounts are additional wages for the same services performed by the individuals who were treated as employees. 

The IRS will issue a § 7436 Notice at the conclusion of the audit or after appeals consideration if no agreement is reached because (1) there was an examination in connection with an audit, (2) a determination was made that the taxpayer was not entitled to relief under § 530 with respect to the year-end bonus amounts, and (3) the IRS and the taxpayer disagree on whether the statutory requirements for § 530 relief have been met. 

Conclusion 

The recent IRS releases relating to employment tax audits provide a key roadmap for navigating worker classification audits. Section 530 can provide a safe harbor to avoid retroactive reclassification results, and § 3509 can provide key relief with reduced rates in some situations where § 530 relief is not available.