Misclassification of Workers and its Aftermath

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Last spring we reported on the Tax Court decision in Mescalero Apache Tribe v. Commissioner, 148 T.C. No. 11 (2017), in which the Tax Court determined that the taxpayer could obtain information about tax reporting by its former employees. The tribe did not classify these individuals as employees during the period of employment; however, the IRS determined that the individuals who worked for the tribe were employees and not independent contractors. Where an employer has misclassified its employees, the employer is liable for certain taxes that would have been paid through proper withholding of employees unless the employer can show that the employees paid the taxes.

The tribe tried to track down the employees to determine if they properly reported the taxes. It could not reach most of them and sought through discovery in Tax Court to find out from the IRS whether the employees paid. The IRS resisted citing the disclosure provisions; however, the Tax Court ordered the IRS to turn over information which would allow the tribe to calculate its liability after taking into account the employee payments. This post is about the rest of the story because, not too long after the opinion came out, the IRS issued CCA 201723020 limiting the scope of the opinion in the view of Chief Counsel’s office. For those interested in this issue, you should also look at the blog post by the National Taxpayer Advocate on this subject.


The CCA takes the position that a taxpayer that has misclassified employees cannot obtain information about the employees from Exam or Appeals but can only obtain the information through the discovery process in court. In a resource starved agency, it seems counterproductive to drive taxpayers into court just to obtain information that will allow the taxpayer to determine the correct liability. No one has this information other than the IRS and the individual employees who are typically scattered to the wind. If the misclassification only involves one or two employees, maybe the employer can readily find the misclassified employees; however, if the number of employees is substantial the employer will almost certainly encounter problems tracking down the all of the employees at the time of the misclassification. The CCA will cause employers in these larger cases to petition the Tax Court just to use discovery.

The opinion provides that:

“It is important to note that the court’s determination that the workers’ return information was discoverable was based largely on the representation by the Tribe that it has already made a significant effort to locate the workers and that it had failed only with respect to a relatively small number.  It is also important to note that IRC 6103(h)(4) authorizes disclosure, but does not require it; thus the court’s determination that the workers’ return information “is disclosable under section 6103(h)(4)(C)” does not create a requirement that the Service disclose the information.

Thus, Mescalero does not stand for the proposition that taxpayers and/or their representatives are entitled to workers’ return information during the conduct of an employment tax audit or at the Appeals consideration level. Instead, the Mescalero decision is limited to discovery requests made by a taxpayer during the pendency of a Tax Court proceeding, where the Tax Court has the ability to determine hether the requested information is disclosable pursuant to IRC 6103(h)(4), AND has balanced the relevancy of the requested information against the burden placed on the Service pursuant to Tax Court Rules 70(b) and 70(c).”

Since section 6103(h)(4) permits disclosure, it seems a better way may be to give the information to taxpayers at the examination level but charge them for the cost of obtaining the information so that the IRS is not the loser in this situation. Charging a reasonable search fee allows the taxpayers to obtain the information early in the process, saves resources of both parties inherent in the use of Appeals and the Tax Court. The decision expressed in the CCA makes a loser out of everyone when a much easier solution seems available. The National Taxpayer Advocate is rightfully critical of the decision in her blog post. Once the attorneys in Chief Counsel’s office opine that the decision to disclose is up to the IRS and not barred by section 6103, the door is open for the IRS to make a reasonable decision. The path suggested in the CCA should be ignored by those entrusted to administer the law.




  1. Was this blog post inspired by the entry of a stipulated decision in this case earlier this week, or is that just a coincidence? Here is the decision, entered by Judge Holmes:


    The decision lists by name dozens of employees who “are classified as employees of petitioner for purposes of federal employment taxes under Subtitle C of the Internal Revenue Code with respect to the periods ending March 31, 2009, through and including December 31, 2009.”

    Then it lists by name dozens of individuals who “are not classified as employees of the petitioner for purposes of federal employment taxes under Subtitle C of the Internal Revenue Code with respect to the taxable periods ending March 31, 2009, through and including December 31, 2009.”

    Then it goes through similar lists of individuals who, for 2010 and 2011, are either employees, or not.

    The bottom line is that the Tribe owes about $10,000 in employment taxes. Those who worked for Chief Counsel are a better judge than I, of how much IRS spent on this case to collect that amount.

    Does anyone else have a problem with the names of employees and independent contractors being disclosed in a public court document, simply because they once received payments that became involved in an IRS audit? Parties can ask that all or parts of their Tax Court cases be sealed. Nonparties, not so much.

    Tax practitioner trivia fans should note that the Tribe is represented by El Paso lawyer David Palmer Leeper, who won (a favorite case of mine) the 1991 Portillo case, involving burden of proof when IRS makes an assessment based only on a Form 1099. Mr. Leeper is also representing the plaintiff in the current case involving another El Paso lawyer whose CPA thought he had filed a return electronically, but had not. (See Leslie Book post at http://procedurallytaxing.com/delinquency-penalties-boyle-in-the-age-of-e-filing/ .)

    If I may be excused for pointing out that there are no easy solutions to complex problems, the facts needed to resolve similar employment-tax cases are probably more than a two-hour “IRS database” search can verify. That’s why it is a better idea to require the employer to make diligent efforts first. Whether it should be done only after a Tax Court petition is filed, is another matter.

    An example: Company pays $10,000 to an individual it considers an independent contractor, and issues a Form 1099-MISC. IRS records show that this individual reported a Schedule C profit of $20,000 that year. How does IRS know that the $20,000 amount included the $10,000 in question? Maybe there are other 1099’s associated with the return, or maybe all the other self-employment income was paid for jobs billed at less than $600.

    On the other hand, early disclosure during examination or appeals may save IRS money, rather than causing resources to be expended elsewhere. The Internal Revenue Manual provides that even after the audit is closed — in some cases, no doubt, when the employer does not want to prolong the agony and is willing to pay more than what is owed — a refund claim can be submitted when additional Form 4669 statements from employees are collected. IRM

    “If the taxpayer has paid the additional employment tax examination assessment after the examination and later wants a refund (for instance, additional payees have been contacted and new Forms 4669 have been secured), the claim would be filed using the appropriate “X” form (e.g., Form 941-X or Form 945-X,) with the attached examination report copy of Forms 4668/4668-B”

    How much time does it require Service Center employees to process such claims? Less time than if the database search had been done in the first place?

  2. Correction: The total assessed employment taxes were about $10,000 per quarter for three calendar years (2009-2011), so a total of $40,000. No penalties were added. The Tribe agreed that it is not entitled to attorney’s fees.

    New Mexico skiers may expect the slot machines to be less generous this season. The Mescalero Apache Tribe owns and operates both the Inn of the Mountain Gods Resort and Casino and Ski Apache Ski Resort, as well other Reservation-based enterprises.

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