The Tax Court decided a case in April on the proper classification of employees that is likely to have far reaching consequences for both employers and employees. An employer sometimes classifies its workers as independent contractors rather than as employees because if they are independent contractors the employer is not required to withhold income and payroll taxes and is not required to pay the employer’s share of any payroll taxes. This classification, if correct, saves the employer money. The IRS has aggressively audited employers and in many instances has reclassified workers as employees.

One consequence of such a reclassification is that the employer becomes liable for the income and payroll taxes owed by the employee as well as the employer’s share of payroll taxes. For large employers this can be a very substantial amount. The employer can avoid liability for the employee’s income and payroll taxes if it can demonstrate that the employee paid the taxes he owed, even though there was no withholding of such taxes by the employer. The question is, how does the employer prove that the employee paid his taxes?

This was the subject of Mescalero Apache Indian Tribe v. Commissioner (148 TC No.11, 4/5/17)The Mescalero Apache Tribe employed hundreds of workers and classified some as independent contractors. Upon audit, the IRS reclassified many of these workers as employees. The Tribe was able to demonstrate that a significant number of the reclassified workers had paid their taxes. It was able to get them to complete IRS Form 4669. On this form, the employee lists the payments he received from the employer, the schedule and line of his tax return he used to report the payments, and makes a statement that all taxes due on the return have been paid. The Tribe had 70 former workers whose status was reclassified to employee by the IRS whom it could not find. It requested the IRS to provide it with information about the tax payments of these 70 workers, but the IRS refused.

The Tribe then filed a motion in the Tax Court to compel discovery and obtain the information about the 70 workers from the IRS. The IRS objected on the basis that IRC Section 6103 prohibits the IRS from disclosing income tax return information. There is an exception that allows disclosures in judicial and administrative tax proceedings, but the statute is not clear as to whom such information may be disclosed. In this case the court determined that the IRS could disclose information from the workers’ tax returns to the extent it would address whether the worker had paid his taxes on the amounts he received from the Tribe. This case takes on added importance as precedent as it was reviewed by the entire court. The IRS may still refuse to provide this type of information to employers because there are courts of appeal not relevant in this case that have held such information cannot be disclosed.

For an employer the case provides additional authority that it may be able to obtain information from the IRS to demonstrate that its workers paid their taxes. For workers who are classified as independent contractors, the case means that if they are reclassified by the IRS as employees, the employer may be able to access their tax return information through the IRS if they don’t willingly provide Form 4669.