President Obama’s State of the Union Speech Highlights Federal Focus on Independent Contractor Misclassification Issue and 1099’s

Listening to President Obama address issues of national importance during his 2011 State of the Union address last night, anyone familiar with independent contractor compliance and 1099 issues could not help but notice two meaningful references to these two related matters, both of which gained widespread attention in 2010.

1.  The first reference was when the President spoke about leveling the playing field.  He stated:

“So tonight, I’m asking Democrats and Republicans to simplify the [tax] system. Get rid of the loopholes. Level the playing field. And use the savings to lower the corporate tax rate for the first time in 25 years — without adding to our deficit.” (Emphasis added.)

This reference to a level playing field appears to correspond to a bill introduced in Congress last year called the Fair Playing Field Act of 2010, which was introduced in both the Senate (S. 3786) and House (H.R. 6128) in September 2010 at a time when both houses of Congress were controlled by Democrats.  As noted in one of my earlier blog posts, this bill was intended to close what the sponsors of the legislation referred to as a “tax loophole allowing businesses to misclassify workers as independent contractors.” According to Sen. John Kerry (D-MA), one of the co-sponsors of the bill, the proposed legislation would eliminate a “safe harbor” in the tax laws that has existed since 1978 and supposedly “creates an unfair environment for businesses that play by the rules and an unfair environment for workers.”  Immediately after the Fair Playing Field Act was introduced, the White House wholeheartedly endorsed the proposed measure.

The so-called loophole that the Fair Playing Field Act sought to close is Section 530 of the Revenue Act of 1978. That law currently affords businesses a safe harbor to treat workers as independent contractors for employment tax purposes if the company has had a reasonable basis for such treatment and has consistently treated such employees as independent contractors by reporting their compensation on Form 1099s.

The President noted how leveling the playing field would result in “savings” that could be used to lower taxes.  This is yet another way of saying that the federal government is seeking to reduce the tax gap by eliminating provisions viewed as tax loopholes. Indeed, one of the Congressional “findings” found in the preamble to the Fair Playing Field Act bill states that “Many workers . . . are employees . . . being treated as independent contractors. Such misclassification for tax purposes contributes to inequities in the competitive positions of businesses and to the Federal and State tax gap . . . .”

Takeaway:  To the extent any Congressional observers believed that the Fair Playing Field Act of 2010 might not be reintroduced in the next Congress, this part of the President’s speech may cause them to reevaluate their view.  The President and members of his party are likely to find common ground with Republicans on this issue when it is couched, as the President did last evening, as a tax gap matter and not as a piece of worker protection legislation.  Similarly, the other employee misclassification bill introduced in Congress in 2010, the Employee Misclassification Prevention Act, is also likely to reemerge in the coming session of Congress, although it too may be dressed up more as a tax gap measure and less as a worker protection issue to spur passage of the bill.

2.  The President also referred indirectly to 1099s when he said:

“Now, I’ve heard rumors that a few of you have some concerns about the new health care law. So let me be the first to say that anything can be improved. If you have ideas about how to improve this law by making care better or more affordable, I am eager to work with you. We can start right now by correcting a flaw in the legislation that has placed an unnecessary bookkeeping burden on small businesses.”

According to commentators, the “flaw” to which the President alluded was a small but controversial tax provision added to the 2,400-page Health Care Reform Act.  That tax provision would require all businesses, beginning in  2012, to issue 1099 tax forms not only to independent contractors but also to any corporation from which they buy more than $600 in goods or services in a calendar year. Small businesses immediately protested, claiming that this non-health care provision somehow inserted into the Health Care Reform Act would mean that they would be burdened with issuing thousands of new tax documents each year.  Evidently, the White House heard those protests.

Takeaway:  President Obama’s promise to eliminate this “flaw in the [health care] legislation” may allow the IRS to continue to focus its attention upon misclassified independent contractors, who currently are the main recipients of 1099s.  Under this so-called “flaw” that the President promised to “correct,” if the IRS would have begun in 2012 to receive hundreds of millions of 1099 forms, misclassified 1099ers might have been more likely to have gone undetected by the IRS.

 

Written by Richard Reibstein.

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