Austin Suicide Pilot Allegedly Upset By Denial of Ind. Contractor Status to Non-Ind. Contractors

February 18, 2010

My colleague Gerald Prante below links to and excerpts from a manifesto allegedly written by the individual that crashed his plane in Austin today.

The suicide pilot’s alleged manifesto evidently cites his outrage at Section 1706 of the Tax Reform Act of 1986, which affected Section 530 of the Revenue Act of 1978 (note, neither are part of the Internal Revenue Code). The section involved high-tech consultants, which faced IRS confusion about whether they should be treated for tax purposes as employees or independent contractors. In 1978, Congress passed a moratorium, allowing individuals to continue as independent contractors (“grandfathered” in or “safe harbored”), as long as they had a reasonable basis for doing so.

As part of the 1986 Tax Reform Act, that moratorium was abandoned for high-tech consultants, who then faced the same employee/independent contractor test as everyone else. High-tech consultants were targeted because there was strong evidence that they were abusing the moratorium as a tax shelter and because it fit a need to offset a separate unrelated tax change in the Act that would result in a revenue reduction. (The 1986 Act closed many tax shelters, using the savings to lower rates across the board.) Those businesses engaged in payroll tax sheltering were hit hard, and unsuccessful attempts were made in 1987 and 1988 to re-impose the moratorium. The IRS’s publication on independent contractors still contains this language today:

Relief provisions. If you have a reasonable basis for not treating a worker as an employee, you may be relieved from having to pay employment taxes for that worker. To get this relief, you must file all required federal information returns on a basis consistent with your treatment of the worker. You (or your predecessor) must not have treated any worker holding a substantially similar position as an employee for any periods beginning after 1977.

Technical service specialists. This relief provision does not apply for a technical services specialist you provide to another business under an arrangement between you and the other business. A technical service specialist is an engineer, designer, drafter, computer programmer, systems analyst, or other similarly skilled worker engaged in a similar line of work.

This limit on the application of the rule does not affect the determination of whether such workers are employees under the common-law rules. The common-law rules control whether the specialist is treated as an employee or an independent contractor. However, if you directly contract with a technical service specialist to provide services for your business and not for another business, you may still be entitled to the relief provision.

Determining whether a high-tech consultant is independent or not can be difficult, and there were accusations at the time that the IRS didn’t help with clear regulations. Further, technicians claim they were singled out, with other professionals being able to use the “safe harbor” provision.

Regardless of that, if someone is an independent contractor, the IRS will treat them as one. The only people harmed are non-independent contractors that want the IRS to treat them like an independent contractor.

Update: The commenters on TaxProf Blog provide some valuable information about the operation of “contract houses” or brokers in the computer consultant context. Companies are reluctant about hiring computer consultants as independent contractors but giving them employee-like duties for fear of facing payroll tax obligations and tax penalties. Brokers exist to be the consultants’ employer-of-record and the consultant is then leased to the company. The broker then takes a significant cut from the consultant’s pay.

The issue seems to have vanished over the last 20 years, since the consultant can incorporate himself or herself (although the IRS discourages one-person corporations). And, of course, if companies are treating programmers and engineers like employees, they shouldn’t be able to pretend that they are independent contractors.

Update (2): One of the many phone calls I’ve gotten referred me to this New York Times piece by David Cay Johnston, which takes an emotional look at what happened to programmers after they were no longer able to be treated like independent contractors while doing employee functions.

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A tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.

A payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue.