May 19, 1998
CRS Report for Congress
Received through the CRS Web
Independent Contractors: Repeal of Section 1706
of the Tax Reform Act of 1986 for Technical
Service Workers: S. 1924
Marie B. Morris
American Law Division
In three-party employment situations involving technical service workers,
companies that use the workers, and firms that supply or broker the services of workers,
the common law rules, and only the common law rules, apply to determine whether or
not the workers are employees of the placement firms. Section 530 of the Revenue Act
of 19781 permits many firms to use a more liberal set of rules to determine the
employment status of their workers. Among other things, section 530 prevents the
Internal Revenue Service from challenging an employer's misclassification of a worker
as an independent contractor if the employer has a reasonable basis for treating the
worker as an independent contractor and certain other requirements are met (including
consistent treatment of the worker and similarly situated workers.) Section 1706 of the
Tax Reform Act of 1986 bars certain firms from claiming the protection of section 530.
Section 1706 took away the statutory safe harbor for firms that place technical service
workers (engineers, designers, drafters, computer programmers, systems analysts, and
similarly skilled workers) with the companies that use the workers' services.
S. 1924, 105th Congress, would repeal section 1706 of the Tax Reform Act of 1986
(which is section 530(d) of the Revenue Act of 1978, as amended). Entitled the
"Technical Workers Fairness Act of 1998," S. 1924 was introduced on April 2, 1998.
This report discusses the background and possible effects of S. 1924.
For further information about the classification of workers as employees or
independent contractors, see CRS Report 93-622 A, Employees and Independent
Contractors. For information about recent tax legislation affecting worker classification,
see CRS Report 96-715A, Independent Contractors: Changes in the Small Business
Tax Bill and ALD General Distribution Memorandum dated August 15, 1997, entitled
Section 530 of the Revenue Act of 1978 is not part of the Internal Revenue Code. Neither
is section 1706 of the Tax Reform Act of 1986.
Congressional Research Service ˜ The Library of Congress
Employment Classification (Independent Contractor) Provisions in the Taxpayer Relief
Act of 1997, P.L. 105-34.
Although workers and the firms for which they work can have any number of
arrangements for providing services and being paid for the services, for tax purposes
workers are either employees or independent contractors, and the firms are either
employers or not. Each status carries specific tax and legal obligations on the part of the
workers and the firms. There are advantages and disadvantages to each classification for
workers. For firms, there is a fairly strong incentive to classify workers as independent
Prior to 1982, the combined total of employer and employee taxes for social security
and medicare was more than the self-employment taxes imposed on independent
contractors. Of course, a firm could avoid paying any employment taxes if the workers
were independent contractors. The firm only incurred employment tax obligations for
employees. After 1982, the combined social security and medicare tax burden
approximated the self-employment tax burden, but the advantage to a firm of classifying
workers as independent contractors remained.
The IRS had fairly strong revenue incentives to assure that workers who were
misclassified as independent contractors were reclassified as employees. A big problem
for the firms was the statute of limitations provisions. If a taxpayer has filed a return,
the statute of limitations is normally three years. If the taxpayer failed to file a return, the
statute of limitations never starts to run. If an employer treated workers as independent
contractors, the employer would not have filed employment tax returns. Consequently,
the IRS could potentially assess the employer for taxes back to the effective date of the
social security and medicare. That could be a heavy burden for what may have been a
In the 1970s and 1980s, when the IRS stepped up enforcement efforts in the
employment tax areas, taxpayers sought legislative relief. In 1978, Congress provided
statutory relief by enacting section 530 of the Revenue Act of 1978 (P.L. 95-600).
Section 530 did three things: (1) It terminated any retroactive employment tax liability
for employers who had treated workers as independent contractors before January 1, 1980,
unless there was no reasonable basis for not treating the worker as an employee. (2) It
spelled out reasonable bases for classifying a worker as an independent contractor,
requiring consistent treatment of the worker and similarly situated workers as independent
contractors, and reliance on judicial or administrative precedent, past IRS audit, or longstanding industry practice . (3) It prohibited the IRS from issuing regulations or revenue
rulings addressing the status of workers as employees or independent contractors for
employment tax purposes.
Originally, section 530 was intended to be temporary
legislation to retain the status quo while Congress took time to figure out what the correct
solution should be.
In the Tax Equity and Fiscal Responsibility Act of 1982 (P.L. 97-248), section 530
of the 1978 Act was extended indefinitely, again to give Congress time to decide whether
a different statutory design would be desirable. In addition, Congress designated qualified
real estate agents and direct sellers as statutory independent contractors. Since a large
number of pending employment status controversies involved those occupations, the 1982
Act provided real estate agents and direct sellers with an immediate solution to their
classification problems. It also took the pressure off Congress to develop a new statutory
worker classification system.
In section 1706 of the Tax Reform Act of 1986 (P.L. 99-514), which originated as
a Senate floor amendment, a subsection (d) was added to section 530 of the Revenue Act
of 1978. The provision barred technical service placement firms from claiming the
protections of the section 530 safe harbors. This meant that placement firms could rely
only on the common law as a defense for their classification of the workers, and it meant
that the IRS was not prohibited from issuing regulations or rulings relating to the
employment status of technical service workers in three-party situations.
Empowered by section 1706, the IRS promptly issued Revenue Ruling 87-41, 1987-1
CB 296. The ruling spelled out the types of arrangements where the IRS would treat a
placement firm as the employer of technical service employees. Basically, if the
placement firm retained the right to control the worker, either by supervising performance
or hours worked or guaranteeing the quality of the work of the worker to the client, then
the relationship was an employer-employee relationship. If the placement firm simply
acted as a broker with no guarantees about performance of the worker and no supervision
of the worker's hours or relationship to the client, then the worker was an independent
contractor and the firm was not the worker's employer. Although there was dissatisfaction
with the Revenue Ruling on the part of workers and firms who could not arrange for their
desired employment classification, the ruling had the advantage of providing clear
standards for technical service workers in three-party situations.
Since section 1706 was enacted, Congress has held a number of hearings2 on
employment classification. None of the hearings focused specifically on section 1706,
but at each of them, there has been testimony both for and against the repeal of 1706.
Those in favor of the repeal argued that section 1706 makes the technical services
industry the only industry that cannot benefit from section 530. They pointed out that
section 1706 was enacted without hearings. They noted that the March 1991 Treasury
study entitled Taxation of Technical Services Personnel: Section 1706 of the Tax Reform
Act of 1986 found that technical service workers are at least as compliant with tax
requirements as those in other industries. They argued that there is no justification for
singling out the technical services placement industry for special treatment. They noted
that a company that contracts directly with a technical service worker gets the benefit of
section 530, if it can qualify, but that placement firms dealing with technical service
See Misclassification of Employees and Independent Contractors for Federal Income Tax
Purposes: Hearing before the Subcommittee on Select Revenue Measures of the House
Committee on Ways and Means, 102d Cong., 2d Sess. (1992); Updated Review of Tax
Administration Problems Involving Independent Contractors: Hearing before the Commerce,
Consumer, and Monetary Affairs Subcommittee of the House Committee on Government
Operations, 103d Cong., 1st Sess. (1993); Employment Classification Issues: Hearings before the
Subcommittee on Oversight of the House Committee on Ways and Means 104th Cong. 2d Sess.
workers do not enjoy this advantage. They believed 1706 is difficult to apply, especially
in multiparty situations such as those contemplated by 1706.
Those opposed to the repeal argue that section 1706 does not cause true independent
contractors to be classified as employees. They claimed that repeal would set a
dangerous precedent by encouraging those who concede they cannot meet the common
law test for independent contractor status to claim they are independent contractors
anyway. They argued that the law is relatively clear and the industry is able to distinguish
employees from independent contractors. They quoted the March 1991 Treasury report
to the effect that section 1706 presents relatively few administrative problems, especially
in comparison with section 530. They believed that the years since the passage of section
1706 have been profitable for the information technology and technical services
industries, in part, because of the relative stability of the work force. They complained
that before the enactment of section 1706, taxpayers that consistently misclassified their
workers were entitled to relief under section 530, while taxpayers who diligently followed
the law would not be entitled to relief because of the consistency requirements. They felt
that the repeal of 1706 would place them at a competitive disadvantage.They asked for
consistency in tax policy to avoid financial disruptions.
S. 1924 would repeal section 1706 of the Tax Reform Act of 1986 (which is section
530(d) of the Revenue Act of 1978). Entitled the "Technical Workers Fairness Act of
1998," S. 1924, 105th Congress, was introduced on April 2, 1998. The bill would be
effective after the date of enactment. The bill would prospectively restore the benefits of
section 530 to placement firms that serve the technical services industries. It is not clear
that the bill would actually benefit existing placement firms, since they would still be
bound by the duty of consistency contained in section 530. If existing firms have been
treating workers as employees since 1987, it is unlikely that section 530 would permit
them to treat those workers as independent contractors, even if S. 1924 is enacted. If
existing firms have been treating workers as independent contractors, then enactment of
S. 1924 would probably make such a choice less likely to be challenged by the IRS.
There appear to be two possible benefits from enactment of the bill. First, there
may be an intangible benefit to the workers. There is anecdotal evidence that workers
who believe that they are independent contractors cannot convince the placement firms
or the companies that ultimately receive their services to treat them as independent
contractors. The workers believe that the repeal of section 1706 will make the placement
firms and the companies more receptive to treating them as independent contractors.
Whether that will be the result cannot be determined. If the placement firms and
companies have a strong preference for the status quo, enactment of S. 1924 may not
change anything. If the technical services community regards S. 1924 as a green light to
classify technical service workers as independent contractors, then S. 1924 may provide
the workers with the ability to determine whether they want to be employees or
independent contractors. Second, enactment of S. 1924 may decrease the perception of
unfairness to the technical services industry. Even though section 1706 applies only to
technical services placement firms, there seems to be a belief that the whole technical
services industry is being unfairly targeted.