[Congressional Record Volume 147, Number 61 (Monday, May 7, 2001)]
[Senate]
[Pages S4418-S4422]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. BOND:
  S. 837. A bill to amend the Internal Revenue Code of 1986 to provide 
a safe harbor for determining that certain individuals are not 
employees; to the Committee on Finance.
  Mr. BOND. Mr. President, for the past several months we have focused 
extensively on the need for tax relief and the means for achieving it. 
As the chairman of the Committee on Small Business, I have argued time 
and again that the individual rate cuts included in the President's tax 
package will have tremendous benefits for small-business owners, the 
vast majority of whom pay taxes at the individual rather than the 
entity level. And time is of the essence since many of these hard-
working Americans are now feeling real pain from the down turn in our 
economy. While I continue to believe that tax relief deserves our 
immediate attention, I cannot ignore another tax priority for small 
businesses, simplification of the tax code.
  With the year 2000 tax-filing season now behind us, thousands of 
small-business owners have once again been reacquainted with the stark 
realities of our current tax code. To keep that picture clearly in 
mind, let me remind my colleague of the results of an investigation 
that the General Accounting Office provided to my committee in the last 
Congress. A small-business owner faces more than 200 Internal Revenue 
Service, IRS, forms and schedules that could apply in a given year. 
While no business will have to file them all, it is a daunting universe 
of forms, including more than 8,000 lines, boxes, and data 
requirements, which are accompanied by over 700 pages.
  Even more disturbing is that in recent years more than three quarters 
of small-business owners hired a tax professional to help them fulfill 
their tax obligations. When we consider the complexity of the forms, 
rules, and regulations, no one should be surprised. And these tax 
professionals are far from inexpensive. By some estimates, small-
business owners pay more than 5 percent of their revenues just to 
comply with the tax law, five cents out of every dollar to make sure 
that all of the records are kept and the forms completed, all before 
the tax check is even written.
  The list of tax provisions crying out for simplification has grown 
considerably in recent years. Therefore, earlier this year, I 
introduced the Small Business Works Act, (S. 189), which includes a 
number of tax-simplification proposals. Today, I rise to introduce 
additional legislation focusing on a particularly troubling and long-
standing area of complexity for America's businesses and 
entrepreneurs--the status of independent contractors.
  Beginning in the last decade and continuing today, there has been an 
important shift in the American workplace, with an increasing emphasis 
on independent business relationships. The traditional single-employer 
career is rapidly being supplanted by independent entrepreneurs who 
provide specialized services on an ``as needed'' basis. They seek out 
individual contracts, apply their expertise, and move onto the next 
opportunity, bound only to their creativity and stamina. The members of 
this new workforce are often described as independent 
contractors, temps, freelancers, self-employed, home-based businesses, 
and even free agents. Whatever their title, they are a rapidly growing 
segment of our economy and one that cannot be ignored.

  Women in particular are playing an important role in this new 
business reality. Since the National Women's Small Business Summit, 
which I hosted in Kansas City last June, I have heard a steady stream 
of success stories about women entrepreneurs who have left the 
traditional workforce to start their own independent businesses, often 
times out of their homes. Today thousands of women are running dynamic 
businessess in fields like public and media relations, executive 
assistance, medical transcription, financial planning, management-
information-systems consulting, and event planning, to name just a few.
  There are a number of reasons for this new business paradigm. 
Continuing innovations in computer and communication technology have 
made the ``victual'' office a reality and allow many Americans to 
compete in marketplaces that not so long ago required huge investments 
in equipment and personnel. In addition, many men and women in this 
country have turned to home-based business in an effort to spend more 
time with their children. By working at home, these families can 
benefit from two incomes, while avoiding the added time and expense of 
day-care and commuting. Corporate downsizing, glass ceilings, and 
company politics, too, contribute to the growth in this sector as many 
skilled individuals convert their knowledge and experience from 
corporate life into successful enterprises operated on their own.
  The rewards of being an independent entrepreneur are also numerous. 
The added flexibility and self-reliance of having your own business 
provide not only economic rewards but also personal satisfaction. You 
are the boss. You set your own hours, develop your own business plans, 
and choose your customers and clients. In many ways, this new paradigm 
provides the greatest avenue for the entrepreneurial spirit, which has 
long been the driving force behind the success of this country.
  With these rewards, however, come a number of obstacles, not the 
least of which are burdens imposed by the Federal government. In fact, 
the tax laws, and in particular the IRS, are frequently cited as the 
most significant problems for independent entrepreneurs today. Changes 
in tax policy

[[Page S4419]]

must be considered by this Congress to recognize this new paradigm and 
ensure that our laws do not stall the growth and development of this 
successful sector of our economy.
  Since 1995, we have made substantial headway on a number of tax 
issues critical to these independent entrepreneurs. In the Taxpayer 
Relief Act of 1997, we restored the home-office deduction putting home-
based entrepreneurs on a level-playing field with storefront 
businesses. The Small Business Job Protection Act of 1996 and the 
Taxpayer Relief Act also made some important strides on the 
unbelievably complex pension rules so that the freelance writer, home-
based medical transcriber, and other small businesses have the 
opportunity to plan for their retirement as they see fit. Finally, and 
arguably most importantly, through several pieces of legislation in the 
last six years, we have finally made the self-employed health-insurance 
deduction permanent and placed it on a path to full deductibility by 
2003, although still too long in my opinion. These examples are just a 
few of the tax law changes already enacted that are helping men and 
women who chose to work as independent entrepreneurs to enjoy a level-
playing field with their larger competitors and still maintain the 
flexibility of their independent business lives.

  Amid this progress, however, one glaring problem still remains 
unsolved for this growing segment of the workplace--there are no 
simple, clear, and objective rules for determining who is an 
independent contractor and who is an employee. Through the Committee on 
Small Business, I have heard from countless small-business owners who 
are caught in the environment of fear and confusion that now surround 
the classification of workers. This situation is stifling the 
entrepreneurial spirit of many entrepreneurs who find that they do not 
have the flexibility to conduct their businesses in a manner that makes 
the best economic sense and that serves their personal and family 
goals. And it is the antithesis of the new business paradigm.
  The root of this problem is found in the IRS' test for determining 
whether a worker is an independent contractor or an employee. Over the 
past three decades, the IRS has relied on a 20-factor test based on the 
common law to make this determination. At first glance, a 20-factor 
test sounds like a reasonable approach, if our home-based financial 
planner demonstrates a majority of the factors, she is an independent 
contractor. Not surprisingly, the IRS' test is not that simple. It is a 
complex set of extremely subjective criteria with no clear weight 
assigned to any of the factors. As a result, small-business taxpayers 
are not able to predict which of the 20 factors will be most important 
to a particular IRS agent, and finding a certain number of these 
factors in any given case does not guarantee the outcome.
  To make matters worse, the IRS' determination inevitably occurs two 
or three years after the parties have determined in good faith that 
they have an independent-contractor relationship. And the consequences 
can be devastating. For example, the business that contracts with a 
management-information-systems consultant is forced to reclassify the 
consultant from an independent contractor to an employee and must come 
up with the payroll taxes the IRS says should have been collected in 
the prior years. Interest and penalties are also piled on. The result 
for many small businesses is a tax bill that bankrupts the company. But 
that is not the end of the story. The IRS then goes after the 
consultant, who is now classified as an employee, and disallows a 
portion of her business expenses, again resulting in additional taxes, 
interest, and penalties.
  All of us recognize that the IRS has a duty to collect Federal 
revenues and enforce the tax laws. The problem in this case is that the 
IRS is using a procedure that is patently unfair and subjective and one 
that forces today's independent entrepreneurs into the business model 
of the 1950s. The result is that businesses must spend thousands of 
dollars on lawyers and accountants to try to satisfy the IRS' 
procedures, but with no certainty that the conclusions will be 
respected. That is no way for businesses to operate in today's rapidly 
changing economy.
  For its part, the IRS adopted a worker-classification training manual 
several years ago. According to then-Commissioner Richardson, the 
manual was an ``attempt to identify, simplify, and clarify the relevant 
facts that should be evaluated in order to accurately determine worker 
classification. . . .'' While I support the agency's efforts to address 
this issue, the manual represents one of the most compelling reasons 
for immediate action. The IRS' training manual is more than 150 pages 
in length and is riddled with references to court cases and rulings. If 
it takes that many pages to teach revenue agents how to ``simplify and 
clarify'' this small-business tax issue, I can only imagine how an 
independent event planner is going to feel when she tries to figure it 
out on her own.
  In recognition of the new paradigm and the IRS' archaic 20-factor 
test, I am introducing the ``Independent Contractor Determination Act 
of 2001.'' This bill is substantially similar to the legislation I have 
introduced in the past two Congresses to resolve the classification 
problem for independent entrepreneurs. It removes the need for so many 
pages of instruction on the IRS' 20-factor test by establishing clear 
rules for classifying workers based on objective criteria. Under these 
criteria, if there is a written agreement between the parties, and if 
our medical transcriber demonstrates economic independence and 
independence with respect to the workplace, based on objective criteria 
set forth in the bill, she will be treated as an independent contractor 
rather than an employee. Moreover, the service recipient, e.g., the 
doctor or hospital, will not be treated as an employer. In addition, 
individuals who perform services through their own corporation or 
limited-liability company will also qualify as independent contractors 
as long as there is a written agreement and the individuals provide for 
their own benefits.
  The safe harbor is simple, straightforward, and final. To take 
advantage of it, payments above $600 per year to an individual service 
provider must be reported to the IRS, just as is required under current 
law. This will help ensure that taxes properly due to the Treasury will 
continue to be collected.
  While the IRS contends that there are millions of independent 
contractors who should be classified as employees, which costs the 
Federal government billions of dollars a year, this assertion is 
plainly incorrect. Classification of a worker has no cost to the 
government. What costs the government are taxpayers who do not pay 
their taxes.
  The Independent Contractor Determination Act has three requirements 
that will improve compliance among independent contractors using the 
new rules set forth in the bill. First, there must be a detailed, 
written agreement between the parties--this will put the home-based 
media-relations consultant on notice at the outset that she is 
responsible for her own tax payments. Second, the new rules will not 
apply if the service recipient does not comply with the reporting 
requirements and issue 1099s to individuals who perform services. 
Third, an independent contractor operating through her own corporation 
or limited-liability company must file all required income and 
employment tax returns in order to be protected under the bill.
  The bill also addresses concerns that have been raised about 
permitting individuals who provide their services through their own 
corporation or limited-liability company to qualify as independent 
contractors. Because some have contended that this option would lead to 
abusive situations at the expense of workers who should be treated as 
employees, the bill continues to limit the number of former employees 
that a service recipient may engage as independent contractors under 
the incorporation option. This limit will protect against misuse of the 
incorporation option while still allowing individuals to start their 
own businesses and have a former employer as one of their initial 
clients.
  Much has also been made to the improperly classified employee who is 
denied benefits by the unscrupulous employer. This issue raises two 
important points. First, the legislation that I am introducing would 
not facilitate this troubling situation. Under the provisions of the 
bill, it is highly doubtful that a typical employee, like a janitor, 
would qualify as an independent contractor. In reality, this issue 
relates to

[[Page S4420]]

enforcement, which my bill simply makes easier through clear and 
objective rules. Second, the issue of benefits, like health insurance 
and pension plans, is extremely important to independent entrepreneurs. 
But the answer is not to force them to all be employees. Rather, we 
should continue to enact legislation like the Small Business Job 
Protection Act, the Taxpayer Relief Act, and the legislation vetoed by 
the Clinton Administration, that permit full deductibility of health 
insurance for the self-employed and better access to retirement savings 
plans.
  The Independent Contractor Determination Act also addresses a special 
concern of technical-service providers, such as engineers, designers, 
drafters, computer programmers, and system analysts. In certain cases, 
Section 1706 of the 1986 Tax Reform Act precludes businesses engaging 
individuals in these professions from applying the reclassification 
protections under section 530 of the Revenue Act of 1978. When section 
1706 was enacted, its proponents argued that technical-service workers 
were less compliant in paying their taxes. Later examination of this 
issue by the Treasury Department found that technical-service workers 
are in fact more likely to pay their taxes than most other types of 
independent contractors. This revelation underscores the need to repeal 
section 1706 and level the playing field for individuals in these 
professions.
  In the last three Congresses, proposals to repeal section 1706 
enjoyed wide bipartisan support. The Independent Contractor 
Determination Act is designed to treat individuals in these professions 
fairly by providing the businesses that engage them with the same 
protections that businesses using other types of independent 
contractors have enjoyed for more than 20 years.
  Another major concern of many businesses and independent 
entrepreneurs is the issue of reclassification. The bill I am 
introducing provides relief to these taxpayers when the IRS determines 
that a worker was misclassified. If the business and the independent 
contractor have a written agreement, if the applicable reporting 
requirements were met, and if there was a reasonable basis for the 
parties to believe that the worker is an independent contractor, then 
an IRS reclassification will only apply prospectively. This provision 
gives important peace of mind to small businesses that act in good 
faith by removing the unpredictable threat of retroactive 
reclassification and substantial interest and penalties.

  For too long, independent entrepreneurs and the businesses with which 
they work have struggled for a neutral tax environment. For an equally 
long time, that tax environment has been unfairly and unnecessarily 
biased against them. It is well past time that the tax code embraces 
one of the fundamental tenets of our country, the free market. We must 
allow individuals the freedom to pursue new opportunities in the ever-
changing marketplace through business relationships that make the best 
sense for them. Our tax code should facilitate those opportunities 
through fair and simple rules that permit the freelance writer, home-
based day-care provider, and every other independent entrepreneur to 
pay their taxes without under interference from the government. Trying 
to force today's dynamic workforce into a 1950s model serves no one. It 
only stands to stifle the entrepreneurial spirit in this country and 
dampen the continued success of our economy.
  The Independent Contractor Determination Act is a common-sense 
measure that answers the urgent plea from independent entrepreneurs and 
the businesses that engage them for fairness and simplicity in the tax 
law. As we work toward the day when the entire tax law is based on 
these principles, we can make a positive difference today by enacting 
this legislation. Entrepreneurs have waited too long, let's get the job 
done!
  I ask unanimous consent that the text of the bill and a description 
of its provisions be printed in the Record.
  There being no objection, the material was ordered to be printed in 
the Record, as follows:

                                 S. 837

       Be it enacted by the Senate and House of Representatives of 
     the United States of America in Congress assembled,

     SECTION 1. SHORT TITLE.

       This Act may be cited as the ``Independent Contractor 
     Determination Act of 2001''.

     SEC. 2. SAFE HARBOR FOR DETERMINING THAT CERTAIN INDIVIDUALS 
                   ARE NOT EMPLOYEES.

       (a) In General.--Chapter 25 of the Internal Revenue Code of 
     1986 (relating to general provisions relating to employment 
     taxes) is amended by adding after section 3510 the following 
     new section:

     ``SEC. 3511. SAFE HARBOR FOR DETERMINING THAT CERTAIN 
                   INDIVIDUALS ARE NOT EMPLOYEES.

       ``(a) Safe Harbor.--
       ``(1) In general.--For purposes of this title, if the 
     requirements of subsections (b), (c), and (d), or the 
     requirements of subsections (d) and (e), are met with respect 
     to any service performed by any individual, then with respect 
     to such service--
       ``(A) the service provider shall not be treated as an 
     employee,
       ``(B) the service recipient shall not be treated as an 
     employer,
       ``(C) the payor shall not be treated as an employer, and
       ``(D) compensation paid or received for such service shall 
     not be treated as paid or received with respect to 
     employment.
       ``(2) Availability of safe harbor not to limit application 
     of other laws.--Nothing in this section shall be construed--
       ``(A) as limiting the ability of a service provider, 
     service recipient, or payor to apply other provisions of this 
     title, section 530 of the Revenue Act of 1978, or the common 
     law in determining whether an individual is not an employee, 
     or
       ``(B) as a prerequisite for the application of any 
     provision of law described in subparagraph (A).
       ``(b) Service Provider Requirements With Regard to the 
     Service Recipient.--For purposes of subsection (a), the 
     requirements of this subsection are met if the service 
     provider, in connection with performing the service--
       ``(1) has the ability to realize a profit or loss,
       ``(2) agrees to perform services for a particular amount of 
     time or to complete a specific result or task, and
       ``(3) either--
       ``(A) has a significant investment in assets, or
       ``(B) incurs unreimbursed expenses which are ordinary and 
     necessary to the service provider's industry and which 
     represent an amount equal to at least 2 percent of the 
     service provider's gross income attributable to services 
     performed pursuant to 1 or more contracts described in 
     subsection (d).
       ``(c) Additional Service Provider Requirements With Regard 
     to Others.--For the purposes of subsection (a), the 
     requirements of this subsection are met if the service 
     provider--
       ``(1) has a principal place of business,
       ``(2) does not primarily provide the service at a single 
     service recipient's facilities,
       ``(3) pays a fair market rent for use of the service 
     recipient's facilities, or
       ``(4) operates primarily from equipment supplied by the 
     service provider.
       ``(d) Written Document Requirements.--For purposes of 
     subsection (a), the requirements of this subsection are met 
     if the services performed by the service provider are 
     performed pursuant to a written contract between such service 
     provider and the service recipient, or the payor, and such 
     contract provides that the service provider will not be 
     treated as an employee with respect to such services for 
     Federal tax purposes and that the service provider is 
     responsible for the provider's own Federal, State, and local 
     income taxes, including self-employment taxes and any other 
     taxes.
       ``(e) Business Structure and Benefits Requirements.--For 
     purposes of subsection (a), the requirements of this 
     subsection are met if the service provider--
       ``(1) conducts business as a properly constituted 
     corporation or limited liability company under applicable 
     State laws, and
       ``(2) does not receive from the service recipient or payor 
     any benefits that are provided to employees of the service 
     recipient.
       ``(f) Special Rules.--For purposes of this section--
       ``(1) Failure to meet reporting requirements.--If for any 
     taxable year any service recipient or payor fails to meet the 
     applicable reporting requirements of section 6041(a) or 
     6041A(a) with respect to a service provider, then, unless the 
     failure is due to reasonable cause and not willful neglect, 
     the safe harbor provided by this section for determining 
     whether individuals are not employees shall not apply to such 
     service recipient or payor with respect to that service 
     provider.
       ``(2) Corporation and limited liability company service 
     providers.--
       ``(A) Returns required.--If, for any taxable year, any 
     corporation or limited liability company fails to file all 
     Federal income and employment tax returns required under this 
     title, unless the failure is due to reasonable cause and not 
     willful neglect, subsection (e) shall not apply to such 
     corporation or limited liability company.
       ``(B) Reliance by service recipient or payor.--If a service 
     recipient or a payor--
       ``(i) obtains a written statement from a service provider 
     which states that the service provider is a properly 
     constituted corporation or limited liability company, 
     provides the State (or in the case of a foreign entity, the 
     country), and year of, incorporation or formation, provides a 
     mailing address, and includes the service provider's employer 
     identification number, and

[[Page S4421]]

       ``(ii) makes all payments attributable to services 
     performed pursuant to 1 or more contracts described in 
     subsection (d) to such corporation or limited liability 
     company,

     then the requirements of subsection (e)(1) shall be deemed to 
     have been satisfied.
       ``(C) Availability of safe harbor.--
       ``(i) In general.--For purposes of this section, unless 
     otherwise established to the satisfaction of the Secretary, 
     the number of covered workers which are not treated as 
     employees by reason of subsection (e) for any calendar year 
     shall not exceed the threshold number for the calendar year.
       ``(ii) Threshold number.--For purposes of this paragraph, 
     the term `threshold number' means, for any calendar year, the 
     greater of (I) 10 covered workers, or (II) a number equal to 
     3 percent of covered workers.
       ``(iii) Covered worker.--For purposes of this paragraph, 
     the term `covered worker' means an individual for whom the 
     service recipient or payor paid employment taxes under 
     subtitle C in all 4 quarters of the preceding calendar year.
       ``(3) Burden of proof.--For purposes of subsection (a), 
     if--
       ``(A) a service provider, service recipient, or payor 
     establishes a prima facie case that it was reasonable not to 
     treat a service provider as an employee for purposes of this 
     section, and
       ``(B) the service provider, service recipient, or payor has 
     fully cooperated with reasonable requests from the Secretary 
     or his delegate,
     then the burden of proof with respect to such treatment shall 
     be on the Secretary.
       ``(4) Related entities.--If the service provider is 
     performing services through an entity owned in whole or in 
     part by such service provider, the references to service 
     provider in subsections (b) through (e) shall include such 
     entity if the written contract referred to in subsection (d) 
     is with such entity.
       ``(g) Determinations by the Secretary.--For purposes of 
     this title--
       ``(1) In general.--
       ``(A) Determinations with respect to a service recipient or 
     a payor.--A determination by the Secretary that a service 
     recipient or a payor should have treated a service provider 
     as an employee shall be effective no earlier than the notice 
     date if--
       ``(i) the service recipient or the payor entered into a 
     written contract satisfying the requirements of subsection 
     (d),
       ``(ii) the service recipient or the payor satisfied the 
     applicable reporting requirements of section 6041(a) or 
     6041A(a) for all taxable years covered by the contract 
     described in clause (i), and
       ``(iii) the service recipient or the payor demonstrates a 
     reasonable basis for determining that the service provider is 
     not an employee and that such determination was made in good 
     faith.
       ``(B) Determinations with respect to a service provider.--A 
     determination by the Secretary that a service provider should 
     have been treated as an employee shall be effective no 
     earlier than the notice date if--
       ``(i) the service provider entered into a contract 
     satisfying the requirements of subsection (d),
       ``(ii) the service provider satisfied the applicable 
     reporting requirements of sections 6012(a) and 6017 for all 
     taxable years covered by the contract described in clause 
     (i), and
       ``(iii) the service provider demonstrates a reasonable 
     basis for determining that the service provider is not an 
     employee and that such determination was made in good faith.
       ``(C) Reasonable cause exception.--The requirements of 
     subparagraph (A)(ii) or (B)(ii) shall be treated as being met 
     if the failure to satisfy the applicable reporting 
     requirements is due to reasonable cause and not willful 
     neglect.
       ``(2) Construction.--Nothing in this subsection shall be 
     construed as limiting any provision of law that provides an 
     opportunity for administrative or judicial review of a 
     determination by the Secretary.
       ``(3) Notice date.--For purposes of this subsection, the 
     notice date is the 30th day after the earlier of--
       ``(A) the date on which the first letter of proposed 
     deficiency that allows the service provider, the service 
     recipient, or the payor an opportunity for administrative 
     review in the Internal Revenue Service Office of Appeals is 
     sent, or
       ``(B) the date on which the deficiency notice under section 
     6212 is sent.
       ``(h) Definitions.--For the purposes of this section--
       ``(1) Service provider.--The term `service provider' means 
     any individual who performs a service for another person.
       ``(2) Service recipient.--Except as provided in paragraph 
     (4), the term `service recipient' means the person for whom 
     the service provider performs such service.
       ``(3) Payor.--Except as provided in paragraph (4), the term 
     `payor' means the person who pays the service provider for 
     the performance of such service in the event that the service 
     recipient does not pay the service provider.
       ``(4) Exceptions.--The terms `service recipient' and 
     `payor' do not include any entity in which the service 
     provider owns in excess of 5 percent of--
       ``(A) in the case of a corporation, the total combined 
     voting power of stock in the corporation, or
       ``(B) in the case of an entity other than a corporation, 
     the profits or beneficial interests in the entity.
       ``(5) In connection with performing the service.--The term 
     `in connection with performing the service' means in 
     connection or related to the operation of the service 
     provider's trade or business.
       ``(6) Principal place of business.--For purposes of 
     subsection (c), the term `principal place of business' has 
     the same meaning as under section 280A(c)(1).
       ``(7) Fair market rent.--The term `fair market rent' means 
     a periodic, fixed minimum rental fee which is based on the 
     fair rental value of the facilities and is established 
     pursuant to a written contract with terms similar to those 
     offered to unrelated persons for facilities of similar type 
     and quality.''.
       (b) Repeal of Section 530(d) of the Revenue Act of 1978.--
     Section 530(d) of the Revenue Act of 1978 (as added by 
     section 1706 of the Tax Reform Act of 1986) is repealed.
       (c) Clerical Amendment.--The table of sections for chapter 
     25 of the Internal Revenue Code of 1986 is amended by adding 
     at the end the following new item:

``Sec. 3511. Safe harbor for determining that certain individuals are 
              not employees.''

       (d) Effective Dates.--
       (1) In general.--The amendments made by this section shall 
     apply to services performed after the date of the enactment 
     of this Act.
       (2) Determinations by the secretary.--Section 3511(g) of 
     the Internal Revenue Code of 1986 (as added by subsection 
     (a)) shall apply to determinations after the date of the 
     enactment of this Act.
       (3) Section 530(d).--The amendment made by subsection (b) 
     shall apply to periods ending after the date of the enactment 
     of this Act.
                                  ____


   Independent Contractor Determination Act of 2001--Description of 
                               Provisions

       The bill addresses the worker-classification issue (e.g., 
     whether a worker is an employee or an independent contractor) 
     by creating a new section 3511 of the Internal Revenue Code. 
     The new section will provide straightforward rules for 
     classifying workers and provide relief from the Internal 
     Revenue Service's (IRS) reclassification of an independent 
     contractor in certain circumstances. The bill is designed to 
     provide certainty for businesses that enter into independent-
     contractor relationships and minimize the risk of huge tax 
     bills for back taxes interest, and penalties if a worker is 
     misclassified after the parties have entered into an 
     independent-contractor relationship in good faith.
       Clear Rules for Worker Classification: Under the bill's new 
     worker-classification rules, an individual will be treated as 
     an independent contractor and the service recipient will not 
     be treated as an employer if either of two tests is met--the 
     ``general test'' or the ``incorporation test.''
       General Test: The general test requires that the 
     independent contractor demonstrate economic independence and 
     workplace independence in addition to a written contract with 
     the service recipient.
       Economic independence exists if the independent contractor 
     has the ability to realize a profit or loss and agrees to 
     perform services for a particular amount of time or to 
     complete a specific result or task. In addition, the 
     independent contractor must either have a significant 
     investment in the assets of his or her business or incur 
     unreimbursed expenses that are consistent with industry 
     practice and that equal at least 2% of the independent 
     contractor's gross income from the performance of services 
     during the taxable year.
       Workplace independence exists if one of the following 
     applies: The independent contractor has a principal place of 
     business (including a ``home office'' as expanded by the 
     Taxpayer Relief Act of 1997); he or she performs services at 
     more than one service recipients facilities; he or she pays a 
     fair-market rent for the use of the service recipient's 
     facilities; or the independent contractor uses his or her own 
     equipment.
       The written contract between the independent contractor and 
     the service recipient must provide that the independent 
     contractor will not be treated as an employee and is 
     responsible for his or her own taxes.
       Incorporation Test: Under this test, an individual will be 
     treated as an independent contractor if he or she conducts 
     business through a corporation or a limited-liability 
     company. In addition, the independent contractor must be 
     responsible for his or her own benefits, instead of receiving 
     benefits from the service recipient. The independent 
     contractor must also have a written contract with the service 
     provider stating that the independent contractor will not 
     be treated as an employee and is responsible for his or 
     her own taxes.
       To prevent the incorporation test from being abused, the 
     bill limits the number of former employees that a service 
     recipient may engage as independent contractors under this 
     test. The limitation is based on the number of people 
     employed by the service recipient in the preceding year and 
     is equal to the greater of 10 persons or 3% of the service 
     recipient's employees in the preceding year. For example, 
     Business X has 500 employees in 2000. In 2001 up to 15 
     employees (the greater of 3% of Business X's 500 employees in 
     2000 or 10 individuals) could incorporate their own 
     businesses and still have Business X as one of their initial 
     clients.

[[Page S4422]]

     This limitation would not affect the number of incorporated 
     independent contractors who were not former employees of the 
     service recipient or independent contractors meeting the 
     general test.
       Additional Provisions: The new worker-classification rules 
     also apply to three-party situations in which the independent 
     contractor is paid by a third party, such as a payroll 
     company, rather than directly by the service recipient. The 
     new worker-classification rules, however, will not apply to a 
     service recipient or a third-party payor if they do not 
     comply with the existing reporting requirements and file 
     1099s for individuals who work as independent contractors. A 
     limited exception is provided for cases in which the failure 
     to file a 1099 is due to reasonable cause and not willful 
     neglect.
       New Worker-Classification Rules Do Not Replace Other 
     Options: In the event that the new worker-classification 
     rules do not apply, the bill makes clear that the independent 
     contractor or service recipient can still rely on the 20-
     factor common law test or other provisions of the Internal 
     Revenue Code applicable in determining whether an individual 
     is an independent contractor or employee. In addition, the 
     bill does not limit any relief to which a taxpayer may be 
     entitled under Section 530 of the Revenue Act of 1978. The 
     bill also makes clear that the new rules will not be 
     construed as a prerequisite for these other provisions of the 
     law.
       Relief From Reclassification: The bill provides relief from 
     reclassification by the IRS of an independent contractor as 
     an employee. For many service recipients who make a good-
     faith effort to classify the worker correctly, this event can 
     result in extensive liability for back employment taxes, 
     interest, and penalties.
       Relief Under the New Worker-Classification Rules: The bill 
     provides relief for cases in which a worker is treated as an 
     independent contractor under the new worker-classification 
     rules and the IRS later contends that the new rules do not 
     apply. In that case, the burden of proof will fall on the 
     IRS, rather than the taxpayer, to prove that the new worker-
     classification rules do not apply. To qualify for this relief 
     the taxpayer must demonstrate a credible argument that it was 
     reasonable to treat the service provider as an independent 
     contractor under the new rules, and the taxpayer must fully 
     cooperate with reasonable requests from the IRS.
       Protection Against Retroactive Reclassification: If the IRS 
     notifies a service recipient that an independent contractor 
     should have been classified as an employee (under the new or 
     old rules), the bill provides that the IRS' determination can 
     become effective only 30 days after the date that the IRS 
     sends the notification. To qualify for this provision, the 
     service recipient must show that:
       There was a written agreement between the parties;
       The service recipient satisfied the applicable reporting 
     requirements for all taxable years covered by the contract; 
     and
       There was a reasonable basis for determining that the 
     independent contractor was not an employee and the service 
     provider made the determination in good faith.
       The bill provides similar protection for independent 
     contractors who are notified by the IRS that they should have 
     been treated as an employee.
       The protection against retroactive reclassification is 
     intended to remove some of the uncertainty for businesses 
     contracting with independent contractors, especially those 
     who must use the IRS' 20-factor common law test. While the 
     bill would prevent the IRS from forcing a service recipient 
     to treat an independent contractor as an employee for past 
     years, the bill makes clear that a service recipient or an 
     independent contractor can still challenge the IRS' 
     prospective reclassification of an independent contractor 
     through administrative or judicial proceedings.
       Repeal of Section 1706 of the Revenue Act of 1978: The bill 
     repeals section 530(d) of the Revenue Act of 1978, which was 
     added by section 1706 of the Tax Reform Act of 1986. This 
     provision precludes businesses that engage technical service 
     providers (e.g., engineers, designers, drafters, computer 
     programmers, systems analysts, and other similarly qualified 
     individuals) in certain cases from applying the 
     reclassification protections under section 530. The bill is 
     designed to level the playing field for individuals in these 
     professions by providing the businesses that engage them with 
     the same protections that businesses using other types of 
     independent contractors have enjoyed for more than 20 years.
       Effective Dates: In general, the independent-contractor 
     provisions of the bill, including the new worker-
     classification rules, will be effective for services 
     performed after the date of enactment of the bill. The 
     protection against retroactive reclassification will be 
     effective for IRS determinations after the date of enactment, 
     and the repeal of section 530(d) will be effective for 
     periods ending after the date of enactment of the bill.
                                 ______