Recent Case: Tough Loss for Taxpayer Who Could Not Use Mailbox Rule to Qualify for Section 530 Employment Tax Relief

Editor’s Note: This is a tough case for an employer who tried to use Section 530 to avoid the harsh effects of the IRS reclassifying his workers from independent contractors to employees. This is commonly called “employment tax examinations” conducted by IRS , or in lay terms, the so-called independent contractor versus employee controversy. Apparently, the one slip up by the employer was the failure to show and prove up that he mailed Forms 1099 to the workers. One little slip up, and unfortunately, he is out of the “safe harbor” of Section 530.

In Martinez v. U.S., Court of Federal Claims, January 5, 2012, 109 AFTR 2d ¶ 2012-325, the Court of Federal Claims held that the owner of a trucking firm who incorrectly treated his drivers as independent contractors, rather than employees, failed to qualify for Section 530 employment tax relief. Where IRS maintained that he failed to meet required reporting consistency for relief because Forms 1099 weren’t filed for his drivers, the employer was unable to use the common law mailbox rule to show the contrary.

Background on §530 relief. Employers are generally required to withhold and pay employment taxes (FICA, FUTA, and withheld income tax) on wages paid to their employees. In general, Code Sec. 3121(d)(2) defines an employee as an individual who, under the common law (case law) rules, has the status of an employee. Under Section 530 of the Revenue Act of ’78, as amended, a taxpayer that incorrectly treats an employee as an independent contractor is nevertheless exempt from employment tax liability if it meets three requirements: (1) The taxpayer does not treat any other individual holding a substantially similar position as an employee for purposes of employment taxes for any period; (2)
all required federal tax returns are filed by the taxpayer on a basis consistent with its treatment of the individual as a nonemployee; and (3) the taxpayer has a reasonable basis for not treating the individual as an employee. (Sec. 530(a), PL 95-600, 11/6/78, as amended by Sec. 9(d)(1), PL 96-167, 12/29/79; Sec. 1(a), PL 96-541, 12/17/80; Sec. 269(c), PL 97-248, 9/3/82)

Background on mailing rules. Under Code Sec. 7502(a), if a return arrives late but is postmarked before the due date, the postmark date is treated as the delivery date. Under Code Sec. 7502(c), registration of a mailing containing a return is prima facie evidence of delivery, and the registration date is the postmark date under the timely mailing-timely filing rule. There is also a mailbox rule under common law. It says that when mail is properly addressed and deposited in the U.S. mails, with proper postage prepaid on it, there is a rebuttable presumption of fact that it was received by the addressee in the ordinary course of the mail.

There is a split in the Circuit Courts as to whether Code Sec. 7502(a) and Code Sec. 7502(c) are the only exceptions to the physical delivery rule that is, whether a taxpayer who didn’t use, or can’t prove that he used, registered or certified mail in mailing a document that IRS denies having received, can use other evidence to create a presumption that the document was delivered.Â The Second and Sixth Circuits and the Court of Federal Claims have held that a taxpayer can’t use circumstantial or extrinsic evidence of mailing to create a presumption of delivery. (Deutsch v. Comm. (CA 2 1979), 44 AFTR 2d 79-5063, Miller v. U.S. (CA 6 1986), 57 AFTR 2d 86-928, Davis v. U.S. (Fed. Cir. 2000), 85 AFTR 2d 2000-1029)Â But the Tax Court, as well as the Eighth, Ninth, and Tenth Circuits, have held that absent contrary proof of a mailing irregularity, proof that a document was properly mailed and postmarked creates a rebuttable presumption that the document was delivered to and received by the addressee. (Walden, (1988) 90 T.C. 947, Wood v. Comm. (CA 8 1990), 66 AFTR 2d 90-5987, Anderson v. U.S., (CA 9 1992) 70 AFTR 2d 92-5010, Sorrentino v. IRS, (CA 10 2004) 94 AFTR 2d 2004-5904)

In Davis, the Court of Federal Claims rejected a taxpayer’s argument that he could prove timely mailing through the common law mailbox rule. (Davis v. U.S. (Ct Fed Cl 1999), 83 AFTR 2d 99-1466)Â Davis was affirmed by the Federal Circuit which stated that the taxpayer’s own uncorroborated testimony, by itself, wouldn’t be sufficient to establish timely mailing under the mailbox rule.

Facts. Severino Martinez operated a sole proprietorship named Martinez Trucking from ’87 until 2000. He treated his drivers as independent contractors, rather than employees, believing that this was standard practice in the area. Other drivers in the area told him he could treat drivers as independent contractors if he annually filed Forms 1099 and distributed copies to his drivers. He began doing so in ’93.

On audit of Martinez’s returns for tax years ’95 and ’96, IRS determined that his drivers were employees and that he had failed to pay federal employment taxes. He paid the assessed taxes, penalties, and interest for one worker for ’95 and ’96, and filed a refund claim and then refund suit with the Court. Martinez contended that he was entitled to Section 530 safe haven relief from the assessments because he consistently treated his drivers as independent contractors and had a reasonable basis for doing so.

IRS conceded that Martinez qualified for relief from the ’95 assessment, but contended that he failed to meet Section 530’s reporting consistency requirement for the ’96 assessment because he hadn’t timely filed Forms 1099 for his drivers. Martinez admitted that he couldn’t prove timely delivery under the physical delivery rule or either Code Sec. 7502 exception. However, he argued that he could prove timely delivery under the common law mailbox rule with proof of timely and proper mailing.

No relief. The Court of Federal Claims held that Code Sec. 7502 provides the only exceptions to the physical delivery rule and that Martinez couldn’t prove timely delivery through the mailbox rule. Martinez admitted that he couldn’t prove timely delivery under the physical delivery rule or either Code Sec. 7502 exception. Accordingly, he couldn’t show reporting consistency and wasn’t entitled to Section 530 relief. The Court of Federal Claims noted that although the Federal Circuit hadn’t expressly adopted a rule, it hadn’t reversed the long-standing Court of Federal Claims precedent that Code Sec. 7502 contained the only exceptions to the physical delivery rule. Thus, the Court followed that precedent in this case.

Further, the Court found that even if Martinez could invoke the mailbox rule, he would still fail to prove timely delivery of the Forms 1099 because he failed to prove timely and proper mailing. Testimony by his witnesses and documentation provided was vague, unreliable or inconclusive, and did not show timely delivery to IRS by a preponderance of evidence.

Good News for Taxpayers: In late September of 2011, IRS launched a new Voluntary Classification Settlement Program (VCSP) for employees that have been misclassified as independent contractors (or as other nonemployees), which was previously reported on this blog on December 9, 2011, IRS FAQs on Voluntary Classification Settlement. The VCSP that allows employers to prospectively reclassifyâ€”as employeesâ€”those workers that they have erroneously treated as independent contractors or as other nonemployees. The program carries generous settlement terms and provides audit relief for previous years.