Tax Byte
Safeguarding Independent Contractor Classifications: IRS Issues First Major Update to Section 530 Relief in 40 Years (Revenue Procedure 2025-10)
Worker classification remains a top priority for the IRS as the agency continues its efforts to recover back payroll taxes from employers who misclassify employees as independent contractors. The financial implications are significant—employment tax noncompliance accounts for approximately $119 billion of the federal tax gap for 2022 alone.
The Foundation: Three Classification Tests
The IRS applies three foundational tests when determining proper worker classification:
Behavioral Test: Examines whether the business controls or has the right to control what work is performed and how the worker performs their duties
Financial Test: Evaluates who controls the economic aspects of the work relationship, such as how payment is structured, whether expenses are reimbursed, and who provides tools/supplies
Type-of-Relationship Test: Considers factors like written contracts, benefits provided, permanency of the relationship, and whether services provided are key to the business’s regular operations
Collectively, these tests incorporate approximately 20 different factors that the IRS weighs when making classification determinations.
Section 530 Relief: A Critical Safe Harbor
Under certain circumstances, businesses may qualify for protection against worker reclassification under Section 530 of the Revenue Act of 1978. This provision can prevent the IRS from reclassifying independent contractors as employees, even when the facts might support employee status under the traditional tests.
Revenue Procedure 2025-10, issued in early 2025, provides updated guidance on Section 530 relief, clarifying and expanding upon previous guidance. This represents the first comprehensive update to Section 530 guidance since Revenue Procedure 85-18 was issued in 1985.
Key Requirements for Section 530 Relief
To qualify for Section 530 protection, a business must satisfy three critical requirements:
1. Reporting Consistency
The business must have filed all required federal tax returns (including Forms 1099) for the workers consistent with independent contractor treatment. Rev. Proc. 2025-10 clarifies that:
- Filing consistency must be satisfied on a period-by-period basis
- Relief is only available for periods and individuals for which proper returns were filed
- Returns filed after the IRS initiates an examination won’t satisfy the requirement
- Good faith mistakes (such as filing the wrong type of information return) won’t disqualify a business
2. Substantive Consistency
The business must not have treated the worker in question, or any worker holding a substantially similar position, as an employee after December 31, 1977. The updated guidance:
- Defines “substantially similar position” as one where job functions, duties, responsibilities, and the control/supervision of those duties are substantially similar
- Clarifies that treating workers as employees in periods after those under audit won’t disqualify a business from relief for earlier periods
- Confirms that entering into a Classification Settlement Program (CSP) or Voluntary Classification Settlement Program (VCSP) agreement constitutes treatment as an employee from the effective date of the agreement
3. Reasonable Basis
The business must have had a reasonable basis for not treating the workers as employees. This can be established through:
- Judicial Precedent: Reliance on court cases, published rulings, or IRS advice. Rev. Proc. 2025-10 clarifies that the precedent must have existed at the time the classification decision was made
- Prior Audit: A past IRS audit that resulted in no employment tax assessments. For audits beginning after 1996, the examination must have specifically considered the worker classification issue. The guidance now explicitly states that audit relief doesn’t apply if the relationship between the taxpayer and workers has changed since the audit
- Industry Practice: Following a long-standing recognized practice of a significant segment of the industry. 25% of an industry (excluding the taxpayer) is deemed “significant.” 10 years is deemed “long-standing” (though shorter periods may qualify).
- Other Reasonable Basis: Any other reasonable basis for the classification decision
Special Considerations
Rev. Proc. 2025-10 provides important clarifications on several additional points:
- Dual Status Workers: The guidance acknowledges that in unusual cases, an individual may perform services for a taxpayer in separate and distinct capacities, and Section 530 relief may apply to one relationship but not another
- Technical Personnel Exception: Section 530 relief is not available for technical personnel (engineers, designers, programmers, etc.) who are provided to clients through arrangements with the taxpayer
- Test Room Supervisors/Proctors: Special relief provisions apply to test proctors or room supervisors who assist in administering college entrance or placement examinations for 501(c) organizations
Burden of Proof
The updated guidance also clarifies that if a taxpayer establishes a prima facie case for Section 530 relief under one of the three statutory safe harbors and has fully cooperated with IRS requests, the burden of proof shifts to the IRS. However, this burden shift doesn’t apply if the taxpayer is relying on the “other reasonable basis” test.
Tax Practitioner Planning:
The detailed guidance in Rev. Proc. 2025-10 provides tax professionals with clearer standards for advising clients on worker classification issues. Given the high stakes involved with employment tax compliance, practitioners should:
- Conduct thorough reviews of client worker classifications using all three IRS tests
- Document the basis for independent contractor treatment contemporaneously
- Ensure timely filing of accurate information returns for all contractors
- Consider whether Section 530 relief might apply when responding to IRS inquiries
The IRS commitment to employment tax compliance shows no signs of waning even though personnel cuts are looming if DOGE and the administration follow through with their proposals. Employment taxes constitute a significant portion of the tax gap. Businesses should expect continued scrutiny of worker classification decisions.