What does Virginia Ruling of the Tax Commissioner P.D. 20-170 conclude about Administration : Audits - Employee/Subcontractor, VEC Information?

Plain-English summary

A Virginia employer was audited and assessed withholding tax for January 2016 through December 2018 because its auditor treated certain workers as employees rather than the independent contractors (subcontractors) the employer had classified them as. The employer appealed, arguing the workers were properly treated as subcontractors.

The Tax Commissioner found a problem with how the assessment was built: the Department's information about the workers came from the Virginia Employment Commission (VEC), which it is authorized to receive and use under Va. Code § 58.1-3 C, and the auditor also allowed some adjustments based on the workers' own Virginia individual income tax filings under Va. Code § 58.1-467. But the auditor did not appear to have independently analyzed whether the workers were actually employees or independent contractors using the factors required by Title 23 VAC 10-140-10, which incorporates the federal common-law test from Treas. Reg. § 31.3401(c)-1 and the factors in Treas. Reg. § 31.3121(d)-1 (as the Department had previously adopted in P.D. 96-280).

Because VEC data alone -- while a useful red flag for compliance issues -- is not a substitute for that factors-based review, the Commissioner did not affirm the assessment but instead returned the case to audit staff to conduct a complete examination of the taxpayer's records, citing P.D. 18-107 as a prior example of the same remedy. This is not a taxpayer win on the merits: the ruling makes clear that an assessment is presumed correct under Va. Code § 58.1-205, so the taxpayer still has the burden of producing sufficient documentation to show its workers were properly classified as subcontractors. The ruling specifically notes that simply having issued the workers Form 1099s is not, by itself, enough proof of independent contractor status.

The practical result: the assessment stands until the audit is redone properly. If the taxpayer isn't satisfied with the outcome of that renewed review, it may file a new appeal within 90 days under Va. Code § 58.1-1821.

What this means for you

Employers currently under a worker-classification audit

If your withholding assessment is based mainly on VEC information showing workers as "employees," this ruling confirms that data point alone does not decide the issue -- the Department is supposed to apply the multi-factor employee/independent-contractor test in Title 23 VAC 10-140-10. But you still carry the burden of proof under Va. Code § 58.1-205, and you'll need actual records addressing the common-law factors, not just the fact that you issued 1099s.

Businesses that rely heavily on subcontractors

Keep documentation that goes to the substance of the working relationship -- degree of control over the work, who supplies tools/equipment, whether the relationship is ongoing, opportunity for profit or loss, and similar factors drawn from Treas. Reg. § 31.3121(d)-1. Issuing 1099s instead of W-2s is a paperwork choice, not proof of classification, and this ruling says so directly.

Accountants and payroll professionals

Note the procedural lesson here: an assessment built solely on VEC cross-match data plus adjustments under Va. Code § 58.1-467, without an independent factors analysis, is vulnerable to being sent back for further audit rather than being overturned outright. Expect the Department to redo the audit request for full documentation rather than simply concede the assessment.

Common questions

Q: Did the taxpayer win this appeal?
A: Not outright. The Commissioner did not cancel the assessment. Instead, the case was returned to audit staff for a complete review of the taxpayer's records because the original audit relied on VEC information without an independent employee/independent-contractor factors analysis.

Q: Is VEC information enough by itself to prove workers are employees?
A: No. The ruling states VEC information is "helpful in identifying possible issues with withholding tax compliance," but Department regulations still require an evaluation of the employer's records under the factors in Treas. Reg. § 31.3121(d)-1, as required by Title 23 VAC 10-140-10.

Q: Does issuing workers a 1099 prove they are independent contractors?
A: No. The ruling expressly says that consistently issuing 1099s "is insufficient proof" that workers should have been classified as independent contractors; the classification still depends on the underlying factors test.

Q: Who has the burden of proof in this kind of dispute?
A: The taxpayer does. Under Va. Code § 58.1-205, a Department assessment is deemed prima facie correct, so the taxpayer must provide sufficient documentation to support its position that the workers were properly treated as subcontractors.

Citations and references

Statutes and regulations:

• Va. Code § 58.1-460 (definition of "employee" for withholding tax purposes)
• Va. Code § 58.1-3 C (Department's authority to obtain VEC worker-classification information)
• Va. Code § 58.1-467 (adjustments reflecting workers' Virginia individual income tax filings)
• Va. Code § 58.1-205 (assessment prima facie correct; burden of proof on taxpayer)
• Va. Code § 58.1-1821 (application for correction of an assessment)
• Title 23 VAC 10-140-10 (employee/independent contractor determination, incorporating Treas. Reg. § 31.3401(c)-1)
• Treas. Reg. § 31.3121(d)-1 (federal common-law factors used as guideline)

Related public documents:

• P.D. 96-280 (10/10/1996) (adopting the Treas. Reg. § 31.3121(d)-1 factors)
• P.D. 18-107 (6/6/2018) (cited as precedent for remanding an audit for full record review)

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 20-170

Original ruling text

September 22, 2020

Re: § 58.1-1821 Application: Withholding Tax

Dear *:

This will respond to your letter in which you seek correction of the withholding tax assessments issued to your client,* (the “Taxpayer”), for the taxable periods January 2016 through December 2018.

FACTS

Under audit, the Taxpayer was assessed for failure to withhold taxes from employee wages during the taxable periods at issue. The Taxpayer appeals, contending the workers were independent contractors, not employees.

DETERMINATION

Virginia Code § 58.1-460 defines “employee” as “an individual, whether a resident or a nonresident of the Commonwealth, who performs or performed any service in the Commonwealth for wages . . . .” The Code of Virginia does not define “independent contractor” for income tax withholding purposes. Under Title 23 of the Virginia Administrative Code (VAC) 10-140-10, the relationship between an employer and employee or independent contractor is determined in accordance with the test set forth in Treas. Reg. § 31.3401(c)-1. In Public Document (P.D.) 96-280 (10/10/1996), the Tax Commissioner found that the factors enumerated in Treas. Reg. § 31.3121(d)-1 should be used as a guideline for determining whether a worker is an employee or an independent contractor.

In accordance with Virginia Code § 58.1-3 C, the Department received information concerning the Taxpayer’s workers’ classifications as employees from the VEC. The Department allowed adjustments to reflect Virginia individual income tax return information filed by the Taxpayer’s workers as provided under Virginia Code § 58.1-467. The Department’s auditor, however, does not appear to have made an independent analysis as to whether the workers were employees or independent contractors.

CONCLUSION

The assessment was based on information obtained from the VEC as authorized under Virginia Code § 58.1-3 C. While such information is helpful in identifying possible issues with withholding tax compliance, the Department’s regulations require an evaluation of an employer’s records to determine if its workers are employees or independent contractors pursuant to the factors enumerated in Treas. Reg. § 31.3121(d)-1. Accordingly, the audit will be returned to the audit staff in order to conduct a complete examination of the Taxpayer’s records as required under Title 23 VAC 10-140-10. See also Public Document 18-107 (6/6/2018).

Under the provisions of Virginia Code § 58.1-205, an assessment of a tax by the Department is deemed prima facie correct. As such, the burden of proof is on the Taxpayer to show the Department’s assessment is incorrect. Accordingly, the Taxpayer must provide sufficient documentation to support its contention that its workers were actually subcontractors for the taxable periods at issue. The fact that the Taxpayer consistently issued 1099s to such workers is insufficient proof that they should have been classified as independent contractors. Again, that determination requires an examination of the factors described above. The Taxpayer must provide documentation as requested by the audit staff. Once the examination of the documentation is completed, the assessment will be adjusted as warranted. If the Taxpayer is not satisfied with the result, it may file an appeal within 90 days of being notified of the outcome of the review pursuant to Virginia Code § 58.1-1821.

The Code of Virginia sections, regulation and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department’s web site. If you have any questions regarding this determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/3380.M

Related Documents

18-107

96-280