Hello and thank you for your question.
Here is how one source characterizes the issue:
In a nutshell, "Section 1706" made it so that the default presumption
for computer consultants was that they were employees, unless proved
For businesses known as "technical services firms" who provide
technical services to their customers (including computer
consultants), Section 1706 removed so-called "Section 530 employment
tax safe havens" that otherwise apply to all other types of businesses
using independent contractors. As a result, if a technical services
firm hires a high-tech worker to perform services for that firm's
customers as an independent contractor, then the firm must prove to
the IRS that this worker is an independent contractor under the
centuries-old "common law" employment test. Even if the firm shows a
strong reason for hiring the worker as an independent contractor --
for example, the IRS approved the firm's practices in a prior audit,
or the treatment conforms to industry practice or a court ruling, all
of which are "safe havens" under Section 530 -- Section 1706 makes
these reasons irrelevant for technical services firms.
The harm to high-tech firms and workers caused by Section 1706 is more
than theoretical. Technical services firms which use independent
contractors -- even if they act in good faith -- can be severely
penalized by the IRS and forced to pay "unpaid" employment taxes
although the contractors have already paid these same taxes in full!
In fact, some IRS auditors use Section 1706 to claim "incorporated"
high-tech independent contractors are not legitimate. Left with only
the common law employment test to prove a worker's status to the IRS,
many high-tech firms will not hire any independent contractors. They
do not want to "attract" an almost-certain IRS audit because the time
and expenses to fight the IRS means that even "winning" the audit is
really a "losing" situation.
What is "Section 1706"?
So the concern is that the Company or its client (really the client --
i.e. the company that you'll be providing services to) might be
accused by the IRS of having you as its employee. The main tax cost
to your being an employee is they would have failed to pay social
security and Medicare tax on your 'wages.'
The social security and medicare tax is 7.65% of the first $94,200
that they pay you, and 1.45% of any excess.
They also could be accused of failing to do the other tax compliance
items that employers must take care of - - giving you the tax
withholding form to fill out, withholding income tax from your 'wages'
and the rest.
Asking them to delete that clause, if they're gong to treat you as an
independent contractor, would be asking them to assume those risks
which they're not likely to do. Nor can you expect them to want to
agree to take you on as an employee - - because there are probably
employee benefits (401k, medical insurance, etc) that they'd have to
pay if they did hire you as an employee and they're not part of the
Which is also why they probably won't agree to submit the question to
the IRS on Form SS-8 for determination.
I'd suggest you consider the actual circumstances of how you're going
to be working, and decide if it's a risk you're willing to take.
Here's the general test:
And here's the sort of facts the IRS would like to see if you're going
to really be an independent contractor (scroll down to "computer
Good luck and thanks for letting us help.
Search terms used:
independent contractor employment tax audit
"section 1706" withholding
Request for Answer Clarification by
22 Nov 2006 22:26 PST
I should have clarified in my original question that I pay myself a
salary out of which I deduct payroll taxes, ss, medicare and
unemployment tax. My company will gross $200,000 out of which I will
pay myself a salary of $120,000 with all pertinent taxes etc.
The motivation as I understand it for the IRS to seek to re-classify a
contract employee is to regain lost payroll taxes from when the
contract employee paying self-employment tax but working for one
"client" for six months. This is where the IRS gets the feeling
someone is trying to avoid paying taxes.
However, in my situation where I am my own employee and pay regular
payroll taxes out of my own salary, then I think the IRS would relax
because taxes are getting paid and nobody is trying to pull a fast
And what would they gain by re-classifying me ? It would simply switch
the burden to my client from me, as I could re-file and get the
payroll taxes I paid returned to me.
So perhaps that puts my question in a better light. Care to share
additional comments on my clarified situation ?