I just worked a challenging case involving a discrimination lawsuit settlement that one of our members received as a former employee. The IRS examiner insisted that self-employment tax should be assessed, and it was not easy to convince her to change her mind.
During our first contact I explained that the member had not been self-employed, but had been a former employee of the company against which she had filed an Equal Employment Opportunity Commission (EEOC) discrimination claim. The employer had agreed to pay her $10K if she would drop her charges. The member accepted the terms and was issued a 1099-MISC tax form for the income. It was listed in the “nonemployee compensation” section of the form, and it was because of this that the examiner maintained that it must be subject to self-employment tax.
Unable to convince the IRS agent, I regrouped. I reviewed the Audit Technique Guide (ATG) for legal settlements and prepared for another round. I contacted her again and explained that since the taxpayer had been an employee she should not be responsible for the self-employment tax. In order to change the outcome of the audit she said the member would have to get a corrected 1099-MISC from the former employer. I explained that the member had already tried to get the form corrected, but no one from the company would return her phone calls.
I referred the examiner to page sixteen of the ATG, which states that unless a taxpayer is self-employed they should not be subjected to self-employment tax. I cited the tax court cases that were mentioned in the guide as well. Still not persuaded, the agent proposed that we petition the tax court if we didn't agree. I told her I was hoping to settle this matter quickly without going through that process. At this point we were stuck.
As a last resort, I contacted the examiner’s manager and was able to explain how I had arrived at the conclusion that the member’s income should not be subject to self-employment tax. Again, I cited the ATG and tax court cases. She said she was willing to consider my position. She would review the case and call me back.
The next day the original examiner called me back. She agreed to correct the exam report, which reduced our member’s tax bill by over $1,200 and allowed us to avoid the lengthy petition process. A little perseverance paid off!
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