IRS’s Voluntary Classification Settlement Program Ignores the Penalty Free Relief Available to Employers under Section 530 of the Revenue Act of 1978

The (VCSP) provides employers partial relief from past federal employment tax obligations related to workers voluntarily reclassified from independent contractors to employees. In its announcement of the program, the IRS stated that the goal of the VCSP is to increase tax compliance and reduce the burden for employers. 

Notably, the burden that is imposed upon those employers participating in the VCSP is far more than what was required by Congress when it enacted Section 530 of the Revenue Act of 1978. 

Under the VCSP, in exchange for being alleviated from interest and penalties on the tax liability attributed to the misclassification, employers will pay a penalty equal to 10 percent of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year.  Although participating employers will not be audited for employment tax purposes for prior years with respect to the worker classification of the workers, they will, however, be subject to a six-year statute of limitations for the first three years under the program instead of the three-year payroll tax statute of limitations.

In discussing the background of worker misclassification in its Announcement, the IRS extensively compared relief obtained under the VCSP to that obtained in the current Classification Settlement Program (CSP). As discussed by the IRS, the CSP allows employers and tax examiners to resolve worker classification issues in the administrative process; however, the VCSP allows for voluntary reclassification of workers as employees outside of the examination context and without the need to go through administrative correction procedures applicable to employment taxes.

Significantly, however, the VCSP Announcement as well as the VCSP Frequently Asked Questions fail to discuss an integral provision in the background of worker misclassification, Congresss safe harbor rule, section 530 of the Revenue Act of 1978, which entitles certain employers to reclassify workers as employees without being imposed a penalty. 

As discussed by Congress:

Section 530 of the Revenue Act of 1997 is a safe harbor for an employer who owes FICA and FUTA taxes resulting from the improper classification of employee as independent contractor. Thus, if a worker employee is misclassified as an independent contractor under the common-law analysis, the employer will nonetheless escape employment tax liability if the conditions of section 530 are met.   Section 530 shields a taxpayer who pays workers for services from employment tax liability if the employer has consistently treated the worker as “other-than-employees” unless the employer had no reasonable basis for doing so. Section 530 should be interpreted liberally in favor of the employer.

Present Law and Background Relating to Worker Classification for Federal Tax Purposes. Page 6. JCX-27-07.Joint Committee on Taxation. (May 7, 2007)

Section 530(a) provides in pertinent:

  1. In general.

    2. – If “

    • for purposes of employment taxes, the taxpayer did not treat an individual as an employee for any period, and
    • in the case of periods after December 31, 1978, all Federal tax returns (including information returns) required to be filed by the taxpayer with respect to such individual for such period are filed on a basis consistent with the taxpayer’s treatment of such individual as not being an employee,

    then, for purposes of applying such taxes for such period with respect to the taxpayer, the individual shall be deemed not to be an employee unless the taxpayer had no reasonable basis for not treating such individual as an employee.

  2. Statutory standards providing one method of satisfying the requirements of paragraph (1). For purposes of paragraph (1), a taxpayer shall in any case be treated as having a reasonable basis for not treating an individual as an employee for a period if the taxpayer’s treatment of such individual for such period was in reasonable reliance on any of the following:
    • judicial precedent, published rulings, technical advice with respect to the taxpayer, or a letter ruling to the taxpayer;
    • a past Internal Revenue Service audit of the taxpayer in which there was no assessment attributable to the treatment (for employment tax purposes) of the individuals holding positions substantially similar to the position held by this individual; or
    •  long-standing recognized practice of a significant segment of the industry in which such individual was engaged.
  3. Consistency required in the case of prior tax treatment.- Paragraph (1) shall not apply with respect to the treatment of any individual for employment tax purposes for any period ending after December 31, 1978, if the taxpayer (or a predecessor) has treated any individual holding a substantially similar position as an employee for purposes of the employment taxes for any period beginning after December 31, 1977 . . .  

    4. Similarly, in order to be eligible for the VCSP, employers must meet the following criteria:

    • Employer must have consistently treated the workers in the past as nonemployees;
    • Employer must have filed all required Forms 1099 for the workers for the previous three years; and
    • Employer must not currently be under audit by the IRS, the Department of Labor, or a state agency concerning the classification of these workers.

By failing to address section 530 in its discussions of the VCSP, the IRS is guiding Taxpayers into a voluntary penalty regime they may otherwise not be subject to.  Because section 530 was never codified as part of the Internal Revenue Code, most Taxpayers are oblivious of its existence. The IRS is taking advantage of this unawareness by marketing the VCSP as if it is the Taxpayers most favorable outcome.  Notably, however, when given a choice under the two schemes, it is inconceivable why Taxpayers would choose to be penalized.   

Section 530 relief was recently discussed on November 17, 2011, during the American Bar Associations (ABA) 22nd Annual Philadelphia Tax Conference.  According to these discussions, which included Ligeia Donis, Assistant Branch Chief in the IRS Office of Chief Counsel, Tax Exempt and Government Entities and numerous tax practitioners, the benefit of VCSP over section 530 relief is the certainty it provides.  According to one practitioner, “although an employer may believe it has an ironclad case for section 530 relief, there is always the possibility the IRS will disagree.”  

Remarkably, this discussion of section 530 is contrary to Congresss Joint Committee on Taxation, which expressly stated that “section 530 should be liberally construed in favor of the Employer.”  Present Law and Background Relating to Worker Classification for Federal Tax Purposes. Page 6. JCX-27-07.Joint Committee on Taxation. (May 7, 2007).  Further, section 530(e)(4) expressly includes the Taxpayers liberal burden of proof when requesting section 530 relief:

(A) IN GENERAL

-If-

  1. A taxpayer establishes a prima facie case that it was reasonable not to treat an individual as an employee for purposes of this section, and
  2. The taxpayer has fully cooperated with reasonable requests from the Secretary of the Treasury or his delegate,

    then the burden of proof with respect to such treatment shall be on the Secretary.

Although the IRS has provided Taxpayers with vast information regarding the VCSP, and similar programs such as CSP, it is silent on the penalty-less framework of section 530.   Unaware of other alternatives, Taxpayers continue to apply to the VCSP and consequently, voluntarily agree to be penalized where it may not otherwise be necessary. 

If you have any questions regarding the Voluntary Classification Settlement Program, relief under section 530 of the Revenue Act of 1978, payroll taxes, or any other tax provision, please contact Fuerst Ittleman, PL at contact@fidjlaw.com.

© Copyright 2011, Fuerst Ittleman, P.L. All rights reserved.

Hill Dermaceuticals Sues FDA Following Approval of Generic Derma-Smoothe

On November 4, 2011, Hill Dermaceuticals, Inc. (Hill), a Florida-based drug manufacturer, sued the U.S. Food and Drug Administration (FDA). Hill brought suit in connection with the FDAs recent approval of three Abbreviated New Drug Applications (ANDAs) submitted by Identi Pharmaceuticals (Identi). Hill, the manufacturer of Derma-Smoothe, an FDA-approved skin treatment, alleges that FDAs recent approvals of the generic formulations of its drug violate the Federal Food, Drug and Cosmetic Act (FDCA).

Found here, Hills Complaint alleges that the FDAs approvals of Identis ANDAs were arbitrary and capricious. In short, Hill alleges that in approving the ANDAs, FDA treated Identi differently and in contravention of the FDCA by foregoing certain testing to show that the drugs are safe for consumers. Because Derma-Smoothe is a topical treatment derived from peanut oil (a major allergen), FDA required Hill to perform testing to show that the refined oils in the drug contained only trace amounts of amino acids. Still required to test every batch it produces, Hill claims that it has “invested more than $1 million to license and develop a proprietary amino-acid analysis.” Because the methods Hill uses to test its products are proprietary, Hill alleges based on information and belief that FDA has approved Identis applications without requiring such testing or verification that Identis drugs have similarly low levels of amino acid.

Further, because Hill is required to declare that Derma-Smoothe has undergone such testing on the label of each product, Hill claims that Identis products cannot be approved as a generic form of Derma-Smoothe because the drug cannot contain such a declaration in product labeling. Under FDA regulations, generic formulations of drugs undergo approval through an Abbreviated New Drug Application (ANDA). Unlike a New Drug Application (NDA), an ANDA requires the manufacturer to demonstrate that its drug is bioequivalent to a drug approved via an NDA. This showing generally requires the generic to demonstrate that it contains the same active ingredients, is used in the same manner and will bear largely the same labeling. Thus, assuming the Hill case survives a motion to dismiss filed by the FDA, the Hill case will confront the extent of the differences that are permissible in product labeling in order for the Agency to make a finding of bioequivalence under the FDCA.  

Fuerst Ittleman will continue to monitor the developments of the Hill case. For more information regarding the ANDA generic drug approval process or for any questions regarding how your company can maintain FDA regulatory compliance, please contact us at contact@fidjlaw.com.

10th Circuit Dismisses Claims against FDA for Failure to Exhaust Administrative Remedies

On November 3, 2011, the U.S. Court of Appeals for the Tenth Circuit affirmed the findings of the District of Wyoming, granting the dismissal of the lawsuit filed by Cody Laboratories, Inc. (Cody) and Lannett Co., Inc. (Lannett) and finding in favor of the U.S. Food and Drug Administration (FDA). Finding that the companies had failed to exhaust administrative remedies, the Tenth Circuit found that it was without jurisdiction to decide the merits of the companies claims. The Tenth Circuit decision may be accessed here.

The lawsuit ultimately arose from two FDA Warning Letters that were issued to Cody and Lannett in 2009. Found here and here, the Warning Letters contain directives from the FDA to cease all manufacturing of unapproved morphine sulfate products, finding that they did not constitute grandfathered drugs under the Federal Food, Drug and Cosmetic Act (FDCA). Grandfathered drugs are those that entered the market prior to the enactment of the FDCA in 1938 and its 1962 amendments and are exempted from the requirement to show effectiveness. Finding that the products were not grandfathered drugs, the FDA concluded that the products were new drugs under the FDCA, thus requiring NDAs. In response to the companies challenge to the lawfulness of the warning letters, the District Court for the District of Wyoming found that because warning letters did not constitute final agency action, it lacked the jurisdiction to entertain the suit.

On appeal, the Tenth Circuit held that the companies claims were not reviewable because the companies had failed to exhaust their available administrative remedies. In particular, the Tenth Circuit found that the failure to utilize the citizen petition procedure provided by the FDA rendered the companies claims unreviewable. 21 C.F.R. § 10.30 provides a citizen petition procedure which affords interested parties the opportunity to receive FDA review of an otherwise unfavorable Agency decision or action. Because Cody and Lannett failed to complete this internal agency review in connection with the decision that the products constituted new drugs under the FDCA, the Tenth Circuit affirmed the district courts decision that it was without jurisdiction to consider the merits of the companies claims.

Warning letters are generally the Agencys first course of action upon discovery of a violation of the FDCA and/or FDA regulations. These letters provide formal notification to offending parties of the specific violations that FDA has observed and gives them the opportunity to respond. If after receiving a FDA Warning Letter the offending party takes all necessary measures to correct such violations, the FDA will typically take no further action. However, because these letters and the suggested corrective measures therein do not technically bind named parties to a specific course of action, courts have found that FDA Warning Letters do not constitute final agency action for the purpose of judicial review. This is so even though it is the practice of FDA to post all warning letters onto its website and thereby subject the offending party to public criticism.

A citizen petition is initiated by an interested party and seeks some form of relief from FDA action. In holding that the companies did not exhaust their administrative remedies because they failed to file citizen petitions, the court appears to have overestimated the efficacy of this process. For instance, citizen petitions are often thought to be an ineffective means for challenging FDA action because FDAs regulations allow for the FDA to indefinitely delay decision-making with little recourse for the interested party. In particular, 21 C.F.R. § 10.30(e)(2) provides that the FDA may respond within 180 days by either approving, denying, or withholding a final decision of a citizen petition. Where a final decision is withheld upon conclusion of the 180 day time period, the FDAs reasoning may be that it has not had the opportunity to render a decision because of other Agency priorities, thus prolonging the timeframe for obtaining final agency action. Thus, because the FDA is not forced to provide a final decision within a definitive timeframe, citizen petitions are often viewed as a woefully ineffective means of obtaining relief.

For more information concerning the FDCA or FDA regulations, please contact us at contact@fidjlaw.com.

FDA Issues SOP Aimed at Standardizing Data Requirements for Premarket Submissions

On November 9, 2011, the U.S. Food and Drug Administration (FDA) published “SOP: Decision Authority for Additional or Changed Data Needs for Premarket Submissions.” The document sets forth limitations to the data requirements that agency reviewers may request when reviewing various types of premarket submissions for medical devices. Found here, the document details how reviewers will be limited in the information they request by requiring managements approval, or “concurrence,” in order to seek new or additional data from those seeking agency review.

Prior to the SOP, there was no written policy in place serving to limit reviewers data requests. Thus, device sponsors often found data requests onerous and irrelevant to the safety and efficacy of medical devices. Hopefully, limitations to such data requests will benefit device sponsors by increasing the predictability and efficiency of the premarket review process.

For more information regarding the FDA premarket review process, contact us at contact@fidjlaw.com.

FDA Withdraws Approval of Breast Cancer Indication from Avastin Label

On November 18, 2011, the U.S. Food and Drug Administration (FDA) announced its decision to revoke the approval of the breast cancer indication for Avastin. Because Avastin will still be approved for its other uses, including the treatment of brain, kidney, lung and colon cancer, the drug will remain on the market despite this recent decision. The FDA initially approved Avastin for the treatment of breast cancer based on evidence showing that the drug may restrict tumor growth. However, according to the FDAs decision to revoke its approval, further clinical data has shown that the drug may only marginally limit tumor growth.

Found here, the decision of FDA Commissioner Margaret Hamburg details the procedures whereby Avastin gained approval for this indication and the reasoning for its recent revocation. In 2008, FDAs Center for Drug Evaluation and Research (CDER) approved Avastin for the treatment of breast cancer through the Agencys accelerated approval process. Set forth in 21 C.F.R. § 601.40-46, this process allows biological products to secure approval for the treatment of life-threatening diseases upon showing some evidence that the drug may provide clinical benefit. However, as a condition to accelerated approval, manufacturers are required to continue clinical testing and report their findings to the FDA. Under 21 C.F.R. § 601.43(a), the FDA may withdraw approval where the required postmarketing testing “fails to verify clinical benefit,” where applicants are noncompliant in performing such testing, and where applicants otherwise fail to comply with other postmarketing restrictions.

Because FDA determined that further studies did not verify the level of clinical benefit that prompted the original approval, CDER proposed its withdrawal of approval for this indication in December 2010. Thereafter Avastins sponsor, Genentech, Inc., was afforded an opportunity to show the FDA why this approval should not be withdrawn. This opportunity for hearing is mandated by 21 C.F.R. § 601.43(b). Genentechs arguments were unavailing, and the FDA ultimately withdrew its approval for the breast cancer indication.

While this indication is no longer permitted in product labeling, doctors may still prescribe the drug for use in the treatment of breast cancer. Although manufacturers are limited to marketing drugs for the indications approved in product labeling, FDA regulations do not prevent doctors from prescribing drugs for other uses, a practice known as “off-label” use. Thus, despite the revocation of this indication in product labeling, Avastin may continue to be used to treat breast cancer.

For more information regarding the FDAs drug approval process, please contact us at contact@fidjlaw.com.

FDA Approves First Blood Product for Stem Cell Therapy

On November 10, 2011, the U.S. Food and Drug Administration (FDA) announced its approval of the first blood product derived from cord blood indicated for treatment as a stem cell therapy. HEMACORD, the hematopoietic progenitor cell-cord (HPC-C) blood product, is intended for use in HPC transplant procedures for individuals affected with various blood disorders.

FDA has recently begun requiring HPC-C manufacturers to submit license applications or investigational new drug applications in order to market these products. Having issued a guidance document detailing the regulatory requirements in 2009, FDA instituted a two-year phase-in period for HPC-C manufacturers. According to the FDA’s press release detailing the approval, found here, HEMACORD marks the first approval of a license application for cord blood as the Agency’s two-year phase-in period for HPC-C manufacturers comes to a close. The phase-in period ended on October 20, 2011.  While the regulatory environment surrounding HPCs and stem cells in general has proven cumbersome to manufacturers, with approvals being scarce since the regulations were promulgated in 2001, the approval may be the first of many in the coming years.

We question, however, whether this “product” approval will ultimately benefit anyone. Doctors have been treating their patients using cord blood for more than 20 years, and more than 20,000 patients have been successfully treated in that time. More information about the history of cord blood transplantation may be found here.

For more information about the FDA regulations or the FDA approval process, contact us at contact@fidjlaw.com.

Bill Aims to Increase Number of Grandfathered Dietary Ingredients

On November 4, 2011, a Bill was introduced before the U.S. House of Representatives that proposes to restrict the definition of “new dietary ingredient” (NDI) under the Federal Food, Drug and Cosmetic Act (FDCA). Introduced by Representative Dan Burton, the “Dietary Supplement Protection Act of 2011” seeks to alter the current definition of NDI by changing the applicable dates for which a dietary ingredient must have previously been marketed in the United States.

Currently, a NDI is defined under the FDCA as “a dietary ingredient that was not marketed in the United States before October 15, 1994 and does not include any dietary ingredient which was marketed in the United States before October 15, 1994.” 21 U.S.C. § 350(b). Those dietary ingredients that are not considered NDIs are commonly referred to as “grandfathered” ingredients. Under the FDCA, only grandfathered ingredients are “generally recognized as safe” (GRAS) for human consumption and may be used as ingredients in dietary supplements without prior FDA notification. On the other hand, if an ingredient is considered a NDI, manufacturers must notify the FDA prior to marketing any product containing such an ingredient. Under 21 C.F.R. § 190.6, manufacturers of dietary supplements containing NDIs must submit a premarket notification, demonstrating that these ingredients are safe for human consumption, at least 75 days before marketing their products.

Found here, the Bill proposes to amend the FDCA “by striking ‘October 15, 1994’ each place it appears and inserting ‘January 1, 2007’.” According to the Bill, Congress believes that the definition of grandfathered ingredients is too narrow based on current knowledge on a range of dietary ingredients and their safety for human consumption. Thus, the Bill will limit the definition of NDI, while at the same time expanding the scope of ingredients that are considered grandfathered under the Act.

For more information about the FDCA or FDA regulations, please contact us at contact@fidjlaw.com.

WTO Finds Country of Origin Labeling a Technical Barrier to Trade

On November 18, 2011, the World Trade Organization (WTO) published its report on the ongoing Country of Origin Labeling (COOL) dispute. Implemented in 2008 as part of the Farm Bill, U.S. manufacturers began requiring country-of-origin to be designated in labeling of meats and other goods regulated by the U.S. Department of Agriculture (USDA). Found here, the WTO report details the complaints raised by Canada and Mexico, including the contention that the labeling requirements constitute Technical Barriers to Trade (TBT), in violation of international treaties between the countries.

Ultimately, the WTOs decision was mixed. While the COOL requirements were generally found to pose technical barriers to trade by discouraging imports from Canada and Mexico, the U.S. did not lose out completely. Rather, WTO decided that although the COOL requirements must stop generally, there are certain exceptions to its findings, including meat. Thus, country of origin labeling will continue to be declared on meat products in the United States without further issue from Canada or Mexico. In addition, because the decisions of the WTO are not technically binding, it is possible for the COOL program to continue in the United States with only informal action, such as tariffs, etc., available as recourse.

For more information about USDA labeling requirements, contact us at contact@fidjlaw.com.

FDA Appeals Finding that it Lacks Power to Prohibit State-Licensed Veterinary Compounding

On November 11, 2011, the U.S. Food and Drug Administration (FDA) appealed a recent decision issued by the District Court for the Middle District of Florida, finding that the FDA lacked the authority to prohibit state-licensed veterinary compounding. The September 12, 2011 decision being appealed details the longstanding practice of pharmacy compounding in the context of veterinary medicine.

Compounding is commonly defined by state law as the practice of filling prescriptions through individualized preparation, as opposed to the manufacturing of drugs in bulk. Unlike the compounding of human drugs, over which the FDA acknowledges it lacks full regulatory control if the compounding pharmacy meets certain requirements, the FDA maintains that it possesses the authority to regulate veterinary compounding.

The case originated after the accidental death of 21 polo horses that received compounded drugs from Franck’s Lab, Inc. (Franck’s), an incident that was ultimately linked to a mathematical error in the issuing veterinarian’s prescription. In addition, Franck’s had received FDA Warning Letters in 2004 and 2005, alleging that Franck’s was impermissibly manufacturing drugs in violation of the Federal Food, Drug and Cosmetic Act (FDCA). In response to the Warning Letters, Franck’s argued that “[s]tate law and good compounding practices . . . allow bulk compounding as long as there is a valid patient physician (veterinarian) relationship.” Because the FDA permits compounding of drugs for human use, Franck’s argued that the FDA must allow the same for veterinary compounding. The FDA, however, rejected this argument and brought suit against Franck’s in April 2010 seeking injunctive relief to stop Franck’s from compounding and distributing animal drugs.

In its order, the District Court found for Franck’s and held that because the states have traditionally exercised authority over pharmacy compounding, the states likewise have the authority to regulate the compounding of animal drugs. By filing its notice of appeal, the FDA has signaled that it is not willing to concede the issue of its authority to regulate veterinary compounding.

Fuerst Ittleman will continue to monitor the Franck’s case. For more information, please contact us at contact@fidjlaw.com.

UFC Claims New York State Law Banning Live MMA Events Violates the First Amendment

On November 15, 2011, Zuffa, LLC, which owns the Ultimate Fighting Championship (“UFC”) brought suit against New York Attorney General Eric Schneiderman and Manhattan District Attorney Cyrus Vance Jr. seeking a declaration that New Yorks ban on live mixed martial arts (“MMA”) events is unconstitutional. More specifically, the complaint, which was filed in the United States District Court for the Southern District of New York, alleges that enforcement of the ban violates UFCs and its “performers” free speech rights protected under the First Amendment. A copy of the UFCs complaint can be read here.

Generally speaking, attempts by the regulate speech fall into two broad categories: 1) “content-neutral” regulations, and 2) “content-based” regulations. The governments attempts to regulate the “time, place, and manner” of the expression or speech at issue, and not the message of the speech, are known as “content-neutral” speech regulations. In order for a “time, place, and manner” regulation to be found constitutional, it must: 1) be content neutral; 2) be narrowly tailored to achieve a significant government interest; and 3) the regulation must leave open alternative channels for communicating the information, i.e. other methods to communicate the same message still exist.

On the other hand, “content-based” regulations which attempt to regulate protected forms of expression are presumed to be unconstitutional. In order for a “content-based” regulation to be found constitutional it must pass strict scrutiny, i.e. the regulation must: 1) serve a compelling government interest which is 2) necessary to achieve this interest and for which there are no less restrictive means that would accomplish the governments goals just as well. It should be noted that all expression is protected unless it falls into one of five categories: 1) obscenity; 2) fraudulent misrepresentation; 3) defamation; 4) advocacy of imminent lawless behavior; or 5) “fighting words.” Speech in these five categories is considered “unprotected speech” and thus may be regulated by the government without violating the First Amendment.

In its complaint, UFC alleges that N.Y. Unconsol. Law § 8905-a (2) (hereinafter “Live MMA Ban”), is an improper “content-based” law and thus violates the UFCs and its performers freedom of expression. The UFC has alleged that, although the law has the appearance of a safety regulation, the legislative history of the Live MMA Ban reveals that the ban was implemented to restrict MMAs misperceived message of violence.