To Assess a Long-Standing Administrative Exclusion under Federal Employment Tax Law for People with Disabilities in Congregate Work Settings for Federal Employment Tax Purposes

In most circumstances, the Federal Insurance Contributions Act (FICA) generally requires employees and employers to pay taxes on all “wages” employees receive, 26 U.S.C. §§ 3101(a), 3111(a), and defines “wages” to include “all remuneration for employment,” § 3121(a). FICA defines “employment” as “any service . . . performed . . . by an employee for the person employing him,” § 3121(b). Unlike other federal employment laws like the Fair Labor Standards Act’s definition of employee however, FICA’s definition of “employee” applies an independent analysis under common law rules in determining the employer-employee relationship and the status of an employee. § 3121(d)(2). Likewise, the Social Security Act, which governs workers' eligibility under the OASDI program, contains a materially identical employee analysis to I.R.C. § 3121(d)(2). 42 U.S.C.S. § 410(j)(2), also citing to common law rules to determine whether an employer-employee relationship exists.

Since a 1965 Revenue Ruling, the Treasury Department has consistently determined that people with disabilities in congregate work settings are not “employees” for federal employment tax purposes. In 1969, the Commissioner of the Social Security Administration issued a ruling that adopted a materially identical exclusion to the one used by the IRS and determined that workers with disabilities in congregate work settings could not be considered employees of the facility until after completing its rehabilitation program and meeting common law employment rules. SSR 69-60. Since these 1960s rulings, both SSA and the Internal Revenue Service (IRS) have maintained that an individual participating in a congregate work setting’s training or rehabilitation program could not be considered an employee of the workshop. Accordingly, the compensation received from the congregate work settings could not be considered wages for Social Security coverage purposes and not subject to FICA taxes. Both agencies further held that only after completing the facility’s training or rehabilitation program could a person be considered an employee of the congregate work setting.

A review of IRS Private Letter Rulings (PLRs) shows that over several years, the agency issued a series of decisions on behalf of “sheltered workshops,” which was used to re-classify workers with disabilities as “clients” and deny their employment status. These rulings may have been used to retroactively re-classify the compensation they received as no longer being “wages” subject to FICA taxes and despite any employment determinations made by the Department of Labor. Following this trend, sheltered workshops may have turned to the Department of Justice to settle lawsuits against the IRS and claim FICA tax refunds claiming their work settings were similar to other workshops that previously received PLRs. 

The purpose of this report is to study the legal implications that may result from the Treasury Department’s 1965 analysis of the employment status of people with disabilities in congregate work settings that may result in dueling classifications for federal employment tax purposes that allows employers to classify workers as a “client under a rehabilitation program” and not employees. It will also look at other federal employment laws that may have adopted the Treasury Department’s analysis that may include the National Labor Relations Act and the Employee Retirement Income Security Act of 1974. 

Report Purpose

An in-depth assessment of a long-standing tax policy exclusion for employees with disabilities in congregate work settings (“sheltered workshops”) that results in “dueling classifications” that conflicts with other federal employment statutes and results in a question whether people with disabilities should be classified as “clients” or “employees.” It will examine potential conflicts of federal employment and tax laws defining an "employee" – for purposes of eligibility for benefits under the Federal Insurance Contribution Act (“FICA”) and other federal employment benefits.