United States: The IRS Offers a Road Map to Entertainment Tax Audits
New Industry Guide is a Must-Read Script for Tax Professionals

In 1992, the Internal Revenue Service announced the formation of industry specific audit groups designed to provide guidance for auditors on tax return questions unique to these industries. Not surprisingly, the industry audit unit garnering by far the most press coverage was the entertainment task force.¹ In conjunction with this audit specialization program, the IRS also began issuing a number of Market Segment Specialization Program (MSSP) guides, including an MSSP guide entitled Entertainment: Important 1040 Issues,² which was based upon the research and experience of Office Exam Group 2321 of the Los Angeles District of the IRS.

This MSSP guide is designed to provide auditors with an overview of activities in the entertainment industry, familiarize auditors with terminology and tax-related issues in the industry, and to provide them with suitable audit techniques. Reading between the lines, the guide also represents the latest IRS campaign against perceived abusive tax practices in the show business world.

As a starting point, the MSSP guide informs auditors that considerable crossover now exists among entertainment job titles, and individuals may function in different job titles on different entertainment projects. This makes the determination of a taxpayer's duties critical, since only ordinary and necessary expenses that are incurred in connection with the taxpayer's trade or business are deductible. For example, acting expenses incurred by a lighting director would not be deductible, since they are not incurred in that taxpayer's trade or business.³

In planning an entertainment audit, the IRS auditor is instructed to develop a solid background on the individual's activities and responsibilities. Thus, it should be anticipated that the IRS auditors will request copies of documents such as contracts, project agreements, deal memos, resumes, and/or working proposals, since these documents frequently provide fundamental information about the nature of a creative person's income, expenses, and reimbursements.⁴ The IRS candidly acknowledges that a taxpayer's reputation and standing in the entertainment business is relevant in ascertaining the nature and extent of expenses that ordinarily would be incurred to maintain such standing.⁵ For example, the MSSP entertainment industry guide states that an unknown actor would usually not send gifts to a prominent producer, and a well-known singer would not need to entertain a cameraman. The guide, however, offers no pro-taxpayer examples, such as an established director entertaining a high-level producer.

Given Hollywood s reputation - deservedly or not - for lavish lifestyles, it is hardly surprising that the MSSP guide devotes substantial attention to personal expense issues and the related topic of recordkeeping requirements. Business expenses in the entertainment industry are perceived by the IRS as one of the areas most subject to both abuse and misunderstanding, as well as differences of opinion.⁶

Generally, personal expenses are not deductible, even if required as a condition of employment,⁷ and the allocation of a personal expense to a business purpose hinges on a specific correlation between expenditure and income source. Consequently, IRS auditors will request all logs and records of travel, meals, and entertainment, and may also request background information explaining each Form W-2 or Form 1099, such as dates worked, job requirements, and specific activities. The IRS believes that most job-related expenses in the entertainment industry are reimbursed by the employer, especially for union signatory productions.⁸ Hence, actors who pay for their own travel or buy costumes must demonstrate that such expenses are not reimbursable. Moreover, no deduction is allowed for an expense that could have been reimbursed had the taxpayer sought reimbursement.⁹

Even in the presence of adequate proof, the IRS can be expected to challenge vigorously certain items, such as clothing. To be deductible as a business expense, clothing must: 1) be required by the employer or be essential to a taxpayer's employment; 2) be unsuitable for general wear or use away from work; and 3) not, in fact, be worn while away from work.¹⁰ Although courts were formerly much more lenient in allowing wardrobe deductions,¹¹ denial of clothing expenses is now commonplace.¹² However, the IRS does acknowledge that certain specialized, protective clothing in the entertainment industry, like a stuntperson's asbestos clothing used in a fire scene or a makeup artist's smock, is deductible, as are true costumes and period clothing (provided no union contract provides for reimbursement).¹³

Practitioners should expect IRS agents to be especially thorough in their auditing of entertainment-type deductions due to the perception within the IRS that show business folk splurge.¹⁴ The Internal Revenue Code specifically prohibits the deduction of lavish or extravagant food and beverage expenses.¹⁵

For meals and entertainment to be validly claimed as business deductions, a taxpayer must first establish the ordinary and necessary nexus to his or her trade or business and also meet stringent substantiation requirements. Thus, an expense considered to be of a type generally constituting entertainment, amusement, or recreation is only deductible if the taxpayer establishes that such item was directly related to, or, in the case of an item directly preceding or following a substantial business discussion, that such item was associated with, a taxpayer's trade or business.¹⁶ Assuming this hurdle is overcome, a taxpayer must also satisfy the following recordkeeping criteria (by adequate records or sufficient corroborative evidence): 1) the amount of each expenditure; 2) the time and place of each expenditure; 3) the specific business purpose for the expense; and 4) occupation or other information relating to the person entertained in order to establish the business relationship.¹⁷

The IRS's cynicism and suspicion of entertainment industry deductions is also illustrated by the devotion of an entire chapter in the MSSP entertainment industry guide to personal expense issues.¹⁸ For example, expenses incurred to maintain an image or appearance will generally be regarded as inherently personal in nature. Likewise, general makeup or hairstyling for auditions will not be allowed, although stage makeup bought for a live performance or audition may be allowed (if not a general over-the-counter product).¹⁹

The IRS can be expected to take an equally tough stance in connection with keeping-current expenses, such as cable TV subscriptions and movie and theater tickets. The taxpayer must demonstrate that these items specifically benefit the employment of a taxpayer in the entertainment industry, since items of general amusement, entertainment, or recreation are ordinarily not deductible.²⁰ Consequently, an actor must identify how a movie or play directly applied to his or her career through appropriate substantiation.²¹

Other items that the IRS will routinely characterize as personal and nondeductible include deductions for general physical fitness and security (e.g., bodyguards and home security). However, if a taxpayer is employed in a capacity that requires physical conditioning for which there is no reimbursement, the IRS will probably be more lenient.²² Likewise, security costs to control fans and paparazzi during a star's appearance are clearly business related and will be deductible (although the producer of the event would usually bear such costs).²³ Clearly nondeductible in the eyes of the IRS, however, are guru and personal counselor types of expenses.²⁴

Entertainment industry audits may also focus on any claimed educational and/or research expenses. Continuing education may be deductible by entertainment industry taxpayers, provided such courses directly relate to a current trade or business and do not qualify a person for a different or higher position. Two examples of permissible deductions would be a country-and-western singer who takes riding lessons in order to procure a role in a commercial (provided the producer does not pay for such coaching)²⁵ and an actor who hires a dialect coach to help him or her prepare to audition for a certain part.²⁶ Similarly, research expenditures incurred in anticipation of a specific job can be deductible, provided the IRS is given sufficient evidence that the anticipated employment was reasonably possible.

For expenses incurred in the course of developing a particular project (such as writing a movie script), the general rule is that such costs are not currently deductible, but instead must be capitalized under the uniform capitalization rules.²⁷ In unusual situations where all rights to a completed project (such as a movie) are sold outright, the recovery of capitalized costs will be allowed as a cost of goods, thereby reducing gross receipts.

Far more commonly, however, a completed project will be exploited over a number of years through various media (theatrical releases, cable release, free television, video rental, etc.), each producing its own revenue stream. In these instances, the IRS's position is that the most appropriate method of recovering production costs is through the income forecast method of depreciation.²⁸ This method requires that the total income for a property - that is, revenue produced from all media over the project's life - be estimated. The annual depreciation expense is computed by multiplying the cost of the property (less estimated salvage value) by a fraction, of which the numerator is the current year's income and the denominator is total estimated income.²⁹

The 1996 tax legislation reformed the income-forecast method of depreciation by providing new rules for 1) determining the amount of estimated income; 2) the adjusted basis of the depreciated property; 3) the allowable depreciation deduction for the property's first year of depreciation; and 4) the payment of interest following a recomputation of depreciation utilizing a look-back method comparing actual to estimated income.³⁰ The effect of these rules is to tighten the income forecast method of depreciation when compared to the discussion in the MSSP guide. For example, the guide states that merchandising receipts are not included in forecasting total estimated income;³¹ however, such receipts generally are now included.³²

If a project is abandoned after capitalized costs have been incurred, a taxpayer is permitted a deduction for the unrecovered basis. However, the IRS will require proof of both an intent to abandon and an affirmative act of abandonment, so that the asset is not retrievable. Merely shelving a script with the possibility of subsequently selling it, or not attempting to exhibit a film if it still may be exploited in the future, are not regarded by the IRS as acts of abandonment.³³

Qualified creative expenses of a certain class of freelance creative professionals, consisting of writers, photographers, artists, and composers, are exempt from the uniform capitalization rules.³⁴ These expenses include all ordinary and necessary expenses incurred by a creative individual whose trade or business activity falls within one of these categories, provided the person is not an employee. This exception entitles eligible creative persons to currently deduct expenses that otherwise would require capitalization (provided such expenses are ordinary and necessary).

However, the MSSP entertainment industry guide also cautions auditors that qualified creative expenses do not include expenses related to printing, motion picture filming costs, videotapes, or other reproduction and distribution expenses.³⁵ Hence, even freelance creative persons who otherwise are exempt from the capitalization rules must still segregate and capitalize nonqualified creative expenses.

Since entertainment industry personnel frequently incur travel and transportation expenses in producing creative works, an IRS entertainment audit will almost assuredly include a review of these deductions. The MSSP entertainment industry guide analysis of these expenses is not unique to the entertainment industry. Rather, the general definitions of travel expenses (expenses incurred while away from home overnight) and transportation (usually, the expense of locomotion within the general vicinity of a taxpayer's trade or business) are reviewed within the context of some entertainment-related examples. Thus, the IRS acknowledges that travel expenses can be incurred in several different profit-generating activities for entertainment industry taxpayers , including performance, job searches, and skill maintenance.

As with all taxpayer travel, the expenses, to be deductible, must be incurred while away from the taxpayer's tax home, generally defined as the taxpayer's regular or principal place of business without regard to the location of the taxpayer's residence.³⁶ If a taxpayer works in two or more locations during the tax year, three objective factors are applied to determine a tax home: 1) the total time spent in each area; 2) the degree of business activity in each area; and 3) the relative amount of income earned in each area.³⁷ When a taxpayer's business is such that he or she has no principal place of business, additional factors are used to determine the tax home.³⁸ Since taxpayers in the entertainment industry frequently work in more than one city during a given year, the determination of a tax home can be critical to the deductibility of travel expenses incurred in connection with a trade or business while away from home.

In addition, even when expenses for otherwise permissible travel items like costs of travel, meals, and lodging are proper, the recordkeeping requirements for travel expenses must still be met. The taxpayer's records, preferably kept at or near the time of the expenditure, or other corroboration, must document the following: 1) the amount of each separate category of expenditure; 2) dates of departure and return; 3) destination(s); and 4) business purpose, including expected business benefit.³⁹ Although a contemporaneous log is not required, the closer in time to the event that the record is created, the more probative is its audit value. Conversely, if there is no log or diary of travel expenses, the greater the need for independent corroborative evidence.⁴⁰

Since entertainment industry personnel frequently travel overseas, the differences in the tax rules between domestic and foreign travel must also be considered. The cost of traveling to and from a domestic destination is allowed in full, provided the trip's primary purpose is for business. Likewise, lodging and meal expenses are allowable for all business-related days.⁴¹

Foreign travel, like domestic travel, must meet the substantiation requirements. However, foreign travel deductions are not governed by the primary-purpose principle applicable to domestic travel. Rather, the cost of traveling to and from a foreign destination must be allocated based on the ratio of bona fide business days to the total number of foreign travel days.⁴²

Local transportation costs can be deducted by persons in the entertainment industry, subject to the same tax rules that apply to other taxpayers. This means that substantiation for all expenses is required, no deduction is available for commuting expenses, but transportation expenses from one business location to another are deductible. The IRS expects taxpayers in the entertainment field to incur automobile expenses while searching for employment and promoting one's self. Thus, auditions are one example cited by the IRS of a common, allowable transportation deduction. Car expenses incurred in connection with continuing education is another deduction that the IRS would usually allow, since education expenses (such as acting or dialect lessons) are also described by the IRS as common in the entertainment industry.⁴³

As part of job-search expenses, the IRS acknowledges that it is reasonable for talent to annually incur photo and video-resume expenses, since they showcase a performer's skills and versatility to potential employers. However, when significant costs are incurred producing a demo to sell a production (song, video, etc.) by promoting the taxpayer's talents, the IRS auditor may inquire whether the demo has a useful life of more than one year, and is therefore subject to depreciation as an asset used in a trade or business.⁴⁴

Showcasing is another example given by the IRS of a promotional expense that a variety of entertainment industry taxpayers (including actors, directors, producers, comedians, and musicians) typically incur while trying to obtain employment. The IRS will request that showcasing expenses be verified by cancelled checks, contracts, letters of agreement, or other evidence documenting the arrangement between the performer, director, or producer and the venue.⁴⁵

Agent and business management fees and commissions are also acknowledged by the IRS as allowable business expenses. However, while agent fees are generally limited to 10 percent by applicable guild contracts, the IRS notes that business management fees are not standard and can vary from 5 percent to 15 percent of gross income or be set at a flat monthly fee.⁴⁶ The IRS may here be confusing the 5 percent fee scale typical for business managers, with the scale for personal managers, which ranges from 10 percent to 20 percent. One word of warning: since business managers often pay entertainers' personal bills and handle their personal affairs, the IRS auditor may question the extent to which a business manager's services are actually devoted to business matters.⁴⁷

In addition to this array of expense-related issues that may be raised during an entertainment audit, the IRS may also inquire about income matters. For example, payors of residuals to entertainers (such as a film studio or a payroll service) typically withhold and file Form W-2, and the IRS auditor may cross-reference such records to insure that residuals are properly reported as income.⁴⁸

Royalty income and license fees from the sale or performance of copyrighted material (such as performance income paid by music performance societies like BMI and ASCAP to songwriters and music publishers and mechanical royalties paid to them by record companies) may also be the subject of IRS cross-referencing, since records of payment are easily obtainable from the payors.⁴⁹

The IRS also notes that advertising and promotional deals occur all the time in the entertainment industry, creating an opportunity for payment in something other than cash - such as fringe benefits or goods for services. For example, auditors may search for unreported income by inquiring whether a performer has received wardrobe or other perquisites, whether a spokesperson received a new car, or if barter compensation occurred in a merchandise-broadcast deal. If the auditor suspects that an entertainer has failed to report all of his or her income, the auditor may attempt to reconstruct income using agent commissions (because they represent a percentage of gross earnings) and/or union and guild dues, which usually are comprised of both an annual fee and an assessment based on the prior year's earnings.⁵⁰

In addition to sleuthing for unreported income, the IRS can also be expected to scrutinize the classification of entertainers as independent contractors. This classification effects the employment taxes of both the entertainer and the employer and the entertainer's income taxes. The IRS utilizes its well-known list of 20 common-law factors in determining whether a person is an employee or an independent contractor.⁵¹

Of paramount importance in this determination is whether the employer has the right to control and direct the individual performing the services, not only concerning the result, but also through the means by which the result is accomplished.⁵² Such control invariably translates into an employer/ employee relationship.

If an entertainer's status is converted from independent contractor to employee, the employer will be liable for the employer's portion of social security and medicare taxes (FICA), as well as a withholding tax on wages. The extent of an employer's potential liability for misclassifying a worker as an independent contractor will depend on whether a Form 1099 was previously filed.⁵³ The employer will also be liable for unemployment taxes (FUTA) on the first $7,000 of wages.⁵⁴

IRS auditors suspecting an employee/independent contractor misclassification will inquire whether an entertainer claiming independent contractor status has received any employee benefits (e.g., health insurance, pension contributions, unemployment insurance), whether an entertainer who is a guild member has an individually negotiated contract (since union and guild agreements are collectively bargained for employees), and whether, after the issuance of Form W-2, the person alleging independent contractor status took any corrective action to support that status (e.g., by requesting a Form 1099). The IRS invariably concludes that the issuance of a Form W-2 is synonymous with employee status.

If an independent contractor is reclassified by the IRS as an employee, then claimed Schedule C business expenses will be disallowed, and most likely transferred to Schedule A of Form 1040. This would produce two adverse tax consequences: 1) the minimum percentage thresholds for itemized deductions usually offset a significant portion of the tax savings that otherwise would be generated by the deductions; and 2) in computing any alternative minimum tax, such expenses are generally nondeductible.

This, of course, is one reason for the continued popularity of loan out corporations among actors and actresses. By incorporating, the loan out corporation provides the services of the actor to the motion picture production company, and expenses like agency and manager commissions and legal and accounting fees are paid for and deducted at the corporate level. The balance of the loan out corporation's income is typically paid to the entertainer/owner as salary and/or bonus.

Since a loan out corporation attempts to sidestep the employee/independent contractor issue and can generate significant tax savings, the IRS may challenge an incorporated entertainer as an unjustified use of the corporate device to obtain the benefits of deductions and shelters that otherwise would not be available.⁵⁵ However, the IRS does not have a good track record when challenging the loan out corporation format, provided the proper formalities (e.g., maintenance of good corporate minutes and existence of an employment agreement between the entertainer and loan out corporation) have been observed.⁵⁶ Accordingly, practitioners should still review the potential tax benefits of incorporating entertainment industry clientele, notwithstanding the IRS's public opposition to the loan out corporation.⁵⁷

Even if an IRS auditor has reason to reclassify an unincorporated entertainment industry person from an independent contractor to an employee, Section 530 of the 1978 Revenue Act affords protection to an employer who had a reasonable basis for treating the worker as an independent contractor, provided the employer relied on one of three safe harbors.⁵⁸ Moreover, the 1996 Small Business Act modified Section 530 after the publication of the MSSP entertainment industry guide, by, among other things, generally liberalizing the industry standard safe harbor for periods after 1996.⁵⁹

From suspected misclassification of workers as independent contractors to the deductibility of travel and entertainment expenses, to the capitalization and cost recovery of creative productions, the MSSP entertainment industry guide sets forth a road map of tax issues affecting the entertainment industry. The guide offers real insight into the potential course and conduct of IRS entertainment audits, and is one script that entertainment tax professionals must read.

1. Including articles in Variety, Hollywood Reporter, and The New York Times. See, e.g., Koch, I.R.S. Agents Stalk The Hollywood Hills, N.Y. Times, Dec. 27, 1992, at 3-25.
2. Department of the Treasury, Market Segment Specialization Program, Entertainment: Important 1040 Issues [hereinafter MSSP Guide] (April 1995).
3. Internal Revenue Code of 1986 [hereinafter I.R.C.] 162; See also Treas. Reg. 1.162-5(b)(3) (educational expenses that qualify a taxpayer for a new trade or business are nondeductible).
4. MSSP Guide at 2-1.
5. Id.
6. MSSP Guide at A-9.
7. I.R.C. 262.
8. MSSP Guide at A-10.
9. See Campbell v. Commissioner, T.C. Mem. 1987-480.
10. Donnelly v. Commissioner, 262 F. 2d 411, 412 (2d Cir. 1959); Rev. Rul. 70-474, 1970-2 C.B. 34.
11. See, e.g., Nelson v. Commissioner, T.C. Mem. 1966-224 (Ozzie and Harriet could deduct clothing worn on their TV show, notwithstanding suitability for general wear).
12. See, e.g., Pevsner v. Commissioner, 628 F. 2d 467 (5th Cir. 1980), rev'g T.C. Mem. 1979-311 (boutique salesperson could not deduct expensive clothing required by employer, even though not worn in personal life).
13. MSSP Guide at 8-3, A-28.
14. MSSP Guide at A-30.
15. I.R.C. 274(k).
16. I.R.C. 274(a).
17. I.R.C. 274(d).
18. MSSP Guide at 8-1 through 8-4.
19. Id. at 8-3.
20. I.R.C. 274(a).
21. See supra text accompanying note 14.
22. MSSP Guide at 8-3.
23. Id. at 8-4.
24. Id. at A-18.
25. Id. at A-14.
26. Id. at A-16.
27. I.R.C. 263A. Both direct costs in producing a creative work (such as researching, preparing, producing, and recording) and an allocation of indirect costs (such as utilities, clerical assistance, equipment rental, and tools) must be capitalized under the uniform capitalization rules.
28. See Rev. Rul. 60-358, 1960-2 C.B. 68; Rev. Rul. 64-273, 1964-2 C.B. 62.
29. This yields the following formula:

AD = CP x (CR ˜ TR), where

AD is annual depreciation expense

CP is total cost of the project

CR is current revenue for the taxable year

TR is total forecasted revenue for the project

30. Small Business Act 1604 (redesignating I.R.C. 167(g) as 167(h) and adding I.R.C. 167(g)), generally effective for property placed in service after September 13, 1995. These charges, inter alia, require income to be taken into account for 11 tax years and clarify and broaden the categories of estimated income to generally include all estimated income. A special rule for a television series provides that syndication income is not required to be taken into account before the earlier of the fourth taxable year beginning after the date the first episode is aired, unless a syndication contract is entered into during the initial 3 years of the series. However, I.R.C. 167(g)(5)(C) now specifically requires the inclusion of merchandise income from the exploitation of characters, designs, scripts, scores, and other incidental income associated with motion picture and television films, but only to the extent such income is earned in connection with the ultimate sale to or use by unrelated persons.
31. MSSP Guide at 4-3.
32. I.R.C. º167(g)(5(C).
33. MSSP Guide at 4-3.
34. I.R.C. º263A(h).
35. MSSP Guide at A-32.
36. See Rev. Rul. 60-189, 1960-1 C.B. 60; Rev. Rul. 73-529, 1973-2 C.B. 37.
37. See Rev. Rul. 73-529, 1973-2 C.B. 37.
38. These factors are set forth in the MSSP Guide at 6-2, citing Rev. Rul. 73-529, 1973-2 C.B. 37.
39. Treas. Reg. 1.274-5T(c).
40. Id.
41. See I.R.C. 162(a); Treas. Reg. º1.162-2.
42. I.R.C. 274(c). However, such allocation is not required if a trip does not exceed one week or the personal portion of the travel time outside of the United States is less than 25 percent of the total travel time. Id.
43. MSSP Guide at 6-4, 6-5.
44. I.R.C. 167, 1231; MSSP Guide at 940. Significantly, in IRS Priv. Ltr. Rul. 9643003, the I.R.S. held that a songwriter's costs incurred recording several songs on a rough-cut demo tape could not be currently expensed, but rather had to be capitalized under the uniform capitalization rules of I.R.C. 263A(b). The I.R.S. specifically found that a songwriter was not a writer whose creative expenses would be exempt from these rules.
45. MSSP Guide at 9-10, 9-11.
46. Id. at 9-13.
47. Id.
48. Id. at 3-1.
49. Id.
50. Id. at 3-1 through 3-3.
51. See Rev. Rul. 87-41, 1987-C.B. 296. For a full discussion of the employee/independent contractor distinction in the entertainment industry, see S. Moore, Employee or Independent Contractor?, Los Angeles Lawyer, Apr. 1995, at 20.
52. See Treas. Reg. 31.3401(c)-1(b).
53. I.R.C. 3509.
54. I.R.C. 3301.
55. See MSSP Guide at A-6 through A-8.
56. A leading case in this area is Sargent v. Commissioner, 929 F. 2d 1252 (8th Cir. 1991), rev'g 93 T.C. 572 (1989) (hockey players are employees of their loan out corporation).
57. See A.O.D., CC-1991-022 (Oct. 22, 1991), in which the I.R.S. announced its nonacquiescence to Sargent, 929 F. 2d 1252.
58. The three safe harbors are:

1) Judicial precedent, published rulings, or a technical advice memorandum or private letter ruling with respect to the taxpayer.

2) Prior I.R.S. audit of the taxpayer in which no assessment was made due to improper treatment of the worker. (For reliance on audits after 1996, the audit must have included an examination for employment tax purposes of whether the worker involved [or a worker with a similar position] was properly classified.)

3) A long-standing recognized practice of a significant segment of the industry in which the work is engaged (industry practice).

Section 530 relief will be denied if

1) The employer failed to file all returns, including appropriate information returns with respect to the workers involved for all periods after 1978; or

2) The employer gives inconsistent treatment to workers with substantially similar positions.

Section 530 relief does not afford protection for the individual entertainer regarding the 2 percent threshold for miscellaneous itemized deductions or any AMT issue. See also MSSP Guide at 9-6.

59. Under the 1996 Small Business Act, the determination of whether an industry practice is long-standing no longer requires a particular fixed length of time. The I.R.S. practice of requiring 10 years standing or proof that the practice existed before 1979 has now been statutorily disapproved. In addition, no fixed percentage has been established for determining whether a significant industry segment has classified workers as independent contractors, and employers are not required to show that more than 25 percent of the industry (excluding the employer itself) follows that practice. (The I.R.S. had previously required a standard of more than 50 percent of the industry.) Moreover, employers seeking to rely on one of the three safe harbors, note 58 supra, need only establish a prima facie case that it was reasonable not to treat an individual as an employee. If an employer does so and cooperates with an I.R.S. investigation, the I.R.S. bears the burden of proving the employer wrong. These new rules are effective for periods after Dec. 31, 1996. The burden-of-proof rule is effective for disputes involving periods after Dec. 31, 1996.