classification rules for employee vs subcontractor status

Daniel Feaster v. Commissioner, TC Memo 2010-157 , Code Sec(s) 3121.
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DANIEL FEASTER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent .
Case Information:
Code Sec(s): 3121
Docket: Docket No. 2296-09.
Date Issued: 07/22/2010
Judge: Opinion by COHEN


Accountant was employee, not independent contractor
Feaster, TC Memo 2010-157
The Tax Court has determined that an accountant was an employee, not an independent contractor. As a result, he could not deduct business expenses on Schedule C.
Background. An individual performing services as an employee may deduct expenses incurred in the performance of services as an employee as miscellaneous itemized deductions on Schedule A, Itemized Deductions, to the extent the expenses exceed 2% of the taxpayer's adjusted gross income. ( Code Sec. 62(a)(2) , Code Sec. 63(a) , Code Sec. 63(d) , Code Sec. 67(a) , and Code Sec. 67(b) ) Itemized deductions may result in alternative minimum tax because miscellaneous itemized deductions aren't taken into account in computing alternative minimum taxable income under Code Sec. 56(b)(1)(A)(i) .
On the other hand, an individual who performs services as an independent contractor is entitled to deduct expenses incurred in the performance of services on Schedule C and is not subject to limitations imposed on miscellaneous itemized deductions. Income and deductions attributable to the trade or business are shown on a Schedule C, and the resultant net profit or loss is taken into account in computing adjusted gross income. ( Code Sec. 62(a)(1) )
Under the common law rules (so-called because they originate from court cases rather than from the Code), an individual generally is an employee if the enterprise he works for has the right to control and direct him regarding the job he is to do and how he is to do it. In general, the factors used to determine if an individual is a common law employee are:
(1) The degree of control exercised by the principal;
(2) which party invests in work facilities used by the individual;
(3) the opportunity of the individual for profit or loss;
(4) whether the principal can discharge the individual;
(5) whether the work is part of the principal's regular business;
(6) the permanency of the relationship;
(7) the relationship the parties believed they were creating; and
(8) the provision of employee benefits.
Facts. From 2002 to 2009, Daniel Feaster was an accountant performing field auditing services for Wm. Langer & Associates, Inc., of the Carolinas (Langer), a company engaged in the business of insurance premium audits and inspections. On Dec. 18, 2002, he provided to Langer a completed Form W-4, Employee's Withholding Allowance Certificate. On Dec. 20, 2002, he signed an acknowledgment statement that was part of a Langer employee job description. The signed statement indicated that Feaster had read the employee job description and understood the company's expectations in regard to the job.
During 2006, Langer paid Feaster $29,615 in wages and withheld $1,915 for Federal income tax, $1,836.13 for Social Security tax, and $429.42 for Medicare tax. Langer reimbursed Feaster $6,764 for expenses.
On his 2006 Form 1040, Feaster reported $30,155 of gross receipts and $19,739.01 of net profits on Schedule C, Profit or Loss From Business. The gross receipts included the wages received from Langer. Feaster deducted car and truck expenses, office expenses, travel and meals expenses, and expenses for business use of his home in arriving at net profit. He reported $76.30 in self-employment tax and attached an explanatory statement that only part of his self-employment income was subject to self-employment tax because one of his clients “deducted fully-matched social security and Medicare tax, from the payments for my services” as shown on the W-2 attached to his return.
IRS determined a deficiency of $1,387 in Feaster's 2006 income tax on the ground that he was an employee. IRS said that he had to include the income as wages and claim any allowable related expenses on Form 2106, Employee Business Expenses, as an itemized deduction on Schedule A.
Accountant was an employee. Before the Tax Court, Feaster argued that in 2006 he was entitled to deduct business expenses on Schedule C because he was an independent contractor. IRS contended that Feaster was a common law employee in 2006.
Applying the common law rules, the Tax Court sided with IRS. The Court noted that Feaster signed his job description, acknowledging his agreement to follow guidelines established by Langer with respect to time limits for cases to be completed, frequency of submissions of completed work to the office, quality of work, charges to the customer, communication with Langer, status or progress reports, submission of itineraries, and closing cases. Feaster testified that he was not very good about complying with his obligations under the agreement to communicate with Langer. Nonetheless, the Tax Court concluded that Langer exercised, or had the right to exercise, control over Feaster in the performance of his services for it.
Feaster testified that he had to provide his own Internet service and that he worked out of his home, incurring office expenses. He acknowledged that he was offered hotel, meal, and vehicle mileage reimbursement and that he was reimbursed for some trip expenses during 2006. He was paid on an hourly basis, and his pay was subject to increase or decrease depending on Langer's assessment of his performance. The Court said that there was nothing to indicate that he had an opportunity for profit or risk of loss from his activities. On balance, none of these factors supported a conclusion that Feaster was an independent contractor.
The Court also stressed that Langer considered Feaster a common law employee, as evidenced by the job description that he signed and the tax reporting by Langer. Based on that evidence and the other factors present in the case, the Court concluded that Feaster was an employee.
EXP ¶34,014.37 Employee and employment relationship in general.
Withholding may be required by an employer as to wages paid to an employee. The term wages for withholding purposes is explained at ¶34,014.01 et seq. and categories of wages excluded from withholding requirements are covered at ¶34,014.13 et seq. ¶34,014.16 et seq. The question of whether payments for services are made to an employee in the scope of an employment relationship is dealt with in the paragraphs that follow, categorized by type of services involved.
The term “employee” in general covers a person who performs services within the scope of a common-law employee. Reg §31.3401(c)-1 . It normally doesn't include persons who offer services as part of their own business, independent contractors (see below), or professional persons who offer services to the public. The most important factor that indicates an employment relationship is the right of the employer to control or supervise the employee's manner of performing the job, rather than to merely require a particular result or work product. Also see Federal Payroll Comparison chart at ¶35,014.07 . Employers in doubt as to whether a particular class of workers are employees can get a ruling by filing Form SS-8 .
Federal judges are treated as employees for purposes of income taxes. Sec. 10103, PL 100-203, 12/22/87 reproduced in Footnote to Code Sec. 219 .
Employee or independent contractor?
The answer makes a lot of difference tax wise. Here is why: If a worker is an “employee,” the employer has to withhold taxes on the wages, and there is liability for Social Security and Federal Unemployment taxes placed on both the employer and employee. But an independent contractor has to pick up the self-employment tax tab on his or her own—and it's a healthy bite (almost twice the amount that would have been withheld if he were an employee). See ¶14,014 .
The following is a list of discussions regarding this issue:
• Directors, partners, and corporate officers. ¶34,014.39 .
• Managerial and supervisory personnel. ¶34,014.40 .
• Clerical and office workers. ¶34,014.41 .
• Workers in industry, construction, and other fields. ¶34,014.42 .
• Janitorial and security work. ¶34,014.43 .
• Sales reps, distributors, and vendors. ¶34,014.44 .
• Drivers, pilots, and trucking personnel. ¶34,014.45 .
• Barbers and beauticians. ¶34,014.46 .
• Attorneys and other legal services. ¶34,014.47 .
• Medical and scientific services. ¶34,014.48 .
• Architects and designers. ¶34,014.49 .
• Accountants and bookkeepers. ¶34,014.50 .
• Entertainers, artists, and writers. ¶34,014.51 .
• Athletes and athletic officials. ¶34,014.52 .
• Fiduciaries. ¶34,014.53 .
• Teachers and students. ¶34,014.54 .
• Domestics and baby sitters. ¶34,014.55 .
• Individuals involved in the farming, fishing, and logging industries. ¶34,014.56 .
• Services performed for unions. ¶34,014.57 .
• Governmental services. ¶34,014.58 .
For classification of workers as independent contractors under Section 530 of the Revenue Act of 1978, see ¶34,014.375 .
Realtors and direct sellers.
The law classifies licensed real estate agents and individuals who are direct sellers as self-employed independent contractors for federal income and employment tax purposes. But, two conditions are attached. First, substantially all of their income for services as real estate agents or direct sellers must be directly related to sales or other output. Second, their services are performed under a written contract that provides they will not be treated as employees for federal tax purposes. ¶35,084 .
For information reporting requirements on payments to independent contractors and direct sellers, see ¶60,41A4 .
Moratorium on certain IRS reclassifications.
As in the past, the employee v. independent contractors battle will generally be waged on a case-by-case basis. However, a moratorium on IRS reclassifications of individuals as employees has been extended indefinitely until Congress passes appropriate legislation. Except with respect to certain technical services workers (as explained below), Treasury and IRS are prohibited from issuing regulations or rulings with respect to the employment status of any individual for purposes of the employment taxes (i.e., income tax withholding, social security taxes, and federal unemployment taxes), until Congress enacts legislation on the classification of workers as independent contractors or employees. Sec. 530(b), PL 95-600, 11/6/78 reproduced in full at ¶34,015.38(5) . See Committee Report at ¶35,081.10 . Instructions for implementing Act Sec. 530 are in Rev. Proc. 85-18, 1985-1 CB 518 .

No moratorium for certain technical service personnel.
The moratorium on regulations and rulings described above does not apply with respect to individuals retained by any taxpayer to provide for other persons services as engineers, designers, drafters, computer programmers, systems analysts, and other similarly skilled personnel. Sec. 530(d), PL 95-600, 11/6/78 as added by Act Sec. 1706, PL 99-514, 10/22/86 . Act Sec. 530(d) is reproduced in full at ¶34,015.38(5) .

Factors for determining employee status.
Under Reg §31.3401(c)-1 , a person is an employee if the person for whom services are performed has “the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work, but also as to the details and means by which the result is accomplished.” Rev. Rul. 87-41, 1987-1 CB 296 , describes 20 factors that are used in determining whether an individual is an employee under the common-law standards and how they apply to technical service specialists in three factual situations.
Computation of employer liability for mistakes.
Suppose an employer makes a mistake. Say a worker has been treated as an independent contractor, and is then reclassified as an employee. Under prior law, there were problem situations. The law now provides a special formula to compute the employer's liability. ¶35,094 .
COMMON LAW RULES to determine whether the taxpayer is an employee. Nationwide Mut. Ins. Co. v. Darden, 503 U.S. 318, 323-325 (1992); Weber v. Commissioner, 103 T.C. 378, 386 (1994), affd. 60 F.3d 1104 [76 AFTR 2d 95-5782] (4th Cir. 1995). Whether an individual is an employee must be determined on the basis of the specific facts and circumstances involved. Weber v. Commissioner, 60 F.3d at 1110; Profl. & Exec. Leasing, Inc. v. Commissioner, 89 T.C. 225, 232 (1987), affd. 862 F.2d 751 [63 AFTR 2d 89-427] (9th Cir. 1988); Simpson v. Commissioner, 64 T.C. 974, 984 (1975). Relevant factors include: (1) The degree of control exercised by the principal; (2) which party invests in the work facilities used by the worker; (3) the opportunity of the individual for profit or loss; (4) whether the principal can discharge the individual; (5) whether the work is part of the principal's regular business; (6) the permanency of the relationship; (7) the relationship the parties believed they were creating; and (8) the provision of employee benefits. See Weber v. Commissioner, 60 F.3d at 1110, 1114; Ewens & Miller, Inc. v. Commissioner, 117 T.C. 263, 270 (2001). We consider all of the facts and circumstances of each case, and no single factor is determinative. Weber v. Commissioner, 60 F.3d at 1110; Ewens & Miller, Inc. v. Commissioner, supra at 270.
Although not the exclusive inquiry, the degree of control exercised by the principal over the worker is the crucial test in determining the nature of a working relationship. See Clackamas Gastroenterology Associates, P.C. v. Wells, 538 U.S. 440, 448 (2003); Leavell v. Commissioner, 104 T.C. 140, 149-150 (1995). To retain the requisite degree of control over a worker, the principal need not direct the worker's every move; it is sufficient if the right to do so exists. Weber v. Commissioner, 60 F.3d at 1110; see sec. 31.3401(c)-1(b), Employment Tax Regs.
The fact that a worker provides his or her own tools, or owns a vehicle that is used for work, is indicative of independent contractor status. Ewens & Miller, Inc. v. Commissioner, supra at 271 (citing Breaux & Daigle, Inc. v. United States, 900 F.2d 49, 53 [65 AFTR 2d 90-1133] (5th Cir. 1990)). Additionally, maintenance of a home office is consistent with independent contractor status, although alone it does not constitute sufficient basis for a finding of independent contractor status. See Colvin v. Commissioner, T.C. Memo. 2007-157 [TC Memo 2007-157], affd. 285 Fed. Appx. 157 [102 AFTR 2d 2008-5301] (5th Cir. 2008).
Benefits such as health insurance, life insurance, and retirement plans are typically provided to employees. Weber v. Commissioner, 103 T.C. at 393-394. The availability of the benefits suggests employee status.