Short Summary:
Prior to and during 1992, Ewens and Miller, Inc. (Petitioner) manufactured bakery products. Petitioner had multiple categories of workers: bakery workers[1]; cash payroll workers[2]; route distributors[3]; outside sales workers.[4]
On November 4, 1991, Petitioner issued a memorandum to all workers stating, among other things, that some workers had been treated as employees and some as independent contractors, however, starting January 1, 1992, all workers would be treated as independent contractors. Those that wished to remain employed as independent contractors would be required to sign a statement accepting responsibility for their own payroll taxes, and those that did not wish to remain employed following the change, would be discharged prior to the start of 1992. After January 1, 1992, there were no changes in the activities Petitioner’s various categories of workers performed. Petitioner’s reason for the conversion was to protect itself from lawsuits and to have better control over the activities of its workers.
Roger Miller, one of the named partners of Ewens and Miller, Inc., a CPA, prepared Petitioner’s Federal corporate income tax returns for 1991 and 1992, and signed Petitioner’s Federal employment tax returns for 1992. For 1991, Petitioner reported salaries and wages of $196,433 on its Federal corporate income tax return; issued 51 Forms W-2 to its employees reporting total wages of $196,432.60; reported $81,143 of sub-contractual labor; and issued 10 Forms 1099-MISC reporting total payments of $37,930.74. For 1992, Petitioner reported no salaries and wages on its Federal corporate income tax return; reported $115,287 of sub-contractual labor; and issued 36 Forms 1099-MISC reporting total payments of $115,287.05.
Petitioner filed Forms 941, Employer’s Quarterly Federal Tax Return, for the four quarters of 1992 and reported no wages subject to withholding, no withheld income tax, no Social Security nor Medicare tax. The final Form 941 filed in 1992 indicated that final wages were paid December 31, 1991, that Petitioner had no employees, and was out of business. Petitioner’s Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, for 1992 also reported no wages, that Petitioner had no employees, and was out of business.
The Commissioner of Internal Revenue (Commissioner) concluded that, for 1992, all of Petitioner’s workers were employees for employment tax purposes. Additionally, the Commissioner concluded Petitioner was not entitled to IRC § 530 (1978) relief for any of these workers and determined penalties pursuant to IRC § 6656.
Key Issues:
Issue 1: Whether the Tax Court’s jurisdiction to decide the proper amount of employment taxes provides the Tax Court with jurisdiction to decide the proper amount of additions to tax and penalties related to employment tax arising from worker classification of IRC § 530 (1978) treatment determinations?
Issue 2: Whether the workers performing services for Petitioner were employees during 1992?
Issue 3 [Issue of first impression]: Whether Petitioner is entitled to “safe harbor” relief as provided by IRC § 530 (1978)?
Primary Holding:
Issue 1: Yes, the Tax Court’s jurisdiction to decide the correct amounts of employment taxes also provides it with the jurisdiction to decide the proper amount of additions to tax and penalties related to employment tax arising from worker classification or IRC § 530 (1978) treatment determinations.
Issue 2: The cash payroll workers, bakery workers, and outside sales workers were common law employees under IRC § 3121(d)(2). The route distributors were statutory employees under IRC § 3121(d)(3).
Issue 3: No, Petitioner is not entitled to “safe harbor” relief as provided by IRC § 530 (1978) because Petitioner did not have a reasonable basis for treating the bakery workers, cash payroll workers, route distributors, and outside sales workers as independent contractors as opposed to employees.
Key Points of Law:
Issue 1: Jurisdiction
- IRC § 6665(a)(2) provides that, except as otherwise provided, any reference in Title 26 to a tax imposed by Title 26 shall be deemed also to refer to the additions to tax, additional amounts, and penalties provided by chapter 68 of subtitle F.
- IRC § 6656, under which the Commissioner determined penalties against Petitioner in the present case, is found in chapter 68 of subtitle F.
- IRC § 7436(e) provides that the term “employment tax” means any tax imposed by subtitle C and does not exclude additions to tax or penalties from the definition of employment tax.
- Therefore, the Court concluded it did have jurisdiction over additions to tax and penalties found in chapter 68 of subtitle F, including additions to tax and penalties related to taxes imposed by subtitle C with respect to worker classification or IRC § 530 (1978) treatment determinations.
Issue 2: Employee v. Independent Contractor
- The Commissioner’s determinations are presumed to be correct, and petitioner bears the burden of proving Commissioner’s determinations are erroneous – this principle extends to Commissioner’s finding that a taxpayer’s workers are employees. Welch v. Helvering, 290 U.S. 111, 115 (1933); Boles Trucking, Inc. v. United States, 77 F.3d 236, 239-40 (8th Cir. 1996).
- If an employer-employee relationship exists, a different characterization of the relationship by the parties is irrelevant. Treas. Reg. § 31.3121(d)-1(a)(3).
- A worker can be a “statutory employee” under IRC § 3121(d)(3) only if he is not a common law employee under IRC § 3121(d)(2).
- To determine a worker’s status as that of an “employee,” courts are to apply common law concepts, and be mindful that doubtful questions should be resolved in favor of employment.
- In determining whether a worker is a common law employee or an independent contractor, the Tax Court considers the following factors: (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 works I part of the principal’s regular business; (6) the permanency of the relationship; and (7) the relationship the parties believed they were creating. Weber v. Commissioner, 103 T.C. 378, 387, 1994 WL 461872 (Aug. 25, 1994), aff’d. per curiam, 60 F.3d 1104 (4th Cir. 1995).
- For employment tax purposes, IRC § 3121(d)(3)(A) provides that an employee is an individual who performs services for remuneration for any person as an agent-driver or commissioner-driver engaged in distributing, among other products, bakery products. [emphasis added]
- The Employment Tax Regulations further provide that an agent-driver or commission-driver includes an individual who operates his own truck or the truck of the person for whom he performs services, serves customers designated by such person as well as those solicited on his own, and whose compensation is a commission on his sales or the difference between the price he charges his customers and the price he pays to such person for the product or service. Treas. Reg. § 31.3121(d)-1(d)(3)(i).
Issue 3: IRC § 530 (1978)
- Congress enacted IRC § 530 (1978) to alleviate what it perceived as the “overly zealous pursuit and assessment of taxes and penalties against employers who had, in good faith, misclassified their employees as independent contractors.” Boles Trucking, Inc. v. United States, 77 F.3d 236, 239 (8th Cir. 1996).
- Under IRC § 530(a)(1) (1978), a taxpayer is treated as having a reasonable basis for not treating an individual as an employee if the taxpayer’s treatment of the individual was in reasonable reliance on (1) judicial precedent, (2) published rulings, (3) technical advice with respect to the taxpayer, (4) a letter ruling to the taxpayer, (5) a past IRS audit of the taxpayer if the audit entailed no assessment attributable to the taxpayer’s employment tax treatment of individuals holding positions substantially similar to the position held by the individual whose status is at issue, or (6) a longstanding recognized practice of a significant segment of the industry in which the individual was engaged. IRC § 530(a)(2) (1978); Veterinary Surgical Consultants, P.C. v. Commissioner, 117 T.C. 141, 147, (2001).
- However, if a taxpayer fails to meet any of the above listed safe havens, they may still be entitled to relief if the taxpayer can demonstrate, in some other manner, a reasonable basis for not treating the individual as an employee. Veterinary Surgical Consultants, P.C. v. Commissioner, 117 T.C. 141, 147, (2001).
Insight:
Particularly with respect to worker classification as either an employee or an independent contractor, this case emphasizes the importance of clearly defining a worker as one or the other. In reviewing a worker’s classification so as to determine whether it is proper, there is no one factor that is dispositive of being classified as an employee or an independent contractor – numerous factors are explored in order to allow an informed conclusion to be made.
Further, this case makes clear that there are consequences for employers who claim to treat their workers as independent contractors, when in reality, there is an employer-employee relationship. If an employer chooses to change the classification of its workers, meticulousness in establishing boundaries, expectations, and the relationships between the employer and workers cannot be overstated.
[1] The bakery workers worked at Petitioner’s plant using equipment and supplies provided by Petitioner. Petitioner did not set the bakery worker’s hours; however, bakery workers could not leave until the daily production quota was met. The bakery workers were paid a fixed amount based on the amount of product produced. In 1991, Petitioner treated the bakery workers as employees and issued each one a Form W-2.
[2] The cash payroll workers were a family of six or seven that had worked for Petitioner for many years prior to 1992. The cash payroll workers performed the same duties as the bakery workers and beginning in 1987, pursuant to an agreement between Petitioner and the family, the cash payroll workers also supervised the bakery workers.
[3] The route distributors used their personal vehicles to transport Petitioner’s products from the plant to individuals or businesses that purchased the products. The route distributors set their own schedules. Some route distributors bought the product and resold it at a higher price; others worked on a commission basis. In 1991, Petitioner issued at least one route distributor a Form W-2.
[4] The outside sales workers marketed Petitioner’s products. They used their own vehicles and set their own schedules. When an outside sales worker sold a product, they received a commission. Petitioner retained the right to hire and fire the outside sales workers. In 1991, Petitioner issued at least two outside sales workers a Form W-2.
