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ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – THE US TAX COURT WEIGHS IN ON THE ON THE ISSUES DETERMINING EMPLOYEE VS INDEPENDENT CONTRACTOR – NEW TESTS AND NEW WORLD VIEWS – PART 2

By Robert S. Schriebman

2018

Introduction

This is Part 2 of a series of articles that will discuss the new US Tax Court Decision of Hampton Software Development, LLC v. Commissioner, 61,197(M), T.C. Memo. 2018-87 (June 19, 2018). Throughout this series of articles we will refer to the taxpayer as "Hampton."

The Hampton case has nothing to do with software development despite the title. The case involves the management a 60-unit apartment complex in Tulsa, OK. The key player is Robert Herndon (Herndon) the property manager of the complex. This is a long decision centering on Herndon and whether he was an employee or independent contractor. The case sets forth a new 8 factor test at the federal level to determine if a worker is an employee or an independent contractor.

The US Tax Court 8 Factor Test

In reaching the Court's decision Judge Chiechi set forth an 8 factor test as follows:

  1. The degree of control exercised by the person for whom the work is performed over the details of the work;
  2. Which party invests in the facilities used by the worker;
  3. The opportunity of the worker for profit or the risk of the worker for loss;
  4. Whether the principal has the right to discharge the worker;
  5. Whether the work is part of the principal's regular business;
  6. The permanency of the relationship between the principal and the worker;
  7. The relationship that the principal and the worker believed they were creating; and
  8. Whether the principal provided the worker any so-called employee benefits.

According to Judge Chiechi, "In resolving the issue of whether a worker is an employee, all of the facts and circumstances must be considered, and no one factor is dispositive." See Weber v. Commissioner, 103 TC 378, 386 (1994). Judge Chiechi did not discuss the IRS famous "20 factor" test in reaching her decision.

In part 2 we will review the basic rules requiring employers to withhold income taxes and FICA taxes and we will also review the Court's analysis of the issue of control.

Basic Employer Withholding Obligations

Employment tax obligations were created under the Federal Insurance Contributions Act (FICA) and so-called unemployment tax under the Federal Unemployment Tax Act (FUTA). These rules can be found in IRC §§ 3101(a), 3111(a), and 3301. The employer holds these taxes "in trust" for the employer. Even if the employer fails to pay over these tax obligations, the employee will still get the benefits under the law.

The definition of employee is found in IRC § 3121(d)(2). An employee includes any individual who, under the usual common law rules applicable in determining the employer-employee relationship has the status of employee. The same definition applies for unemployment tax purposes. IRC § 3306(i).

The Issue of Control

Both the IRS and the EDD determine an employer-employee relationship by the presence of control. If a person has the right to exercise control over the work being performed, with respect to not only the result to be accomplished, but also the details and the means by which that work is accomplished, the person doing the hiring is an employer. See Regulation §§31.3121(d)-1(c)(2), 31.3306(i)-1(b), 31.3401(c)-1(b), Employment Tax Regs.

Ironically, an employer does not have to actually, in fact, control the worker at all. What is important, under federal law, is that the employer has the "right" to control and it does not matter whether or not the right is actually exercised. In other words, the employer "need not stand over the ... worker and direct every move made by that worker." Weber v. Commissioner, 103 T.C. at 388 (1994). Nor is it necessary, in order to find the worker to be an employee, that the employer supervises every detail of that worker's job. As long as the employer has the right to supervise, that worker is an employee. In other words, supervision and control are two different things.

The type of work, the skills of the worker, and the nature of services provided, often govern the degree of control necessary for a finding of employee status. Unskilled workers, requiring supervision, are clearly employees, but highly skilled and educated workers such as lawyers, doctors, or dentists may still be employees even though no supervision is actually exercised.

The Tax Court found Herndon to be an employee, even though he did not need supervision. He did routine work, such as plumbing and maintenance. He also did whatever was necessary to make apartments livable for new tenants. This included construction skills, such as painting, replacing old carpet and drywall work. Herndon mowed the lawn using the Hamptons' lawn mower. He also did the various work set forth in Part 1 of this series.

The Hamptons had the right to control what Herndon did. The Court found that they directed and controlled the work done at the apartment complex, by giving Herndon instructions as to what to do and what not to do. And specifying the dates on which Herndon was required to do his work and setting forth priorities. They gave him guidelines and required him to submit reports on the status of the non-routine work that he was doing. Herndon also worked out of the Hamptons' office.

The fact that Herndon was not supervised did not undermine the Court's findings that the Hamptons retain the right to direct or control what Herndon did.

All of these factors went into a sort of "control soup" that established Herndon to be an employee.

Conclusion

In Part 3 we will review the rest of the factors used by the Court as well as review Hamptons' failed effort to argue for safe harbor relief under Section 530 of the Revenue Act of 1978.

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Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States. He has successfully dedicated more than 40 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments. Mr. Schriebman is in private practice. He is not affiliated in any way with the EDD and he is not employed by the EDD or any other agency of the State of California.

Robert Schriebman has written the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See "California Tax Collection Practice and Procedures" and "California Taxation Practice and Procedure," both published by Commerce Clearing House.

Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, "IRS Tax Collection Procedures - A Manual for Practitioners" published by Commerce Clearing House.

Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, "IRS Tax Collection Procedures - A Manual for Practitioners" published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See "California Tax Collection Practice and Procedures" and "California Taxation Practice and Procedure," both published by Commerce Clearing House.

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