ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – HOW TO BE BOTH AN EMPLOYEE AND AN INDEPENDENT CONTRACTOR FOR THE SAME EMPLOYER, AND BEAT THE FTB AT THE SAME TIME
By Robert S. Schriebman
How can a person be both an employee and an independent contractor working for the same company? How does he/she avoid paying California personal income taxes while residing in Texas but being paid by a California-based company? Christopher Wood accomplished both feats.
On July 8, 2019 the Office of Tax Appeals (OTA) published the Wood case. The OTA held that the FTB could not tax independent contractor income paid to Wood by his California-based company, Konrad Consulting, LLC (Konrad), Wood worked as a W2 wage earner for Konrad designing software and occasionally doing consultant work. He was paid $90,000 during 2015 as a W2 wage earner. However, he also assisted Konrad for a 3-month period in 2015 for various bid proposals. Wood resided in Texas and his work was Texas-based. He was paid $48,000 for these services and received a 1099. During this 3-month period he held virtual computer-based conferences with Konrad customers located in Canada.
The OTA did not question Wood’s status as an independent contractor. Apparently, the FTB was not concerned with worker status, but focused its attention and demands on whether Wood was required to file a California non-resident personal income tax return for 2015. The FTB argued that Wood had California source income because Konrad was a California employer. The OTA held that he was not required to do so.
The Wood Case
The FTB demanded that Wood file 2015 California return because his sole source of 1099 income came from a California employer. The Case of Christopher Wood, OTA Case No. 18042717, 2019-OTA-264 (July 8, 2019). The FTB issued Wood a Notice of Proposed Assessment (NPA) for his 1099 income and Wood filed a timely appeal. At the hearing he produced all kinds of documentary evidence proving that he resided in Texas. He also pointed out that the ultimate recipient of his services was a Canadian company based in Vancouver. The FTB argued that they have a new rule that if services “benefit” a California-based company, then the income received by the worker is California-based income requiring that a personal non-resident income tax return be filed, even if Wood received only one dollar ($1)!! The FTB argued that while Wood worked primarily with the Canadians, Konrad, his principal, benefited from his services because Konrad was the successful bidder.
The FTB prepared a “dummy return” estimating Wood’s tax exposure. The first thing the OTA discussed was that the actions of the FTB in estimating Wood’s exposure was reasonable and rational (Todd v. McColgan (1949) 89 Cal.App.2d 509). The next argument of the FTB was in reference to the Revenue Taxation Code, specifically Section 17041(a)(1). California residents are taxed on all income regardless of where it is received or earned. This did not apply to Wood because he offered ample proof that he was a Texas resident. However, Section 17951(a) provides that non-residents are taxed on California-based income. The FTB then cited a complicated multi-step formula for including and excluding sources of income. However, the OTA held that the complex formula did not catch Mr. Wood.
The OTA acknowledged that Konrad did benefit from Wood’s services in securing successful bids. However, Konrad was an incidental beneficiary. The real beneficiary was the Canadian company, a customer of Konrad. Accordingly, Wood did not have to file a California personal income tax return.
This case is important for two reasons. It can be used in an EDD audit to show that rare happening where one worker is allowed to be both a common law employee, receiving a W2, and an independent contractor receiving a 1099. The EDD was not involved in this case, but if it had been a good solid argument could be made for duo worker status. The case is also important to show that if the ultimate beneficiary of services is not a California-based company, a non-resident does not have to file a California personal income tax return.
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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