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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 3

By Robert S. Schriebman



This is Part 3 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 3 we will review the following factors used by the US Tax Court in reaching the conclusion that Herndon was a common law employee and the Hamptons owe the IRS employment and withholding taxes:

  • Herndon’s investment in facilities
  • Herndon’s opportunity for profit and risk of loss
  • The Hamptons’ right to discharge Herndon at will
  • Was Herndon’s services an integral part of Hamptons’ business?
  • Permanency of the relationship between Herndon and the Hamptons
  • The intent of the parties
  • Herndon’s receipt of employee benefits
  • Availability of safe harbor relief under Section 530 of the Revenue Act of 1978.

Herndon’s Investment in Facilities

Where the worker has little or no investment in facilities used to accomplish his work, that fact tends to prove that the worker is an employee and not an independent contractor.

While Herndon used his own maintenance tools such as, a hammer, saw, drill, and mud bucket for carpentry work and for plumbing maintenance work, this was not sufficient in the eyes of the Tax Court. Herndon operated out of the Hamptons’ office and used their equipment in addition to his own. For example, he used the company’s lawn mower to cut the grass.

Therefore, this factor had little weight in Herndon’s favor.

Herndon’s Opportunity for Profit and Risk of loss

There were two factors discussed by Judge Chiechi that gave me pause. This is one of them. I disagreed with her reasoning. A long-standing position taken by the EDD and the IRS that if a worker does not have an opportunity for profit or a risk of loss in the arrangement, the worker is usually held to be an employee. Here Herndon received a rent-free apartment and flat fee of $2,000 per month, regardless of how many hours he worked.

The Tax Court held that a negotiated flat fee paid to a worker does two things: (1) insulates the worker from suffering a loss if the cost of the project exceeds the amount budgeted; and (2) prevents the worker from realizing a profit if, after completion of the project, the actual cost is less than what was initially estimated. The Court further held that a flat fee prevents a worker from increasing, through his efforts, the earnings received for his work.

As an attorney who has consistently charged clients flat fees, over many years, I can tell you with clear knowledge and experience that I have lost money on plenty of cases. In most of my cases I come out OK, but in my worldview and experience, flat fees certainly carry both risks of loss and opportunities for profit. In my opinion the Tax Court got it wrong here.

The Hamptons’ Right to Discharge Herndon at Will

The Tax Court had made up its mind that Herndon was an employee. It held that both Herndon and the Hamptons could terminate their relationship at will. Most findings of an independent contractor relationship will examine a written contract to determine if premature termination could result in exposure for damages. There was no written contract between the Hamptons and Herndon.


Was Herndon’s Work an Integral part of Hamptons’ Business?

If Herndon’s work was an essential part of the operation of the Hampton’s apartment complex, that factor would tend to show Herndon to be an employee. Of all factors used by both the EDD and the IRS, this is perhaps the most difficult to overcome in attempting to prove the worker to be an independent contractor. Most successful businesses do not spend money on things that are not an integral part of their operations. It is easy, therefore, to use this factor to establish an employer-employee relationship.

The Tax Court found that Herndon’s work “played an integral role in the business [petitioner’s apartment complex business] by keeping vacancies to a minimum, [and] maintaining the physical integrity of the propert[y].” Calveston Portfolio, Ltd. V. Commissioner, 144 TC 118.

I believe that the Court reached the right conclusion in this factor.

Permanency of the Relationship between Herndon and the Hamptons

Herndon had worked for the prior owners of the apartment complex for about 15 years before the Hamptons acquired it. He continued his duties as usual. Herndon occasionally did odd jobs for owners of neighboring properties but this work was few and far between. Permanency in the relationship is a strong indication that the worker is an employee.

The Intent of the Parties

This is the second part of the opinion that gave me pause. The Court stated the following, “Where the principal and the worker intend to establish an independent contractor relationship, ‘such an intention does not carry much weight [in determining whether the worker is an independent contractor or an employee] when the common law factors compel a finding that an employer-employee relationship exists.” Calveston Portfolio, Ltd. V. Commissioner, 144 TC 119.

I think the Tax Court brushed over this factor without doing its homework. In any business relationship the intention of the parties is of primary importance. Herndon was never asked by Judge Chiechi what he thought the relationship was. She only pointed out “…he did not expressly testify what the relationship he intended to establish with petitioner when he began working for it in 2006.” The Hamptons made a stupid mistake by not appearing at the Tax Court trial.

There was no written contract between Herndon and the Hamptons. As Samuel Goldwyn famously said, “An oral contract is not worth the paper it’s written on.”

Herndon’s Receipt of Employee Benefits

Herndon received none of the usual employee benefits such as health insurance. He was paid for vacations and a few days off here and there. He also received a rent-free apartment.

Availability of Safe Harbor Relief under Section 530 of the Revenue Act of 1978


Safe harbor provisions were available to the Hamptons if they satisfied all of the following requirements: (1) The Hamptons did not treat Herndon as an employee for any period; (2) the Hamptons consistently treated Herndon as an independent contractor in all tax returns filed after the tax year 1978; and (3) the Hamptons had a reasonable basis for not treating Herndon as employee. All three of these requirements must be satisfied.

The Hamptons flunked the first requirement that they consistently treated Herndon as an independent contractor because they failed to give him a Form 1099-MISC. This is required by IRC §§ 6041(a) and 6041A(a). Because of this failure they were denied safe harbor relief. The Tax Court did not have to look any further.


On the whole I believe the Tax Court decision was the right one. It is too early to say with any certainty whether the IRS will modify its famous 20-factor test to reduce things down to 8-factors used in this case. It is doubtful that the EDD will pay any attention to this decision other than to use it to the EDD’s benefit against an employer. If the employer adopts a strategy of using only these 8 factors to attempt to win the day against the EDD, that effort will not succeed in my opinion. After all the EDD has its new Dynamex case with only a 3-part ABC Test. When it comes to the EDD, 3 large marbles are better than 8 small ones.


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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