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ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – WORKER CLASSIFICATION GUIDELINES IN A POST COVID-19 GIG ECONOMY – PART 1

By Robert S. Schriebman
2020

Introduction

This is Part 1 of a 3-Part series that will review guidelines for worker classification in a post COVID-19 gig economy in light of the US Tax Court’s decision in Santos v. Commissioner.  The decision was issued on June 17, 2020. (Santos v. Commissioner, T.C. Memo 2020-88, T.C.M, June 17, 2020).  Leticia Santos owned and operated a cleaning referral service, as a sole proprietor, where she had contracts with building owners and apartment managers to clean and make ready apartments and offices for new tenants.  She won her Tax Court case and the workers were held to be independent contractors. The case is important on many levels.

IRS worker classification cases do not come out often.  It is important, therefore, to review them carefully when they do come out.  The Santos case, I believe, has much to offer especially as we adjust to a new world post COVID-19.

In Part 1, I will review the facts in the Santos case and all of the factors that the US Tax Court found important in determining that workers engaged in cleaning and janitorial services were found to be independent contractors.  Before doing so, however, I would like to say a few words about operating a business as a sole proprietor as opposed to a corporation or LLC.

Avoid Operating as a Sole Proprietorship

A sole proprietorship may have the advantages of simplicity and cost savings.  You don’t have to concern yourself with the recognition and formalities of a separate entity such as a corporation or LLC.  You also do not have the additional expenses associated with these entities, such as annual minimum franchise taxes, and the costs of additional income tax returns.  You can be your own boss and not answer to anyone.  But, when it comes to exposures for business related liabilities and full exposure for payroll tax non-compliance, a sole proprietorship affords you no protections at all.  Leticia Santos won her case against the IRS as will be explained in this series of articles.  If she had lost, she would have been fully liable for 100% of the additional payroll taxes the IRS assessed against her.

The saddest cases that come across my desk are those where the business owners operated as sole proprietors.  This is especially true when these individuals did not protect their rights by filing timely petitions with both the EDD and the IRS.  If they had been incorporated, they may have dodged some very large bullets, or at least minimized their personal exposure.

It makes smart business sense to take the steps necessary to protect yourself and your personal assets at the beginning of the enterprise.  If you wait too long things can get complicated and the costs of restructuring may generate substantial accounting and attorney fees.

The Facts in the Santos Case

When Leticia Santos first started in business, she cleaned apartments and offices by herself.  She soon hired a couple of workers to assist her.  Eventually, her business grew and prospered.  Soon, she found herself with contracts from building owners, and apartment managers to clean and refurbish vacant properties for new tenants.  Instead of doing the work herself, she became a referral service operating much like a domestic agency or nursing registry.  She offered cleaning jobs to a list of workers that she treated as independent contractors.  She issued those workers 1099s instead of W2s.  She did not file any federal payroll tax returns – no 941s and no 940s.  Her job was strictly limited to management and administration.  The IRS audited Leticia’s business and found that she misclassified workers and that these workers should have been treated as common law employees.  Accordingly, the IRS assessed back withholding and employment taxes.  Leticia disagreed with the IRS and filed a petition in the US Tax Court.  The following is a list of factors used by the US Tax Court in holding that Leticia’s workers were indeed independent contractors.

US Tax Court Factors Favorable for Independent Contractor Status

  • The Court found that Santos operated very much like a registry.
  • Santos rarely supervised a worker. No training was required.
  • The only “qualifying control” that Santos exercised was directing a worker after the cleaning job was finished, to return to the job site if the work was deficient. This rarely happened.
  • Apartment owners required Santos to have liability insurance and workers compensation insurance.
  • There were no written contracts with workers. The only written contracts were with building owners and apartment managers.
  • No workers were ever terminated.
  • Workers could refuse any job.
  • Workers got the job done at their own pace, without pressure from Santos.
  • There was no guarantee of a minimum amount of work or frequency of work.
  • Workers used their own cleaning supplies.
  • Workers were paid a flat fee per job. They were paid by the week. There were no benefits of any kind.
  • Workers were free to work for others and they were free to hire their own assistants.
  • Workers used their own vehicle or took public transportation. There were no reimbursements.
  • Once on the premises, the property manager gave the worker a key and told the worker where to go, and what needed to be done.
  • Workers testified during the US Tax Court proceeding. Note: this is very important factor.  If you want to win your case, especially at an EDD related hearing, it is important to have witnesses who will back you up.

Conclusion

Leticia Santos’ cleaning workers give the appearance of being gig workers.  They do not have to take a specific assignment and show up for short-term engagements.  Hers may very well be another gig economy model.

In Parts 2 and 3, I will review the US Tax Court’s reasoning in the Santos matter.  The Court had an interesting side comment on written contracts establishing an employer-employee relationship where the worker should have been classified as independent contractor.  This is a switch!  Finally, I will discuss how the Santos case could be an exception to the new standards set forth in AB-5.

***

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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