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ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – WORKER CLASSIFICATION GUIDELINES IN A POST COVID-19 GIG ECONOMY – PART 3

By Robert S. Schriebman
2020

Introduction

This is Part 3 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 2, I discussed the presumption of correctness on the part of the auditor in both an EDD and IRS worker status audit.  I also discussed the key element of control, the definition of control, and the elements of control used by the US Tax Court.

In this Part 3 I will discuss the following issues.

  • How the US Tax Court saw the Santos case as a potential model for a gig-based business.
  • The importance the US Tax Court found in the factor of workers’ compensation coverage carried by Santos. Did this factor alone establish control?
  • The intention of the parties and how important a written contract may be in establishing an employer-employee relationship.
  • How the three elements of AB-5 might impact a situation like the Santos’ matter.

Can the Santos Case be a Potential Model for a Gig-Based Business?

Leticia Santos had written contracts with building owners and apartment managers to clean and make ready vacancies for new tenants. She had no written contracts with workers. She had a list of workers and would contact them on a job-by-job basis.  Workers were free to accept or reject a specific cleaning assignment.  As these workers were highly experienced, the control Santos exercised was minimal.

The US Tax Court held that Santos’ role was more that of a dispatcher or facilitator, acting as a financial and linguistic bridge or intermediary between her workers and the apartment complexes.  She directed her workers as to the result to be accomplished and expected the result to be done in a proper manner and to the satisfaction of the property managers.  The workers used their own discretion as to the means and methods of accomplishing the final results.  Thus, concluded the Court, the workers were independent contractors.

The Worker’s Compensation Issue

Santos’ clients required that she carry liability insurance and worker’s compensation insurance.  If this were an EDD audit, that factor alone may be fatal to any argument that the workers are independent contractors.  However, the US Tax Court did not see it that way.  Instead, the Court did not find this to be definitive evidence that Santos had the requisite degree of control over her workers.  The Court found that this factor only went to the relationship between Santos and the property owners, and had no legal bearing on her relationship with her workers.  This may be a strong argument to use against the EDD when they try to pin the employer-employee relationship on the principal.  At least it can be a bargaining chip in settlement negotiations or brought to the attention of a CUIAB judge.

The Importance of the Intention of the Parties

When it comes to determining the intention of the parties, actions speak louder than words.  Here Santos consistently issued 1099s to all workers and did not file quarterly or annual payroll tax returns.  She also offered credible testimony during the trial.  The judge found that she certainly thought she was creating an independent contractor relationship with her workers.

The Importance of a Written Contract Setting Forth Worker Status

Just how important is a written contract that sets forth an employer-employee relationship? If we are discussing an EDD audit, I can tell you from many years of experience, that the EDD pays little attention to a contract setting forth a principal independent contractor relationship. I have had audits where I can swear that the auditor never bothers to read the contract.  In the Santos case, the Tax Court turned a written contract providing employer-employee relationship on its head by stating, “A contract purporting to create an employer-employee relationship will not control where the common law factors established that the relationship does not exist.”  In other words, the Court can actually find that the workers are independent contractors.  I thought this observation was significant; a real switch!

Conclusion

Is it possible for a US Tax Court case to be used in arguing around AB-5 (Labor Code § 2750.3)?  There are three key elements to avoiding AB-5.

In Santos it was very clear that the workers were free from the control and direction of Leticia Santos – element number one is satisfied.

The Tax Court held that Santos was in the business of dispatching and facilitating a match between the workers and apartment managers.  So, it can be argued that the workers performed services that are outside the usual course of business – element number two is satisfied.

There are many EDD administrative decisions that have held that cleaning and janitorial services are conducted by independent contractors and therefore, they are independently established trades or occupations – element number three is satisfied.

Understand that AB-5 is new and EDD audits are just getting underway due to COVID-19.  As Samuel Goldwyn was fond of saying, “Nobody knows nothing.”

***

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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