ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – WORKER CLASSIFICATION GUIDELINES IN A POST COVID-19 GIG ECONOMY – PART 2
By Robert S. Schriebman
This is Part 2 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 this Part 2, I will review the elements of the favorable decision in the Santos case. I will first discuss the presumption of correctness on worker status audits. I will also discuss the definition of the all-important element of control necessary for an employer-employee relationship. Finally, I will discuss the US Tax Court’s decision in Weber v. Commissioner that sets forth the key elements consider by the Court in worker status matters.
Presumption of Correctness in Worker Status Audits
In general, an auditor’s determination in either an IRS notice of deficiency or an EDD notice of assessment, carries with it a presumption of correctness. Even if the assessment is based upon an estimation, instead of an actual examination of the employer’s books and records, that proposed assessment is presumed to be correct. The employer bares the burden of proving otherwise. Therefore, it is a mistake to show up at a hearing and attempt persuade a judge or hearing officer that the assessment should be thrown out because it is based on estimations. Long ago, the US Supreme Court upheld an IRS audit that was based solely upon estimations due to the lack of cooperation on the part of the employer-taxpayer and his accountant.
The Key Definition of Control – The Weber Case
If you have studied the articles on this website, you will soon discover that the key to determining whether a worker is an employee or an independent contractor, is based upon the presence of the element of control. The extent to which the principal has the right to exercise control over the worker is the “crucial test” in determining the nature of a working relationship. (Weber v. Commissioner, 103 T.C. 378, (1994)). Actual control does not necessarily have to be exercised by the principal. As long as that principal has the right to control, it is the right that is the all-important sub-element to the primary element of control. But where is the definition of control to be found? Afterall, both the EDD and the IRS must find and define the element of control in order to successfully establish an employer-employee relationship.
Employment Tax Regulation § 31.3121(d) may very well be the genesis definition used by both the EDD and the IRS.
“Generally…an employer-employee relationship exists when the person for whom services are performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work but also as to the details and means that result is accomplished. That is, an employee is subject to the will and control of the employer not only as to what shall be done but how it shall be done. In this connection, it is not necessary that the employer actually direct or control the manner in which the services are performed; it is sufficient if he has the right to do so. The right to discharge is also an important factor indicating that the person possessing that right is an employer. Other factors characteristic of an employer, but not necessarily present in every case, are the furnishing of tools and the furnishing of a place to work, to the individual who performs the services. In general, if an individual is subject to the control or direction of another merely as to the result to be accomplished by the work and not as to the means and methods for accomplishing the result, he [or she] is an independent contractor. An individual performing services as an independent contractor is not as to such services an employee under the usual common law rules…”
Weber Case Factors
The Weber case, cited above, has set forth the relevant factors used by the US Tax Court in reaching a decision on a worker status issue. Here are those factors:
1. A degree of control exercised by the principal over the worker.
2. Which party invests in the work facilities used by the worker?
3. The worker’s opportunity for profit or loss.
4. Whether the principal can discharge the worker.
5. Whether the work is part of the principal’s regular business.
6. The permanency of the relationship.
7. The relationship the parties believed they were creating.
No single factor alone will decide the status of the worker. The judge must take into account all facts and circumstances. See also Ewen’s & Miller v. Commissioner, 117 T.C. at 270.
The IRS uses a 21-factor test to determine worker status; the EDD uses a 23-factor test. It is not clear of this writing the impact AB-5 will have on the 23-factor test.
In Part 3, I will review the issue of workers’ compensation and its impact on the Tax court’s conclusion that the cleaning workers were independent contractors. I will also review a very interesting position taken by the Court where it disregarded the employer-employee relationship set forth in a written contract to find that the real status of the worker was an independent contractor. Finally, I will also discuss how the Santos case can be a model for a gig-based business
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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