Tax Court: Sole Proprietor’s Sub-contractors are Employees

The taxpayer in Kurek v. Commissioner was a sole proprietor in the business of home renovations. He reported his business income on Schedule C and hired approximately 30 workers to assist him on various projects. He did not: issue Forms 1099 or W-2 to any of the workers, offer employee benefits, carry unemployment insurance or workers compensation insurance. An IRS examination determined that the workers were employees for FICA, FUTA and federal income tax withholding purposes. Mr. Kurek petitioned the Tax Court.

Whether a worker is classified as an employee or independent contractor is a facts and circumstances test based on a variety of factors. The determinative question, however, is whether the employer has the right to control and direct the worker, even if he did not actually do so.

Mr. Kurek had some pretty good facts in his favor: None of the workers worked full-time; each worker was paid on a project-by-project basis; each worker set his own hours and schedule; each worker used his own tools; workers could work for other construction groups; and workers were replaced if they failed to meet a deadline. All of these facts weigh in favor of independent contactor status.

However, the Tax Court found otherwise. The Court emphasized that the taxpayer (1) exercised ultimate authority over the workers as to their job responsibilities, (2) approved the quality of their work, and (3) paid them weekly rather than at the end of the project. It also considered the fact that only the taxpayer communicated with the homeowners, and that he alone was responsible for the success or failure of the projects. It gave considerably less weight to the factors in favor of independent contractor status and concluded that the workers should be classified as employees because the taxpayer failed to prove that he did not control them.

The taxpayer also did not qualify for Section 530 relief because he did not file a Form 1099 for any of the workers.

Read the opinion here:
Kurek v. Commissioner, T.C. Memo 2013-64

6th Circuit: Severance Payments Not Subject to FICA Withholding

In a long-awaited decision, the Sixth Circuit has held that severance payments following involuntary lay-offs were not wages for FICA reporting purposes. The decision is an opportunity for refund claims by corporate taxpayers who have made similar severance payments after shutting down a physical location or line of business. Neither a bankruptcy or complete business closure is necessary. Taxpayers should contact their tax advisors to review their facts before filing a claim.

The facts of this case are as follows. Quality Stores, Inc., the operator of Central Tractor Farm & Country, went through bankruptcy proceedings beginning in the fall of 2001. Quality Stores closed all locations and operations. As part of the closures, the company filed pre- and post-petition severance plans for its employees that included payments for job losses. FICA and Federal income taxes were withheld from the payments.

Quality Stores later filed a claim for refund of over $1 million for the employer and employee portions of the remitted FICA taxes. The claim was denied by the IRS and the taxpayer sought relief in the Bankruptcy Court. The Bankruptcy Court found that the severance payments were supplemental unemployment compensation benefits (“SUB payments”) and therefore not wages for purposes of FICA withholding. The refund was proper. The District Court affirmed. The government appealed.

The Court of Appeals was asked to determine whether the payments were SUB payments, and if they were, whether or not they were also wages for purposes of FICA withholding. IRC Section 3402(o) provides for the “[e]xtension of withholding to certain payments other than wages.” The Court’s decision turned on the question of whether or not the SUB payments were “other than wages” as suggested by Section 3402(o). If the payments were not wages for FICA purposes, then the refund should be granted.

The Court of Appeals reviewed the matter de novo and agreed with the lower courts’ determinations that the payments were SUB payments. This was an important determination because it was a point of distinction between the Sixth Circuit’s analysis and that of the Federal Circuit. In CSX Corp. v. U.S., 518 F.3d 1328 (Fed. Cir. 2008), the Federal Circuit Court of Appeals held that similar severance payments were wages subject to FICA withholding.

The Sixth Circuit held that the Quality Stores payments were SUB payments as defined by a five-part test drawn from IRC Sec. 3402(o)(2)(A). In the Sixth Circuit’s view a payment meeting the following requirements was a SUB payment:

(1) an amount paid to an employee; (2) pursuant to an employer’s plan; (3) because of an employee’s involuntary separation from employment, whether temporary or permanent; (4) resulting directly from a reduction in force, the discontinuance of a plant or operation, or other similar conditions; and (5) included in the employee’s gross income.

It further opined that the payments need not be tied to the payment of unemployment compensation and that there was no distinction between payments made in a lump sum and those made over a period of time.

By contrast, the Federal Circuit had determined that a SUB payment must meet an eight part test that was set forth in a 1956 IRS Revenue Ruling. The Sixth Circuit rejected this approach, found that the severance payments were SUB payments, and proceeded to determine the meaning and purpose of Section 3402(o).

The Sixth Circuit held that “the necessary implication” of the phrase “shall be treated as if it were a payment of wages” in Section 3402(o)(1) is “that Congress did not consider SUB payments to be “wages,” but allowed their treatment as wages to facilitate federal income tax withholding for taxpayers.” It then recognized the possibility that the language may be ambiguous, a concession to the Federal Circuit’s contrary conclusion, and reviewed the title and intent of the statute. The Court’s review yielded the same conclusion – Congress did not intend that SUB payments be treated as wages for FICA purposes and they should not be treated as such.

The Sixth Circuit’s ruling, like the CSX opinion, considered the Supreme Court’s holding in Rowan Cos. v. United States, 452 U.S. 247 (1981)(holding the definition of wages is the same for FICA and income tax purposes). It also distinguished government arguments based on the Supreme Court’s decisions in Environmental Defense v. Duke Energy Corp., 549 U.S. 561 (2007), and Mayo Found. for Med. Educ. & Research v. United States, 562 U.S. ___, 131 S. Ct. 704 (2011), and its own decision in Appoloni v. United States, 450 F.3d 185 (6th Cir. 2006).  It also rejected the IRS administrative guidance that played a more significant role in the CSX decision.

This opinion has set up a clear split in the circuits and it is likely that the government will pursue further review of this case. A petition for rehearing is due on October 22. A petition for certiorari to the United States Supreme Court would be due on December 6.

Read the opinion here:
U.S. v. Quality Stores, Inc., No. 10-1563 (6th Cir. Sept. 7, 2012)

In re FedEx Ground

The District Court for the Nothern District of Indiana denies a motion for immediate appeal of 12 consolidated cases filed against FedEx Ground. The question before each of the consolidated cases was whether FedEx drivers were independent contractors or employees, the latter of which would subject the company and drivers to state and federal employment taxes.

Read the decision here:
In re FedEx Ground, No. 3:05-MD-527 RM (N.D. Ind. Feb. 11, 2011)