The Federal Tax Court has held that a company operating a masonry subcontracting business failed to properly treat its workers as employees. Although the workers were hired by the job and were free to work for others, a factor indicating independent contractor status, almost all of the other factors weighed in favor of employee status. For example, they were controlled by the subcontractor when they were on the job, and they had no significant investment in facilities.
BACKGROUND
The Internal Revenue Service defines an “employee” as an individual who, under common law (case law) rules, has the status of an employee. When deciding whether you can safely treat a worker as an independent contractor, there are two separate tests you should consider. One is the 20-factor common law test which is found on
Form SS-8 and the other is the reasonable basis test. In the reasonable basis test the courts have found that whether an individual is a common law employee is a question of fact to be determined by applying the following factors:
(1) The degree of control exercised by the principal;
(2) Which party invests in work facilities used by the individual;
(3) The opportunity of the individual to realize a profit or loss;
(4) Whether the principal can discharge the individual;
(5) Whether the work is part of the principal’s regular business;
(6) The permanency of the relationship; and
(7) The relationship the parties believed they were creating.
Under current law, a taxpayer that incorrectly treats an employee as an independent contractor is nevertheless exempt from employment tax liability if it meets three requirements:
• The taxpayer does not treat any other individual holding a substantially similar position as an employee for purposes of employment taxes for any period;
• All required federal tax returns are filed by the taxpayer on a basis consistent with its treatment of the individual as a nonemployee; and
• The taxpayer has a reasonable basis for not treating the individual as an employee.
FACTS
Atlantic Coast Masonry, Inc. had two shareholders/corporate officers,
Blanche Dempsey and James
Dempsey. Blanche was the company’s president and bookkeeper, and James was its vice president, procuring all masonry work and overseeing dayto-day operations. James submitted proposals for masonry jobs on the company’s behalf to general contractors for construction projects. Under the proposals, Atlantic furnished all labor, materials, equipment, and supervision necessary to complete the job. James did not personally manage the construction projects but rather contracted with others to supervise or be the foreman of the job. Masons and laborers were hired on a per-job basis and brought their own tools and equipment to the jobs site. They worked an eight-hour day, but they were paid on a piecework basis (i.e., by the number of blocks, bricks, or cubic yards of cement laid). James established the amount to be paid per block, brick, or cubic yard, and the masons and laborers were paid in cash. When a particular job was completed, the masons and laborers were let go. If another job was in progress, they were invited to join the new project if workers were needed.
The masons and laborers could be fired at will. Atlantic’s operations were conducted in an informal manner where transactions were conducted in cash and often not recorded adequately. There were few written contracts or agreements, and the documentation that did exist was incomplete and contradictory.
Atlantic hadn’t filed income tax return for the years 2004 through 2006.
In 2006, after being informed by the
IRS that it had been selected for an employment tax examination, Atlantic and its owners began filing returns for the years at issue, including Forms

1099-MISC for its masons and laborers.
The IRS ultimately determined that
Atlantic owed a total of over $700,000 in employment tax.
WORKERS WERE EMPLOYEES, NOT
INDEPENDENT CONTRACTORS.
Applying the seven employee vs. independent contractor tests, the Tax
Court had no trouble finding that
Atlantic’s masons and laborers were employees.
Although they reported to independentcontractor supervisors, Atlantic, through
James Dempsey, had the authority to tell them what jobs they were to do, and how and when they were to perform their work (Test 1).
The masons did bring their own trowels, levels, and tape measures to the work site, but none of the parties had any significant investment in facilities (Test 2).
The masons and laborers had no opportunity for profit or loss (Test 3), and
Atlantic had the right to fire the workers, who were an integral part of its business (Tests 4 and 5).
The masons and laborers were engaged on a per-job basis and were free to work elsewhere (Test 6, the only factor that weighed in favor of independent contractor status), and there was no testimony on the relationship the parties created (Test 7 was neutral).
Note: The IRS has a Voluntary
Compliance Settlement Program which allows an employer to seek prospective treatment for workers.
It is important to also note that although the IRS uses the common law or reasonable basis tests many states have enacted laws that are more stringent.
For instance, per New Jersey
Unemployment Compensation Law, services performed by an individual for remuneration shall be deemed to be employment unless and until it is shown to the satisfaction of the
Division that..."the individual meets the following provisions”.
(A) Such individual has been and will continue to be free from control or direction over the performance of such service, both under his contract of service and in fact; and
(B) Such service is either outside the usual course of the business for which such service is performed, or that such service is performed outside of all the places of business of the enterprise for which such service is performed; and
(C) Such individual is customarily engaged in an independently established trade, occupation, profession or business.
The New York State Court of Appeals,
New York's highest court, recently issued an interesting decision that provides a simple explanation of the difference between an employee and an independent contractor. In sum, the
Court found that the question was how much control the employer has over the individual both as to the methods by which they do their work and the form and content of their work results.
Hiring the right firm for your tax planning and return preparation is vital to your financial success.
Both NJBiz and New Jersey Business Magazine rank RotenbergMeril as one of the top accounting firms in New Jersey, and our firm has recently been recognized by INSIDE Public Accounting as one of the Top Five Fastest Growing Firms in the Northeast. When you need a powerful ally in the areas of tax planning and return preparation, rely on RotenbergMeril.
T o learn more about our firm’s capabilities and how we can serve your tax planning and preparation needs, visit www.rmsbg.com or call (201) 487-8383.
RotenbergMeril is PCAOB registered and a member of the Center for Public Company Audit Firms, the
Employee Benefit Plan Audit Quality Center, and the Forensic Valuation Services (FVS) section of the
American Institute of Certified Public Accountants. We offer comprehensive technical skills, extensive knowledge and experience, and a sustained commitment to personal attention that help our diverse clients meet their financial and regulatory objectives. Our integrated and specialized services include:
• Audit & Accounting Services
• Public Company & SEC
Services
• Benefit Plan/ERISA Services
• Taxation Services
• Financial Outsourcing Services
• Litigation Support and
Valuation Services
• International Consulting