U.R. Neely v. Commissioner ( 2001 )

116 T.C. No. 8UNITED STATES TAX COURT
U.R. NEELY, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 14936-98. Filed February 13, 2001.
P contends that R is barred from assessing
additional employment taxes because the notice of
determination concerning worker classification was
issued after the expiration of the general 3-year
period of limitations under sec. 6501(a), I.R.C. R
contends that the period of limitations on assessment
is indefinitely extended pursuant to sec. 6501(c)(1),
I.R.C., by reason of P’s fraud in the filing of various
employment tax returns.
Held: The elements of fraud in the employment tax
context are the same as those in the income, estate,
and gift tax contexts.
Held, further, P did not commit fraud for purposes
of sec. 6501(c)(1), I.R.C. Accordingly, R is barred by
the statute of limitations from assessing additional
employment taxes for the taxable periods in issue.
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Kirk A. McCarville, for petitioner.
John W. Duncan, for respondent.
VASQUEZ, Judge: Respondent issued to petitioner a notice of
determination concerning worker classification. Petitioner
contends that respondent is barred from assessing additional
employment taxes for the taxable periods in issue on the grounds
that the notice of determination was issued after the expiration
of the general 3-year period of limitations under section
6501(a).1 Respondent argues that the period of limitations on
assessment remains open pursuant to section 6501(c) by reason of
petitioner’s fraudulent conduct.
In a previous opinion, we addressed whether this Court
possesses jurisdiction to address issues pertaining to the period
of limitations on assessment in the context of a case brought
under section 7436. We resolved that inquiry in the affirmative.
See Neely v. Commissioner, 115 T.C. 287 (2000). Accordingly, we
now address whether the period of limitations on assessment
expired prior to the issuance of respondent’s notice of
determination.
1
All section references are to the Internal Revenue Code
as amended, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
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FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are
incorporated herein by this reference. Petitioner resided in
Phoenix, Arizona, at the time he filed his petition in this case.
Petitioner’s Background
Petitioner graduated from high school in 1972 and
immediately thereafter began working in the air-conditioning
business by installing ductwork for his father. In 1976, after
attending one semester of college, petitioner went to work for
Geottle’s Metal Products (Geottle). Petitioner’s initial
responsibilities at Geottle included installing sheet metal and
air-conditioning units. He later worked his way up into the
estimating department, where he bid jobs on behalf of his
employer.
In 1985, petitioner left Geottle and formed his own business
called the A/C Co. (the company).2 The company specialized in
the installation of air-conditioning equipment and associated
ductwork, and the company’s principal place of business was
located in Mesa, Arizona. The activities of the company during
1992 constitute the focus of respondent’s determination.
2
The company was initially operated as a partnership
between petitioner and an associate, whom petitioner later bought
out. At all times during the 1992 tax year, the company was
operated by petitioner as a sole proprietorship.
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Activities of the Company During 1992
The company experienced a busy year in 1992. Petitioner had
approximately 100 jobs, with each job lasting anywhere from 6
weeks to 6 months. While petitioner typically maintained a
workforce of approximately 20 to 25 people, during 1992 that
figure increased to 40. Most of the employees served in the
field as installers. Petitioner, a superintendent, an estimator,
and an office manager operated out of the business office.
At some point in 1992, Robert Cook approached petitioner
about working at one of his job sites. Mr. Cook, however,
conditioned his services upon being paid in cash. Due to his
need for labor, petitioner agreed, but only after informing Mr.
Cook that he would be issued a Form 1099 with respect to the cash
payments made to him.
William Baker and Dennis Page were hired by petitioner under
similar circumstances. Petitioner did not meet with these
individuals; rather, he hired them on the recommendation of his
job foremen. Mr. Baker and Mr. Page each insisted on being paid
in cash for their services, a condition to which petitioner again
agreed on the understanding that Forms 1099 would be issued with
regard to the payments.
Petitioner’s arrangements with Messrs. Cook, Baker, and Page
(collectively, the workers) constitute the only instance in which
petitioner paid a worker in cash for services rendered. During
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less busy times, petitioner rejected requests from individuals to
be paid in cash.
Petitioner’s Internal Accountant
Ann Gerber (formerly Ann Melcher) served as the company’s
office manager from 1986 until the company was sold in 1994. Ms.
Gerber was responsible for all monetary aspects of the business.
In addition to collecting receivables and paying expenses, Ms.
Gerber maintained the company’s books and processed the payroll.
As part of her payroll obligations, Ms. Gerber calculated the
proper amount of employment taxes3 to be withheld from each
employee’s paycheck.
Each time petitioner notified Ms. Gerber that a worker was
to be paid in cash, he instructed her that the worker was to be
issued a Form 1099 to reflect the payment. Petitioner believed
that the issuance of a Form 1099 was sufficient to keep him in
compliance with relevant tax laws.
The workers submitted weekly timecards to Ms. Gerber, and
she would distribute the appropriate cash payments to them. In
order to generate the cash necessary to pay the workers, Ms.
Gerber would write a check from the company’s account to
3
For convenience, we use the term “employment taxes” to
refer to taxes under the Federal Insurance Contributions Act
(FICA), secs. 3101-3128, the Federal Unemployment Tax Act (FUTA),
secs. 3301-3311, and income tax withholding, secs. 3401-3406.
See Henry Randolph Consulting v. Commissioner, 112 T.C. 1, 1 n.1
(1999).
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petitioner. The amount of the check included petitioner’s weekly
$500 draw, plus whatever amounts were owed to the workers. After
depositing petitioner’s $500 draw to his individual account, Ms.
Gerber received the remainder of the check proceeds in cash. She
in turn distributed the cash to the workers in the amounts they
were owed. As a result of this practice, the amounts paid to the
workers were reflected on the company’s books as distributions to
petitioner. Petitioner was not aware that the cash payments to
the workers were being accounted for in this manner.
Ms. Gerber withheld no employment taxes from the amounts
paid to the workers. In addition, Ms. Gerber did not issue Forms
1099 to the workers, as such was the responsibility of
petitioner’s outside accountant. Petitioner did not instruct nor
suggest to Ms. Gerber that the cash payments were not to be
reported to the Internal Revenue Service.
Petitioner’s External Accountant
Kenneth Messmer, a certified public accountant, served as
petitioner’s outside accountant starting in 1986. Mr. Messmer
was responsible for preparing petitioner’s Form 1040, Individual
Income Tax Return (which included the activities of the company
on Schedule C, Profit or Loss From Business), and all of the
company’s required employment tax returns. Additionally, Mr.
Messmer prepared the necessary Forms W-2, Wage and Tax Statement,
and Forms 1099 pertaining to the company.
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Mr. Messmer’s contact with Mr. Neely was limited; he instead
dealt primarily with Ms. Gerber. Ms. Gerber coded the checks
written on behalf of the company to various expense accounts, and
Mr. Messmer prepared the relevant tax returns based on such
information.
Petitioner’s Employment Tax Returns
Petitioner filed various employment tax returns relating to
the operations of the company during 1992. Below is a summary of
the Forms 941, Employer’s Quarterly Federal Tax Return, filed on
behalf of the company:
Quarter Date Income Tax
Ending Filed Total Wages Withholding1 FICA2
3/31/92 8/4/92 $70,188 $6,335 $10,739
6/30/92 8/4/92 70,188 6,335 10,739
9/30/92 10/31/92 113,345 10,330 17,342
12/31/92 1/31/93 113,380 9,159 17,347
1
Income Tax Withholding, secs. 3401-3406.
2
Federal Insurance Contributions Act, secs. 3101-3128.
With respect to the company’s 1992 tax liability under the
Federal Unemployment Tax Act, secs. 3301-3311, petitioner filed a
Form 940-EZ, Employer’s Annual Federal Unemployment (FUTA) Tax
Return, on March 1, 1993. The form reflected total payments to
employees of $353,172, total taxable wages of $176,286, and a
FUTA tax liability of $1,410. Petitioner was current in payment
of his employment tax obligations listed on the above-described
returns.
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Over the course of 1992, petitioner’s company made cash
payments of $19,985 to Mr. Cook, $21,694 to Mr. Baker, and
$15,414 to Mr. Page. The payments were not included in the
appropriate employment tax returns. Petitioner, however, was not
aware in signing the returns that the payments to the workers had
been omitted.
Petitioner’s Individual Income Tax Return
During the review of his 1992 individual income tax return
with Mr. Messmer, petitioner informed Mr. Messmer that he had not
received all of the amounts which were reflected on the company
accounts as his personal draw. After further investigation, Mr.
Messmer became aware that the payments coded as petitioner’s
personal draw included the cash payments made to the workers.
Mr. Messmer therefore made an adjusting entry to petitioner’s
draw account by subtracting the cash payments to the workers and
adding those payments to the labor expense account under cost of
goods sold. Petitioner's 1992 individual income tax return was
selected for examination in 1995. In the course of the
examination, the revenue agent noticed that the cost of goods
sold reported by petitioner varied from the figure carried on the
company’s books by $57,000. Petitioner initially did not know
the reason for the discrepancy, but he later informed the revenue
agent that the discrepancy was attributable to the cash payments
made to the workers.
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Petitioner described the workers to the revenue agent as
independent contractors. Petitioner further informed the revenue
agent that the workers had provided services to other people and
that they reported directly to the appropriate job sites.4
Petitioner cooperated with the revenue agent in every aspect
requested and provided her with all pertinent documents and
records.
Petitioner and respondent settled all matters relating to
the examination of petitioner’s individual income tax return. As
part of the settlement agreement, petitioner stipulated various
aspects of the relationship which the workers maintained with the
company,5 and respondent allowed the payments to the workers to
be included in the labor component of cost of goods sold. At
this point, petitioner provided respondent with Forms 1099-MISC,
Miscellaneous Income, concerning the payments to the workers.
Notice of Determination
On June 11, 1998, respondent mailed to petitioner a Notice
of Determination Concerning Worker Classification Under Section
7436 in which respondent determined that (1) the workers were
4
The revenue agent was equivocal in her recollection that
petitioner had described the workers as having submitted bids to
him for particular jobs.
5
Specifically, petitioner stipulated that (a) the workers
were required to comply with petitioner’s instructions about
when, where, and how their work was to be performed; (b)
petitioner had the right to discharge each of the workers; and
(c) the workers could have terminated their relationship with
petitioner at any time without incurring liability.
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employees of the company for purposes of Federal employment taxes
under Subtitle C (Employment Taxes and Collection of Income Tax)
of the Internal Revenue Code, and (2) petitioner was not entitled
to “safe harbor” relief provided by section 530 of the Revenue
Act of 1978, Pub. L. 95-600, 92 Stat. 2763, 2885. Respondent
attached to the notice of determination a schedule detailing the
proposed additional employment taxes.6 Respondent also asserted
a section 6663 fraud penalty with respect to such additional
taxes.
Petitioner filed with the Court a timely petition seeking
our review of the notice of determination pursuant to section
7436. The notice was issued after the expiration of the general
3-year period of limitations on assessment as set forth in
section 6501(a). No consents extending the period of limitations
have been executed.
6
In his petition, petitioner disputed the amounts of the
employment taxes and penalties that were set forth on the
schedule accompanying the notice of determination. We previously
granted respondent’s motion to dismiss in part for lack of
jurisdiction as to the amounts of employment taxes and related
penalties, in keeping with our decision in Henry Randolph
Consulting v. Commissioner, 112 T.C. 1 (1999). Subsequent to our
granting of respondent’s motion, Congress amended sec. 7436(a) to
provide the Tax Court with jurisdiction to determine the correct
amounts of employment taxes that relate to the Secretary’s
determination concerning worker classification. See Community
Renewal Tax Relief Act of 2000 (CRTRA), Pub. L. 106-554, sec.
314(f), 114 Stat. 2763. This amendment was made retroactive to
the effective date of sec. 7436(a). See id. sec. 314(g).
Accordingly, we have since vacated our prior order to dismiss in
part for lack of jurisdiction as to the amounts of employment
taxes relating to respondent’s determination concerning worker
classification.
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OPINION
The sole matter for determination is whether the period of
limitations on assessment expired prior to the issuance of
respondent’s notice of determination. Petitioner contends that
the assessment of any additional employment tax liability is
barred by the statute of limitations under section 6501, as the
notice of determination was issued after the general 3-year
period of limitations provided by section 6501(a). Respondent,
on the other hand, contends that the general limitations period
under section 6501(a) does not apply in this case. Respondent
claims that the employment tax returns at issue were false and
fraudulent with an intent to evade tax and that the period of
limitations thereby remains open pursuant to section 6501(c)(1).7
Accordingly, whether respondent’s notice of determination was
timely issued depends on whether petitioner committed fraud in
the filing of the employment tax returns.
This is the first instance in which this Court has been
called upon to determine whether a taxpayer committed fraud in
the employment tax context. Nonetheless, the determination of
fraud for purposes of the period of limitations on assessment
7
Respondent also alleged in his answer that the failure of
petitioner to reflect the cash payments to the workers on the
appropriate employment tax returns constituted a willful attempt
by petitioner to defeat or evade employment taxes, justifying an
indefinite extension of the period of limitations pursuant to
sec. 6501(c)(2). However, respondent neither argued this point
at trial nor raised it in the course of the posttrial briefing.
Accordingly, we treat this argument as having been withdrawn.
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under section 6501(c)(1) is the same as the determination of
fraud for purposes of the penalty under section 6663, see Rhone-
Poulenc Surfactants & Specialties v. Commissioner, 114 T.C. 533,
548 (2000), and an extensive body of law exists addressing the
fraud penalty in the income, estate, and gift tax contexts. We
shall rely on such case law in our analysis below.
Fraud is defined as an intentional wrongdoing designed to
evade tax believed to be owing. See Edelson v. Commissioner, 829
F.2d 828, 833 (9th Cir. 1987), affg. T.C. Memo. 1986-223; McGee
v. Commissioner, 61 T.C. 249, 256 (1973), affd. 519 F.2d 1121(5th Cir. 1975). The Commissioner bears the burden of proving
fraud and must establish it by clear and convincing evidence.
See sec. 7454(a); Rule 142(b). To satisfy the burden of proof,
the Commissioner must show that (1) an underpayment in tax
exists, and (2) the taxpayer intended to conceal, mislead, or
otherwise prevent the collection of taxes. See Parks v.
Commissioner, 94 T.C. 654, 660-661 (1990).
Petitioner concedes that his failure to include the cash
payments made to the workers on the appropriate employment tax
returns resulted in an understatement in tax. Accordingly, we
focus on whether the understatement was a product of fraudulent
intent. As described below, the record in this case does not
support a finding that petitioner acted with an intent to
conceal, mislead, or otherwise prevent the collection of taxes.
Petitioner testified that he believed the employment tax
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returns to be accurate at the time he signed them. He was not
aware that the payments to the workers should have been included
in the employment tax returns, and, in any event, he was not
specifically aware that the payments were not so included.
Furthermore, petitioner did not know that the payments to the
workers had been coded for accounting purposes as distributions
to himself. Petitioner’s testimony in this regard was highly
credible, and we note that it was corroborated by the testimony
of his former office manager and his outside accountant.
Ms. Gerber stated that she had no problems with Mr. Neely in
terms of his honesty with her and that he never asked her to do
anything that made her uncomfortable in terms of her job
responsibilities and duties. Similarly, Mr. Messmer testified
that he at no time had reservations as to petitioner’s
forthrightness and honesty in terms of producing the documents
and information necessary for him to prepare full and accurate
tax returns. Even the revenue agent who conducted the
examination of petitioner’s income tax return conceded that
petitioner cooperated with her in every aspect requested and
provided her with all pertinent records and documents. These
witnesses do not paint petitioner as one out to deprive the
Commissioner of his rightful tax revenue.
The only potential “badge of fraud” in this case is
petitioner’s agreement to pay the workers in cash. The cash
arrangement, however, was not part of a scheme on the part of
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petitioner to underreport employment taxes. In each case, the
request to be paid in cash was initiated by the worker.
Petitioner agreed to the workers’ requests because he needed
additional labor to satisfy his exceptionally high volume of
contracts. Furthermore, petitioner conditioned the arrangement
on the understanding that the company would issue a Form 1099
reflecting the cash payments. Petitioner instructed Ms. Gerber
to see that Forms 1099 were in fact issued to the workers. It
was thus petitioner’s intent that the Commissioner be aware of
the cash payments as opposed to the contrary.
Respondent has not established, let alone on a clear and
convincing basis, that petitioner intended to conceal, mislead,
or otherwise prevent the collection of taxes. As a result,
section 6501(c)(1) does not operate to extend the period of
limitations on assessment beyond the 3-year period set out in
section 6501(a). Accordingly, as the period of limitations
expired prior to the issuance of respondent’s notice of
determination, the assessment of any additional employment tax
liability for the taxable periods in issue is barred.
To reflect the foregoing,
Decision will be entered for
petitioner.