Rosato v. Comm'r

T.C. Memo. 2010-39
UNITED STATES TAX COURT
THOMAS & CAROL ROSATO, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 20353-08. Filed February 25, 2010.
Alan J. Garfunkel, for petitioners.
Shawna A. Early, for respondent.
MEMORANDUM OPINION
COHEN, Judge: Respondent determined a deficiency of $56,471
and an accuracy-related penalty of $11,294 under section 6662(a)
in relation to petitioners’ 2006 Federal income tax. After a
concession by petitioners, the issues for decision are (1)
whether Thomas Rosato (petitioner) was an independent contractor,
statutory employee, or common law employee and (2) whether
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petitioners are subject to the section 6662(a) penalty. Unless
otherwise indicated, all section references are to the Internal
Revenue Code in effect for the year in issue, and all Rule
references are to the Tax Court Rules of Practice and Procedure.
Background
This case was submitted fully stipulated under Rule 122, and
the stipulated facts are incorporated as our findings by this
reference. Petitioners resided in New York at the time the
petition was filed.
Beginning in 1975 petitioner worked as a salesperson for
O.C. Tanner (Tanner), a company headquartered in Salt Lake City,
Utah, that provides products and services that assist companies
with developing programs for recognizing and rewarding their
employees. Petitioner entered into an employment agreement with
Tanner dated April 21, 1975, that detailed petitioner’s sales
territory in the New York City area. Tanner also provided
petitioner with a list of clients that he was not allowed to
solicit, and petitioner was not permitted to work as a
salesperson for Tanner’s competitors or other employers while he
was acting as a salesperson for Tanner. This noncompetition
obligation was limited to the time petitioner was acting as a
salesperson for Tanner.
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The 1975 employment agreement identified petitioner as an
“employee” of Tanner. Terms of the employment agreement included:
The Employee shall devote his full working time
and his best efforts to the service of the Company in
selling and promoting the Company’s products in
accordance with Company policies and under Company
direction; and, during the term of this agreement, he
shall not engage in outside business activities. He
shall have no authority to bind or obligate the Company
in any way without prior written authorization from an
official of the Company in Salt Lake City.
* * * * * * *
Any expense incurred by the Employee in excess of
his expense allowance shall be paid by him; and the
Employee shall not obligate the Company in any way for
any of his expenses without prior written authorization
by an officer of the Company in Salt Lake City, Utah.
* * * * * * *
The Employee is not authorized to and shall not handle
any money or other forms of payment by customers unless
specifically directed to do so by an official of the
Company in Salt Lake City, Utah in special instances.
The employment agreement was supplemented with several
addenda regarding compensation and expense allowances between
1976 and 1983. In August 1984, Tanner advised its salespeople by
letter that the company was adopting the principles of the Golden
Rule within the employer-employee relationship, eliminating
signed or unsigned written agreements and that
As a first step * * * all contracts, whether
signed or unsigned, are no longer necessary.
The company intends to honor the terms of these
agreements as they relate to your compensation, your
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territory, and other general policy matters regarding
your employment relationship with the company.
In the future, instead of stating policies in
written contracts, the company will utilize letters,
bulletins, staff memos, etc. to define company policies
and explain company changes.
A letter dated November 26, 1984, from Tanner and addressed
to petitioner, instructed him that by signing and returning a
copy of this letter he acknowledged that his prior written
agreement with the company was terminated and that he supported
Tanner’s new policies. Petitioner signed and dated the letter
December 2, 1984. Tanner did not alter the relationship with
petitioner or salespersons holding similar situations and
intended to continue treating them as employees.
In a letter dated January 23, 2002, Tanner notified
petitioner of “the conditions of your employment at O.C. Tanner”
because of several concerns regarding petitioner’s actions at
work. These conditions included that petitioner attend monthly
counseling sessions (some of which Tanner scheduled for
petitioner), conduct weekly meetings, and provide corresponding
written reports to Tanner. During 2006 petitioner continued to
work as a salesperson for Tanner in New York, New York. Tanner
required petitioner to attend company sales meetings and training
sessions and expected petitioner to have a presence in the New
York office. However, Tanner did not set petitioner’s work hours
or instruct him when to work, he could take days off as he chose,
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and he could perform some of his sales work from home. According
to Tanner, in 2006
Mr. Rosato was expected to devote his working
hours to the advancement of O.C. Tanner’s interests.
We also expected him to work solely for O.C. Tanner and
not to engage in side businesses that competed with
O.C. Tanner. Mr. Rosato was free to engage in other
business activities (e.g., leasing real estate) so long
as it was done on his own time. If Mr. Rosato had left
O.C. Tanner, he would not be prohibited from working
for a competitor, although we would have insisted he
maintain OCT’s confidences and trade secrets.
Tanner’s understanding of the nature of its relationship
with petitioner for the period of 1975 through 2006 was that
at all times he was an at-will employee.
In addition to working as a salesperson for Tanner during
2006, petitioner managed Tanner’s regional office in New York,
New York. In this capacity, petitioner supervised salespersons,
secretaries, and other administrative personnel in the New York
regional office whom Tanner hired.
With respect to the New York office and its employees,
Tanner and petitioner followed a cost-sharing arrangement based
on a formula set forth by Tanner. Petitioner paid for a portion
of his office, half of the cost of his personal secretary, and
half of the cost of his own administrative assistant. Petitioner
also paid commissions to other New York-based Tanner salespersons
from the commissions that he received from Tanner. Petitioner
had input regarding the hiring of these salespersons.
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Petitioner was permitted to participate in Tanner’s
Retirement Plan for Sales Representatives and in Tanner’s profit-
sharing plan. During 2006 petitioner was included in Tanner’s
medical insurance plan, section 401(k) plan, group term life
insurance plan, and unemployment insurance plan. Petitioner made
contributions toward the cost of the medical insurance plan, to
the section 401(k) plan, and to the group term life insurance
plan.
Tanner outlined expense reporting requirements in the
Monthly Regional Expense Report Instructions dated January 2006.
Tanner’s expense report instructions identified expenses that
were considered reimbursable and nonreimbursable. Accordingly,
petitioner submitted monthly expense reports to Tanner for
reimbursement of operating expenses such as phone, utilities,
postage, customer entertainment, office supplies, and meals.
Petitioner did not receive reimbursements from Tanner for all of
his business expenses related to sales efforts on behalf of
Tanner.
Petitioner received a Form W-2, Wage and Tax Statement, from
Tanner for 2006 that reported his income as “Wages, tips, other
compensation”. The Form W-2 also reported that Tanner withheld
Federal and State income taxes and Social Security and Medicare
taxes and that Tanner had established a section 401(k) plan
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account for petitioner. Tanner did not report that petitioner
was a statutory employee on the Form W-2.
Petitioners jointly filed a Form 1040, U.S. Individual
Income Tax Return, for 2006 and left blank line 7, “Wages,
salaries, tips, etc.” On an attached Schedule C, Profit or Loss
From Business, petitioner’s wife reported profit from a “Real
Estate Sales” business. On another attached Schedule C,
petitioner reported his principal business or profession as
“Outside Sales” and reported gross receipts or sales of $468,378,
the wage amount shown on the Form W-2 that Tanner issued.
Petitioner checked the box on line 1 of his outside sales
Schedule C, misrepresenting that his Form W-2 identified him as a
statutory employee. Petitioner did not claim expenses for the
business use of a home on the Schedule C.
In the notice of deficiency, the IRS determined that
petitioner was a common law employee and therefore was not
permitted to report income and expenses on Schedule C. The
explanation in the notice stated:
Only statutory employee income can be offset by
expenses reported on Schedule C, Profit or Loss From
Business, or Schedule C-EZ. Since your employer did
not indicate on Form W-2, Wage and Tax Statement, that
you were a statutory employee, we cannot allow the
expenses used to offset that income on Schedule C or
Schedule C-EZ.
On the basis of this determination, the IRS reported
petitioners’ tax required to be shown on the 2006 return as
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$126,216--$56,471 more than petitioners had reported. The IRS
further determined that petitioners are liable for the accuracy-
related penalty under section 6662(a).
Discussion
An individual performing services as an employee may deduct
expenses incurred in the performance of services as an employee
as miscellaneous itemized deductions on Schedule A, Itemized
Deductions, to the extent the expenses exceed 2 percent of the
taxpayer’s adjusted gross income. Secs. 62(a)(2), 63(a), (d),
67(a) and (b), 162(a). Itemized deductions may be limited under
section 68 and may have alternative minimum tax implications
under section 56(b)(1)(A)(i).
An individual who performs services as an independent
contractor is entitled to deduct expenses incurred in the
performance of services on Schedule C and is not subject to
limitations imposed on miscellaneous itemized deductions. A
statutory employee under section 3121(d)(3)(D) is not an employee
for purposes of section 62 and may deduct business expenses on
Schedule C. See Rosemann v. Commissioner, T.C. Memo. 2009-185;
Rev. Rul. 90-93, 1990-2 C.B. 33.
Petitioners argue that in 2006 petitioner was an independent
contractor or statutory employee and is entitled to deduct
business expenses on Schedule C. Respondent contends that
petitioner was a common law employee in 2006 and that
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unreimbursed employee expenses are thus properly reportable on
Schedule A, subject to the 2 percent of adjusted gross income
limitation.
An individual qualifies as a statutory employee under
section 3121(d)(3) only if the individual is not a common law
employee pursuant to section 3121(d)(2). See Ewens & Miller,
Inc. v. Commissioner, 117 T.C. 263, 269 (2001); Rosemann v.
Commissioner, supra. Section 3121(d) defines “employee”, in
pertinent part, as follows:
(2) any individual who, under the usual common law
rules applicable in determining the employer-employee
relationship, has the status of employee; or
(3) any individual (other than an individual who
is an employee under paragraph (1) or (2)) who performs
services for remuneration for any person--
* * * * * * *
(D) as a traveling or city salesman, other
than as an agent-driver or commission-driver,
engaged upon a full-time basis in the solicitation
on behalf of, and the transmission to, his
principal (except for side-line sales activities
on behalf of some other person) of orders from
wholesalers, retailers, contractors, or operators
of hotels, restaurants, or other similar
establishments for merchandise for resale or
supplies for use in their business operations;
if the contract of service contemplates that
substantially all of such services are to be performed
personally by such individual; except that an
individual shall not be included in the term “employee”
under the provisions of this paragraph if such
individual has a substantial investment in facilities
used in connection with the performance of such
services (other than in facilities for transportation),
or if the services are in the nature of a single
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transaction not part of a continuing relationship with
the person for whom the services are performed; * * *
Because an individual qualifies as a statutory employee only if
the individual is not a common law employee, we will first decide
whether petitioner was a common law employee of Tanner.
Although the income tax treatment of a taxpayer’s trade or
business expense deductions under section 62(a) depends on
whether the taxpayer is “[performing] * * * services * * * as an
employee”, subtitle A of the Internal Revenue Code does not
define “employee”. Under these circumstances, we apply common
law rules to determine whether the taxpayer is an employee.
Nationwide Mut. Ins. Co. v. Darden, 503 U.S. 318, 323-325 (1992);
Weber v. Commissioner, 103 T.C. 378, 386 (1994), affd. 60 F.3d
1104 (4th Cir. 1995).
Whether an individual is an employee must be determined on
the basis of the specific facts and circumstances involved.
Profl. & Executive Leasing, Inc. v. Commissioner, 89 T.C. 225,
232 (1987), affd. 862 F.2d 751 (9th Cir. 1988); Simpson v.
Commissioner, 64 T.C. 974, 984 (1975). Relevant factors include:
(1) The degree of control exercised by the principal; (2) which
party invests in the work facilities used by the worker; (3) the
opportunity of the individual for 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; (7) the relationship the parties believed they
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were creating; and (8) the provision of employee benefits. See
Avis Rent A Car Sys., Inc. v. United States, 503 F.2d 423, 429
(2d Cir. 1974); Ewens & Miller, Inc. v. Commissioner, supra at
270; Weber v. Commissioner, supra at 387. We consider all of the
facts and circumstances of each case, and no single factor is
determinative. Ewens & Miller, Inc. v. Commissioner, supra at
270; Weber v. Commissioner, supra at 387.
Although not the exclusive inquiry, the degree of control
exercised by the principal over the worker is the crucial test in
determining the nature of a working relationship. See Clackamas
Gastroenterology Associates, P.C. v. Wells, 538 U.S. 440, 448
(2003); Leavell v. Commissioner, 104 T.C. 140, 149-150 (1995).
To retain the requisite degree of control over a worker, the
principal need not direct the worker’s every move; it is
sufficient if the right to do so exists. Weber v. Commissioner,
supra at 387; see sec. 31.3401(c)-1(b), Employment Tax Regs.
Relying on Hathaway v. Commissioner, T.C. Memo. 1996-389,
petitioners assert that “Tanner’s lack of control and lack of the
right to control the manner and means by which petitioner
solicited sales strongly supports a finding that petitioner was
* * * not an employee of Tanner”. Unlike petitioner, the
traveling salesperson in Hathaway was not required to attend
sales meetings or maintain an office presence and was permitted
to sell nonconflicting lines of merchandise from other companies.
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Additionally, Tanner’s January 2002 letter to petitioner that
outlined “conditions of [petitioner’s] employment” shows that
petitioner had superiors at Tanner who oversaw and supervised his
performance.
The fact that a worker provides his or her own tools, or
owns a vehicle that is used for work, is indicative of
independent contractor status. Ewens & Miller, Inc. v.
Commissioner, supra at 271 (citing Breaux & Daigle, Inc. v.
United States, 900 F.2d 49, 53 (5th Cir. 1990)). Additionally,
maintenance of a home office is consistent with independent
contractor status, although alone it does not constitute
sufficient basis for a finding of independent contractor status.
See Colvin v. Commissioner, T.C. Memo. 2007-157, affd. 285 Fed.
Appx. 157 (5th Cir. 2008).
Petitioner and Tanner followed a cost-sharing arrangement
with respect to the New York office. The record does not reflect
the detailed terms of this arrangement. Further, although
petitioner incurred additional expenses related to Tanner sales
activities and hired a personal secretary and administrative
assistant, it was his decision to incur these additional costs,
and Tanner shared some of these expenses. Cf. Hathaway v.
Commissioner, supra (salesperson not reimbursed for office space
expenses and only provided minimal supplies from company such as
order forms, sample swatches, and preaddressed envelopes).
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Additionally, petitioner claimed that he worked from home on
occasion, but he has not presented any evidence that he made
expenditures to establish a home office qualifying under section
280A. See Cole v. Commissioner, T.C. Memo. 2006-44; Lewis v.
Commissioner, T.C. Memo. 1993-635.
The opportunity for profit or loss indicates nonemployee
status. Simpson v. Commissioner, supra at 988. Earning an
hourly wage or fixed salary indicates that an employer-employee
relationship exists. See Kumpel v. Commissioner, T.C. Memo.
2003-265. Petitioner was not paid a fixed wage; and because he
shared expenses with Tanner, he risked a net loss if his profits
did not exceed his expenses.
Where the principal retains the right to discharge a worker,
it is indicative of an employer-employee relationship. See
Colvin v. Commissioner, supra. Tanner retained the right to
discharge petitioner at will.
Petitioner’s sales efforts were an integral part of Tanner’s
regular business of providing products and services relating to
assisting companies with developing programs for recognizing and
rewarding their employees. Where work is part of the principal’s
regular business, it is indicative of employee status. See
Simpson v. Commissioner, supra at 989; Rosemann v. Commissioner,
T.C. Memo. 2009-185.
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Permanency of a working relationship is indicative of common
law employee status. See Rosemann v. Commissioner, supra. The
lengthy working relationship between Tanner and petitioner weighs
in favor of petitioner’s being a common law employee.
The record shows that Tanner considered petitioner a common
law employee. Petitioner and Tanner did not have a written
employment contract in place in 2006. However, after Tanner
adopted the Golden Rule principle, the parties continued to honor
the terms and conditions of the original employment contract, and
in 2002 Tanner further mandated conditions that petitioner had to
follow to maintain his position. The withholding of taxes is
consistent with a finding that an individual is a common law
employee. See Packard v. Commissioner, 63 T.C. 621, 632 (1975).
Tanner provided petitioner a Form W-2 for 2006 and withheld
Federal and State income taxes and Social Security and Medicare
taxes from petitioner’s pay.
Benefits such as health insurance, life insurance, and
retirement plans are typically provided to employees. Weber v.
Commissioner, 103 T.C. 393-394. Petitioner participated in
Tanner’s medical insurance plan, section 401(k) plan, group term
life insurance plan, and unemployment insurance plan. Tanner
also reimbursed petitioner for business expenses according to
outlined terms.
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Considering the record and weighing the factors, we conclude
that petitioner was a common law employee of Tanner in 2006.
Thus petitioner is precluded from being a statutory employee
pursuant to section 3121(d)(3). See Ewens & Miller, Inc. v.
Commissioner, 117 T.C. 269; Rosemann v. Commissioner, supra.
Respondent determined that petitioners are liable for an
accuracy-related penalty under section 6662(a) for 2006. Section
6662(a) and (b)(1) and (2) imposes a 20-percent accuracy-related
penalty on any underpayment of Federal income tax attributable to
a taxpayer’s negligence or disregard of rules or regulations, or
a substantial understatement of income tax. Section
6662(d)(1)(A) defines “substantial understatement of income tax”
as an amount exceeding the greater of 10 percent of the tax
required to be shown on the return or $5,000. A taxpayer is
negligent when he or she fails “‘to do what a reasonable and
ordinarily prudent person would do under the circumstances.’”
Korshin v. Commissioner, 91 F.3d 670, 672 (4th Cir. 1996)
(quoting Schrum v. Commissioner, 33 F.3d 426, 437 (4th Cir.
1994), affg. in part and vacating in part T.C. Memo. 1993-124),
affg. T.C. Memo. 1995-46.
Under section 7491(c), the Commissioner bears the burden of
production with regard to penalties and must come forward with
sufficient evidence indicating that it is proper to impose
penalties. Higbee v. Commissioner, 116 T.C. 438, 446 (2001).
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However, once the Commissioner has met the burden of production,
the burden of proof remains with the taxpayer, including the
burden of proving that the penalties are inappropriate because of
reasonable cause or substantial authority. Id. at 446-447.
Respondent determined that petitioners have an underpayment
of tax that is attributable to a substantial understatement of
income tax in 2006. Respondent contends that the amount of tax
required to be shown on petitioners’ 2006 tax return is $126,216
and the understatement of income tax is $56,741, which is greater
than $5,000 and than 10 percent of the amount of tax required to
be shown and thus is substantial. Furthermore, respondent
asserts that when they received a Form W-2 from Tanner that
reported petitioner’s 2006 earnings as salary or wages and did
not classify petitioner as a statutory employee, petitioners were
put on notice that these earnings were not eligible for reporting
on Schedule C. Respondent’s burden of production has been met.
Petitioners argue that they are not liable for the section
6662(a) penalty because Hathaway v. Commissioner, T.C. Memo.
1996-389, “constitutes substantial authority on which * * *
[petitioners] relied”. Because the authority upon which
petitioners rely is materially distinguishable from the instant
case, it is not substantial authority for their erroneous
position. See Antonides v. Commissioner, 91 T.C. 686, 703
(1988), affd. 893 F.2d 656 (4th Cir. 1990).
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The accuracy-related penalty under section 6662(a) will not
be imposed with respect to any portion of the underpayment as to
which the taxpayer acted with reasonable cause and in good faith.
Sec. 6664(c)(1). The decision as to whether a taxpayer acted
with reasonable cause and in good faith is made by taking into
account all of the pertinent facts and circumstances. Sec.
1.6664-4(b)(1), Income Tax Regs. The most important factor is
the extent of the taxpayer’s effort to assess his or her proper
tax liability. Id. This factor includes, in some circumstances,
the taxpayer’s reasonable and good faith reliance on the advice
of a tax professional. Id.
Petitioners’ substantial understatement of income tax
resulted from claiming deductions on Schedule C that were
properly reportable on Schedule A. Petitioners have failed to
show that this position was taken with reasonable cause and in
good faith within the meaning of section 6664(c)(1). Petitioners
do not argue that they reasonably relied on the advice of a
professional, such as an accountant, to support their claim that
they had reasonable cause for, and acted in good faith with
respect to, any portion of the underpayment of tax for 2006. See
sec. 1.6664-4(b)(1), Income Tax Regs. Furthermore, on their 2006
tax return, petitioners misrepresented petitioner’s employee
status as reported on the Form W-2 from Tanner. Petitioners have
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failed to establish that they are not liable for the accuracy-
related penalty under section 6662(a).
We have considered all arguments made by the parties. To
the extent not mentioned or addressed, they are irrelevant or
without merit. To reflect the foregoing,
Decision will be entered
for respondent.