The Tax Court ruled that a worker was an employee rather than an independent contractor partly because he was paid a daily rate during the four years he worked for an energy company and he supervised other employees.
The worker classification issue has been a headache for taxpayers and the IRS for decades. Generally, under common-law rules, a worker is an employee if the person for whom the service is performed has the right to control and direct the worker performing the services, not just as to the result but also as to how it is accomplished. Control does not have to be exercised; the existence of the right to control is sufficient. But control is a vague and often litigated criterion.
Michael Neil McWhorter was employed from 2001 into 2004 by Boyle Energy Services and Technology Inc., which hired him because of his specialized knowledge and expertise in the industry. He worked on a project-by-project basis and was paid a flat rate per day. He provided no timesheets to the company. He had authority to supervise the company’s employees but not to hire or fire them. He had a credit card with the company name on it and a business card with the company logo on it.
He received Forms 1099 for 2001, 2002, 2003 and 2004. He never received a Form W-2 from the company. No income tax was withheld, and he paid no estimated tax.
McWhorter failed to file a return for the tax year 2002 (also for 2001). His only explanation was that he did not want to sign a return filed as an independent contractor. The IRS prepared a substitute return under IRC § 6020(b) that included the $126,760 in compensation from Boyle. A notice of deficiency included the taxpayer’s liability for self-employment tax as well as penalties for failure to file, failure to pay and failure to pay estimated tax.
McWhorter challenged the deficiency in Tax Court, where the issues were whether he was an employee or independent contractor and whether he was liable for the penalties.
The IRS relied upon common-law factors and cited Breaux and Daigle Inc. v. U.S. (65 AFTR2d 90-1133) and the 1947 Supreme Court case U.S. v. Silk (35 AFTR 1174)—paradoxically, both cases that had found employee status. The IRS took the position that in this instance, the lack of control by the company, lack of permanency of the relationship and the skill required for the job indicated independent contractor status. The Service conceded that two other factors—McWhorter’s lack of opportunity to share in any profits or risk of loss and his lack of any investment in business facilities—supported employee status. But it also argued that the understanding of the parties as to the contract should be given weight. Although the taxpayer contended there was an ongoing dispute with the company regarding his status, the IRS said he essentially acquiesced to the company’s understanding of independent contractor status by continuing to work there. The court found this troubling but still concluded that he was an employee.
The court determined that a job lasting from 2001 to 2004 was not impermanent and that neither the lack of control exercised by the company nor the degree of skill of the taxpayer distinguished his situation from that of an employee. The court determined the IRS had not met its burden of proof under section 7491(a). Because McWhorter was an employee, he was not liable for selfemployment tax, the court held. However, he was found liable for income tax, the section 6651(a)(1) and (2) penalties for failure to file and failure to pay, and the section 6654(a) penalty for failure to pay estimated tax. He might also be liable for his share of FICA tax, the court said.
Michael Neil McWhorter v. Commissioner, TC Memo 2008-263
By Tina Quinn, CPA, Ph.D., chair and professor of accounting, Arkansas State University, Jonesboro, Ark.