A district court allowed an in-home personal care provider a refund of employment taxes, finding it had a reasonable basis to treat its workers as independent contractors rather than employees.
Facts: When she began working as a provider of personal care to residents of a facility in Bryn Mawr, Pa., Helen Carney learned that other workers there had contracted with, and were referred by, home health agencies in the region. Carney researched three such agencies and learned that two of them treated their workers as independent contractors. In 2004, she started her own agency, Nelly LLC, later incorporated as Nelly Home Care Inc. Carney used an independent contractor agreement for her workers, whom she called "companions," that she patterned after that of one of the other local companies.
In 2007, the IRS audited the personal income tax returns of Carney and her husband for the 2004 and 2005 tax years, concluding that Carney underreported her income and paid personal expenses through her business in 2004 and 2005. The IRS later conducted an employment tax audit of Nelly and determined that the companions were employees for federal tax purposes. Nelly paid employment taxes for 2008 through 2012 and sued for recovery in the District Court for the Eastern District of Pennsylvania.
Issue: Section 530 provides relief from liability for employment taxes if the taxpayer had a reasonable basis for not treating individuals as employees. A taxpayer can demonstrate a reasonable basis by basing its classification of workers on (1) judicial precedent, published rulings, technical advice with respect to the taxpayer, or a letter ruling to the taxpayer; (2) a past IRS audit of the taxpayer in which there was no assessment attributable to the treatment of individuals holding substantially similar positions for employment tax purposes; or (3) a long-standing recognized practice of a significant segment of the industry in which an individual was engaged. Courts also have allowed relief if the taxpayer demonstrates by some other manner it had a reasonable basis for not classifying one or more workers as employees. The IRS contended Nelly could not reasonably rely on prior audits, industry practices, or any other basis for treating its workers as independent contractors. Nelly countered that it met both the second and third safe harbors under Section 530.
Holding: The court determined that Nelly did not qualify for any of the statutory safe harbors but nonetheless did have a reasonable basis under Section 530 for treating the workers as independent contractors. Although in its audit of the Carneys, the IRS requested Nelly's Forms 1099, it did so to examine questionable deductions and expenses on the couple's personal returns, not the status of the business's payees, the court noted. Therefore, Nelly could not rely on the audit for relief under the second statutory safe harbor.
The two local agencies on whose practices Carney based hers did not constitute a significant segment of her industry, nor did Carney thereby show that the practice was long-standing, the court found. Although Carney later performed a more extensive survey, many of those companies surveyed were outside her area and also did not represent a significant segment of the industry, the court said, and it denied relief under the third statutory safe harbor.
Nonetheless, the court determined that the facts showed that Nelly met the criteria for the "reasonable basis" safe harbor. The court noted that Carney had done significant research about the employee classification question. Also, although the purpose of the IRS's audit of Carney's personal return did not establish the prior-audit safe harbor, it was reasonable for Carney to interpret the IRS's silence during and after the audit with respect to Nelly's workers' treatment as independent contractors as acquiescing to it, the court said. Moreover, state regulations she learned about in a Pennsylvania Department of Health conference supported her belief that her arrangement, which she also referred to as a "registry," was appropriate, the court said. Specifically, she was told that state regulations define a "home care registry" as a business that "supplies, arranges or refers independent contractors to provide home care services."
Having determined that Nelly qualified for the "reasonable basis" safe harbor for treating its workers as independent contractors and was entitled to a refund of the employment taxes, the court said it was not necessary for it to determine whether Nelly should have treated the workers as employees.
- Nelly Home Care, LLC, No. 15-439 (E.D. Pa. 5/10/16)
—By Paul Bonner, a JofA senior editor.