In Cardiovascular Center LLC v. Commissioner of Internal Revenue Service, the Tax Court had to determine the employment status of the workers at cardiovascular Center, LLC pursuant to IRC section 7436.

In a Notice of Employment Tax Determination of Worker Classification (notice of determination), the Internal Revenue Service (IRS) determined that petitioner (1) failed to classify some of its workers as employees during tax periods beginning in 2010 through 2015; (2) was not entitled to relief under the Revenue Act of 1978 (RA 1978) (section 530); and (3) was therefore liable for federal employment taxes and additions to tax under section 6651(a)(1) and (2) for the tax periods at issue.

According to court documents, Cardiovascular Center, LLC, the petitioner, is an active Arizona limited liability company whose sole member is Dr. Frank Daniel Kresock. The petitioner was treated as a disregarded entity for federal tax purposes. Therefore, income and deductions were reported on Dr. Kresock’s personal tax returns. Dr. Kresock operated his medical practice through petitioner. Janine Smith works with Dr. Kresock in his medical practice as the office manager and as a registered health information technologist. Sabrina Banuelos, Jane Blevins, Leonor Moreno, and Nohemi Morales (collectively, workers) also work with Dr. Kresock as medical assistants in the practice. The employment status of these four workers and Ms. Smith is at issue. Each worker was paid with a cashier’s check signed by Dr. Kresock following a submission of a biweekly timesheet, which was approved by Ms. Smith. The workers were paid a set hourly rate. The timesheets identified them as “employees” and Ms. Smith as “manager.” According to the biweekly timesheets, the workers often worked in excess of 70 hours, indicating a full-time schedule, and were paid an increased hourly rate for work performed in excess of eight hours per workday.

Ms. Smith was not paid directly by the petitioner for the tax periods at issue. However, Dr. Kresock paid her personal bills, such as her mortgage payments on homes titled in her name, since Dr. Kresock and Ms. Smith resided together. At trial Ms. Smith testified that she “volunteered” for petitioner (without remuneration) by “helping out in the practice.”

All workers were subject to Dr. Kresock’s supervision and reported to him. The workers were expected to follow the office procedures that were set by and communicated to them by Dr. Kresock and Ms. Smith. None of the workers was able to realize a profit or loss because of their services. There were no formal employment contracts between Ms. Smith and petitioner or between petitioner and the workers. The workers determined their own schedules, where they were permitted to arrive and leave, at any time, without adverse consequences from Ms. Smith or Dr. Kresock.

The workers worked with petitioner for several years. Three of the workers were previous participants in practical training petitioner hosted as part of their program of study. These workers began working with petitioner after expressing an interest in working for petitioner during their practical training.

Ms. Smith was responsible for managing the office and the workers and performing coding tasks. Ms. Smith worked “almost every day.” At Ms. Smith’s direction, the workers performed both “front office” and “back office” duties, including answering phones, taking care of patients, completing prior authorizations, faxing prescriptions, collecting payments, scheduling appointments, checking blood pressure, pulse, and weight, making entries into patient charts, and taking patients to patient rooms.

Petitioner did not file or furnish Form 1099-MISC, Miscellaneous Income, or W-2, Wage and Tax Statement, reporting the compensation paid to the workers, nor did it file any associated employment tax returns (Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, and Form 941, Employer’s Quarterly Federal Tax Return) for the tax periods at issue.

The Courts determine a worker’s employment status by applying common law concepts, while keeping in mind that doubtful questions should be resolved in favor of employment. The court consider various factors in determining whether a worker is a common law employee or an independent contractor including: (1) the degree of control exercised by the principal over the worker; (2) which party invests in the work facilities used by the worker; (3) the worker’s opportunity for profit or loss; (4) whether the principal can discharge the worker; (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. No single factor is dispositive, and all facts and circumstances must be considered.

The U.S. Court of Appeals for the Ninth Circuit, the court to which an appeal of this case would lie under section 7482(b), has similarly considered a list of non-exhaustive factors as a guide in this inquiry. The IRS in Rev. Rul. 87-41, 1987-1 C.B. 296 has also issued guidance using 20 factors in determining whether an employment relationship exists. The principal’s degree of control over the worker is a crucial factor in determining whether an employment relationship exists. To that end, “[a]n employer-employee relationship exists when the principal retains the right to direct the manner in which the work is to be done, controls the methods to be used in doing the work, and controls the details and means by which the desired result is to be accomplished.”

Over the years courts have identified on a case-by-case basis various facts or factors that are relevant in determining whether an employer-employee relationship exists. In 1987, based on an examination of cases and rulings, the Internal Revenue Service (“IRS”) developed a list of 20 factors that may be examined in determining whether an employer-employee relationship exists. The degree of importance of each factor varies depending on the occupation and the factual context in which the services are performed; factors other than the listed 20 factors may also be relevant.

The 20 relevant factors identified by the IRS:

1.  Instructions: If the person for whom the services are performed has the right to require compliance with instructions, this indicates employee status.

2.  Training: Worker training (e.g., by requiring attendance at training sessions) indicates that the person for whom services are performed wants the services performed in a particular manner (which indicates employee status).

3.  Integration: Integration of the worker’s services into the business operations of the person for whom services are performed is an indication of employee status.

4.  Services rendered personally: If the services are required to be performed personally, this is an indication that the person for whom services are performed is interested in the methods used to accomplish the work (which indicates employee status).

5.  Hiring, supervision, and paying assistants: If the person for whom services are performed hires, supervises or pays assistants, this generally indicates employee status. However, if the worker hires and supervises others under a contract pursuant to which the worker agrees to provide material and labor and is only responsible for the result, this indicates independent contractor status.

6.  Continuing relationship: A continuing relationship between the worker and the person for whom the services are performed indicates employee status.

7.  Set hours of work: The establishment of set hours for the worker indicates employee status.

8.  Full time required: If the worker must devote substantially full time to the business of the person for whom services are performed, this indicates employee status. An independent contractor is free to work when and for whom he or she chooses.

9.  Doing work on employer’s premises: If the work is performed on the premises of the person for whom the services are performed, this indicates employee status, especially if the work could be done elsewhere.

10. Order or sequence test: If a worker must perform services in the order or sequence set by the person for whom services are performed, that shows the worker is not free to follow his or her own pattern of work and indicates employee status.

11. Oral or written reports: A requirement that the worker submit regular reports indicates employee status.

12. Payment by the hour, week, or month: Payment by the hour, week, or month generally points to employment status; payment by the job or a commission indicates independent contractor status.

13. Payment of business and/or traveling expenses. If the person for whom the services are performed pays expenses, this indicates employee status. An employer, to control expenses, generally retains the right to direct the worker.

14. Furnishing tools and materials: The provision of significant tools and materials to the worker indicates employee status.

15. Significant investment: Investment in facilities used by the worker indicates independent contractor status.

16. Realization of profit or loss: A worker who can realize a profit or suffer a loss as a result of the services (in addition to profit or loss ordinarily realized by employees) is generally an independent contractor.

17. Working for more than one firm at a time: If a worker performs more than de minimis services for multiple firms at the same time, that generally indicates independent contractor status.

18. Making service available to the general public: If a worker makes his or her services available to the public on a regular and consistent basis, that indicates independent contractor status.

19. Right to discharge: The right to discharge a worker is a factor indicating that the worker is an employee.

20. Right to terminate: If a worker has the right to terminate the relationship with the person for whom services are performed at any time he or she wishes without incurring liability, that indicates employee status.

Recently, the IRS has identified three categories of evidence that may be relevant in determining whether the requisite control exists under the common-law test and has grouped illustrative factors under these three categories: (1) behavioral control; (2) financial control; and (3) relationship of the parties. The IRS emphasizes that factors in addition to the 20 factors identified in 1987 may be relevant, that the weight of the factors may vary based on the circumstances, that relevant factors may change over time, and that all facts must be examined.

Section 530, when applicable, affords taxpayers relief from federal employment taxes even if the relationship between the principal and the worker would otherwise require the payment of those taxes. To qualify for section 530 relief, a taxpayer (1) must not have treated the worker as an employee for any period for purposes of federal employment taxes (historic treatment requirement); (2) must have consistently filed all federal tax returns (including information returns) required to be filed by the taxpayer with respect to the individual for periods after 1978 on a basis consistent with the taxpayer’s treatment of that individual as not being an employee (reporting consistency requirement); (3) must have had a reasonable basis for not treating the worker as an employee, e.g., the taxpayer’s treatment of the worker was in “reasonable reliance” on one of the items specified in section 530(a)(2) (reasonable basis requirement); and (4) must not have treated as an employee any individual holding a position “substantially similar” to that of the worker in question (substantive consistency requirement).

Under a literal reading of that text, all requirements must be met in order for the petitioner to receive the relief described therein. Accordingly, the petitioner is not entitled to section 530 relief and is therefore liable for the federal employment taxes reflected in the notice of determination. We find petitioner has failed to establish its qualification for the reasonable basis requirement under the third requirement of section 530, nor has petitioner satisfied the second requirement of section 530 as it is undisputed petitioner failed to file Forms 1099- MISC for the tax periods at issue.

The Court has determined after consideration of the record and the relevant factors, the relationship between petitioner and Ms. Smith and petitioner and the workers is best characterized as an employment relationship. The critical factor of whether petitioner exercised control over the workers is met. Additional factors such as the investment in the work facilities used by the workers, the workers’ opportunities for profit or loss, whether the work was part of petitioner’s regular business, and the permanency of the relationship all lean significantly in favor of the finding that this was an employment relationship.

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Further reading:

T.C. Memo. 2023-64 Docket No. 24412-21. May 18, 2023.

Rev. Rul. 87-41, 1987-1 C.B. 296.

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