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Tax Court Treats Unsupervised Worker as an Employee

Employers often want to treat workers as independent contractors, rather than employees. But the worker might also benefit from claiming independent contractor status.

Oct 29th 2019
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In a new case, McGuigan, T.C. Summary Opinion 2019-27, 9/30/19, the Tax Court examined the facts involving a worker who had a long-term relationship with an employer.

Frequently, employers prefer to classify workers as independent contractors to avoid payment of payroll taxes and costly fringe benefits for employees. Otherwise, they are usually on the hook for those payments.

As far as the workers go, they may be able to fully deduct business expenses if they are self-employed. Conversely, if they are treated as employees, unreimbursed employee business expenses could only be deducted as miscellaneous expenses, subject to a floor of two percent of adjusted gross income (AGI). Under the Tax Cuts and Jobs Act (TCJA), no deduction is allowed for miscellaneous expenses for 2018 through 2025, regardless of AGI.

In the new case, the taxpayer, who was a diesel technology specialist, had a long-standing business relationship with an entrepreneur. After the entrepreneur started a new company, he invited the taxpayer to work for him. Based on an oral agreement, the taxpayer performed gas recovery services for this employer at multiple oil well sites across Montana and North Dakota.

The taxpayer’s duties included moving gas recovery equipment between oil well sites, setting up and maintaining the equipment to recapture gas and training oil company employees to ensure continued plant operations. Much of the equipment was leased directly to the employer, but it was entrusted to the taxpayer. He worked at the oil sites without direct supervision and set his own hours, which varied with the task at hand.

Each day the taxpayer filed work reports showing that he was providing quality service. Additionally, the taxpayer submitted equipment logs.

The taxpayer was responsible for work-related expenses including food, lodging, travel and insurance. He was also responsible for any expenses arising from damage to the equipment during transport. The employer didn’t reimburse him for these expenses. Also, the taxpayer drove his own truck to the various worksites and took his tools with him.

On his tax returns for 2014 and 2015, the taxpayer declared himself a “mechanic.”  Accordingly, he filed a Schedule C as a self-employed individual for the two tax years in question. But the employer provided W-2s to the taxpayer reflecting the amounts paid to him.

The Tax Court listed the following factors to be examined in deciding whether an employer-employee relationship exists:

  • The degree of control exercised by the principal over the details of the work
  • Which party invests in the facilities used in the work
  • The opportunity of the taxpayer for profit or loss
  • Whether the principal has the right to discharge the taxpayer
  • Whether the work is part of the principal’s regular business
  • The permanency of the relationship
  • The relationship the parties believe they are creating

In its analysis, the Tax Court determined that the majority of the factors indicated that the taxpayer was an employee, even though he worked without any supervision. Thus, he could only deduct unreimbursed employee business expenses as miscellaneous expenses.

Lesson to Be Learned

In a borderline situation, advise your clients to collect proof that points toward independent contractor status. Significantly, make sure that employment agreements are put in writing, spelling out the key terms of the arrangement.  

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Another Look at the Employee vs. Contractor Issue

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