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					      tAXeS in your prActice


tax court rules Attorneys Were
employees of law firm
bY SCOTT E. VINCENT                         Statutory and Common Law                       (2) the worker’s opportunity for
                                            background                                  profit or loss;
                                               Code §§ 3111 and 3301 impose                (3) the worker’s investment in
                                            FICA (Social Security) and FUTA             facilities;
   A recent Tax Court decision has          (unemployment) taxes on employers for          (4) the permanence of the
important employment tax implications       wages paid to their employees. Code         relationship; and
for law firms that do not treat attorneys                                                  (5) the skill required in the operation.
                                            § 3121(d)(2) provides that for FICA tax
working with the firm as employees.
                                            purposes the term “employee” includes
In Donald G. Cave A Professional Law                                                       However, § 530 of the Revenue
                                            any individual who has the status of an
Corp. v. Commissioner, T.C. Memo                                                        Act of 1978 (as amended) provides
                                            employee under common law. Code
2011-48, the Tax Court found that                                                       retroactive and prospective relief
                                            §§ 3121(d)(1), 3121(d)(3) and 3121(d)
attorneys working with an S corporation                                                 from employment tax liability for
                                            (4) describe other individuals who are
law firm were employees of the firm for                                                 employers who misclassified workers
                                            considered employees for FICA tax
employment tax purposes, and that the                                                   as independent contractors using the
                                            purposes regardless of their status under
firm was liable for employment taxes                                                    common-law facts and circumstances
                                            common law. These individuals are
and penalties with respect to amounts                                                   standards. Section 530 applies only if:
                                            commonly referred to as “statutory”
paid to the attorneys for the periods in
                                            employees.
question. This decision was contrary to                                                     (1) the taxpayer does not treat
the independent contractor treatment                                                        an individual as an employee
                                               An officer of a corporation who
that the law firm sought to sustain with                                                    for any period, and does not
                                            performs substantial services for the
the IRS and in Tax Court, and also                                                          treat any other individual
                                            corporation and receives remuneration
required employment taxes with respect                                                      holding a substantially similar
                                            for such services is a statutory employee
to the S corporation’s sole shareholder.                                                    position as an employee for
                                            for employment tax purposes (Code
                                            §§ 3121(d)(1), 3306(i), and 3401(c)).           purposes of employment tax for
                                                                                            any period — the substantive
                                               Whether a worker is an independent           consistency requirement;
                                            contractor or employee under the                (2) for post-1978 periods,
                                            common law rules generally is                   “all federal returns (including
                                            determined by whether the enterprise            information returns) required
                                            he works for has the right to control           to be filed by the taxpayer” with
                                            and direct him in completing the job            respect to the individual for
                                            in question. The Court of Appeals for           such period “are filed on a basis
                                            the Fifth Circuit, to which the case in         consistent with the taxpayer’s
                                            question is appealable, considers the           treatment” of the individual as
                                            following factors in deciding whether a         a nonemployee — the reporting
                                            worker is a common law employee:                consistency requirement; and
                                                                                            (3) the taxpayer had a “reason-
                                               (1) The degree of control the                able basis” for not treating the
                   SCOTT E. VINCENT
                   vincent, fontg &         principal has over the worker;                  worker as an employee (judicial
                   hansen, llc                                                              precedent or IRS rulings, a past
                   Kansas city

124 / Journal of the Missouri Bar
    IRS audit, or a long-standing               Upon examination, the IRS deter-          work and compensation arrangements
    practice of a significant segment        mined that Donald Cave, the associate        strongly suggested that he was the firm’s
    of the relevant industry) — the          attorneys and the law clerk were the         employee during the periods in ques-
    reasonable basis requirement.            firm’s employees for 2003 and 2004           tion.
                                             and that the firm was not entitled to
Factual background                           § 530 relief. The IRS concluded that            The Tax Court also agreed with the
    Donald G. Cave A Professional Law        Donald Cave was a statutory employee,        IRS and determined that no § 530 relief
Corp. (the “firm”) was incorporated as a     and that the associate attorneys and law     was available with respect to the workers
Louisiana professional law corporation.      clerk were common-law employees. As a        for the following reasons:
Its business consisted primarily of repre-   result, the IRS determined that the firm
senting individuals injured in accidents,    was liable for employment taxes and          •	 Although § 530 relief is not by its
and fees generated from the provision        penalties. The Tax Court agreed with all        terms limited to situations involving
of legal services were its only source of    aspects of the IRS determination.               worker classification under com-
income in 2003 and 2004. All attor-                                                          mon law, the Tax Court has previ-
ney’s fees and reimbursements of case        Tax Court Decision                              ously held that it is not available
expenses were paid directly to the firm,         The Tax Court noted that, during            with respect to statutory employees.
which then paid a portion of the gross       the years in question, Donald Cave was          Donald Cave was the firm’s statu-
fee (generally one-half or one-third) to     the firm’s president, made virtually all        tory employee for the periods in
the attorney who handled the case.           corporate decisions with respect to the         question, so § 530 relief was not
                                             firm, received a percentage of the legal        available with respect to him.
   The firm was an S corporation for         fees recovered in cases he handled, and
federal income tax purposes in 2003          received draws from the firm of $48,000      •	 The firm did not establish that it
and 2004. Donald Cave was the firm’s         and $360,000. These facts established           had any reasonable basis for treating
president and sole shareholder.              that Donald Cave was the firm’s statuto-        the associate attorneys as indepen-
                                             ry employee under Code § 3121(d)(1).            dent contractors, so § 530 relief was
   For 2003 and 2004, firm did not                                                           not available for these workers.
treat Donald Cave, three associate at-          After reviewing all of the relevant
torneys and a law clerk as employees         facts and circumstances, the Tax Court       •	 Section 530 relief was not avail-
for employment tax purposes. The firm        concluded that the associate attorneys          able for the firm’s law clerk because
issued Forms 1099-MISC to the associ-        were the firm’s common-law employees.           the firm had previously treated law
ate attorneys and the law clerk for those    Three of the five specific factors — de-        clerks as employees.
years. The firm did not issue a Form         gree of control, investment in facilities,
W-2 or a Form 1099-MISC to Donald            and permanence of the relationship           Conclusion
Cave for 2003 and 2004.                      – indicated an employer-employee                The Cave case provides a key
                                             relationship. The Tax Court found that       warning to law firms treating
   Donald Cave believed it was appro-        the remaining factors were neutral.          attorneys as independent contractors
priate for the firm to treat the associate   Importantly, the Tax Court also noted        without carefully documenting the
attorneys and law clerk as independent       that the work performed by the associ-       relationship and establishing the
contractors because he did not have          ate attorneys was an integral part of the    basis for the treatment. It is also an
sufficient control over their work. The      firm’s business, which further supported     important reminder that S corporation
record did not disclose, however, the        the conclusion that the workers were         shareholders of a law firm are also
basis on which he determined it was ap-      employees.                                   employees of the firm, and some
propriate for the firm to treat them and                                                  reasonable portion of their distributions
himself as independent contractors. The         The Court also concluded that the         from the firm should be treated as
firm’s certified public accountant agreed    law clerk was a common-law employee          compensation for employment tax
with Donald Cave that the attorneys          after finding that three of the five         purposes.
and law clerk should be classified as in-    specific factors — degree of control,
dependent contractors for employment         investment in facilities, and profit or
tax purposes but did not investigate the     loss — were indicative of an employer-
facts or do any research to verify Mr.       employee relationship. In particular,
Cave’s position.                             the firm’s control over the law clerk’s



                                                                                                             March-April 2011 / 125

				
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