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Reflectxion Resources Inc. v. Commissioner (T.C. Memo. 2020-114)

On August 3, 2020, the Tax Court issued a Memorandum Opinion in the case of Reflectxion Resources, Inc. v. Commissioner (T.C. Memo. 2020-114). The primary issue before the court in Reflectxion Resources was whether the Tax Court has jurisdiction to determine whether the petitioner was entitled to relief from worker classification liabilities pursuant to § 530 of the Revenue Act of 1978.

Background

The petitioner was as a medical staffing agency during 16 quarters (at least) from 2008 through 2011 (the periods at issue). It employed various therapists to fulfill contracts with healthcare facilities, who sought therapists for temporary staffing and for direct hire purposes. Though the petitioner operated throughout the country, they hired local therapists for the client.

The petitioner also has “travel” shrinks, some of whom were reimburse correctly (and withheld) for travel expenses, but others were reimbursed with the reimbursements for travel expenses not treated as subject to employment taxes. The IRS took issue with this latter characterization, though the ultimate merits of the argument were not at issue in this particular Tax Court opinion.

The Gevity Arrangement

From March 31, 2008, through September 30, 2010 (11 quarters), the petitioner contracted with Gevity HR, Inc. (GHI) for GHI to report wages and withholding of the petitioner’s employees on Forms 941 (Employer’s Quarterly Federal Tax Return) and Forms W-2 (Wage and Tax Statement). Although GHI reported the wages and withholding, it did so under its own EIN.

GHI did not report the travel expenses as wages subject to employment taxes. Furthermore, the petitioner did not deposit FICA taxes or withhold from the therapists’ income with the IRS under its own EIN. For the subsequent quarters (after the contract was terminated with GHI) the petitioner did withhold and deposit appropriately (absent the travel expenses, of course).

The Audit and Proposed Liabilities

Exam determined that the petitioner’s travel reimbursement plan violated the accountable plan rules provided in IRC § 62 and its accompanying regulations. Further, Exam determined that petitioner’s travel reimbursement practice constituted “wage recharacterization” in violation of Treas. Reg. § 1.62-2(d).

During the audit, the petitioner argued that (for employment tax purposes, the therapists were GHI’s employees because GHI was their “statutory employer” pursuant to IRC § 3401(d)(1) during the 11 quarters at issue. The petitioner also maintained that it qualified for relief from any employment tax liabilities under § 530 of the Revenue Act of 1978, Pub. L. No. 95-600, 92 Stat. at 2885 (§ 530). The IRS proposed the employment tax liabilities, and the petitioner filed a protest with the IRS.

The Petitioner’s Argument in Appeals

In a letter sent to Appeals, the petitioner argued that through application of Florida law (which controlled the contract), GHI was the IRC § 3401(d)(1) employer, and thus the petitioner was not required to file any payroll tax returns treating its employees as subject to wage withholding. For this reason, the petitioner argued, it should be subject to § 530 relief from withholding for these periods.

The IRS’s Notice of Determination of Worker Classification

The IRS issued a Notice of Determination of Worker Classification (NDWC) which determined that the petitioner was not entitled to § 530 relief for the 11 quarters and that the petitioner was, therefore, liable for additional employment tax, additions to tax, and penalties. The NDWC observed that under Treas. Reg. §31.3401(a)-4(b), if a, expense allowance arrangement (reimbursement) does not satisfy the requirements of IRC § 62(c) and Treas. Reg. §1.62-2, all amounts paid under the arrangement are treated as paid under a non-accountable plan, are included in wages, and are subject to withholding and payment of employment taxes when paid.

Tax Court Jurisdiction for Employee Classification Issues

The Tax Court has “limited jurisdiction” over cases involving employment taxes imposed under subtitle C of the Code. See IRC § 7436; Am. Airlines, Inc. v. Commissioner, 144 T.C. 24, 31-32 (2015). Thus, if in connection with an audit of a taxpayer, there is an actual controversy regarding a determination by Exam with respect to the classification of employees or that the taxpayer is not entitled to relief under § 530(a), the Tax Court has jurisdiction (on petition of the taxpayer) to uphold the determination or to make a redetermination. IRC § 7436(a)(1)-(2). This is a loaded section, and the Tax Court further breaks it down into more digestible elements.

First, the IRS must “determine” that the taxpayer’s workers are employees or that the taxpayer is not entitled to IRC § 530 relief – either or both will suffice. See Am. Airlines, Inc., 144 T.C. at 33. Second, the determination must have been made “in connection with an audit” of the taxpayer’s returns and “as part of an examination”. That is to say, if the IRS makes its determination in some other context (such as in ongoing litigation), no jurisdiction will lie. Third, there must be an “actual controversy” regarding that audit determination.

The phrase “actual controversy” is a term of art in the declaratory judgment context, and its use in IRC § 7436 corresponds to the fact that this Code section is, essentially, a declaratory judgment provision. Malowney v. Fed. Collection Deposit Grp., 193 F.3d 1342, 1347 (11th Cir. 1999); SECC Corp. v. Commissioner, 142 T.C. 225, 237 (2014); Henry Randolph Consulting v. Commissioner, 112 T.C. 1, 11-12 (1999). A “controversy” in this sense means that is appropriate for judicial determination. Aetna Life Ins. Co. of Hartford, Conn. v. Haworth, 300 U.S. 227, 240-41 (1937). Thus, if a taxpayer concedes that the worker is an employee, then, there is no “actual controversy.” Similarly, if the IRS determines that the taxpayer is not entitled to § 530 relief, but the taxpayer did not argue entitlement, then there is no “actual controversy,” either.

Relief under IRC § 530

When an employer misclassifies employees as independent contractors, Congress provided an avenue of relief by enacting § 530. Three requirements must be met in order for the employer to receive relief. First, the employer must not have treated the individual as an employee. Second, the employer must have filed tax returns consistent with the treatment as a non-employee Third, the employer must have had a reasonable basis for not treating the individual as an employee.

All three requirements must be met in order for the employer to qualify for relief under § 530. Thus, § 530 has no application where the employer did treat the worker as an employee. For employment taxes that result not from the mischaracterization of the worker but from some other error in reporting and paying employment tax, § 530 has no application.

Because the petitioner satisfied both the test set forth in IRC § 7436 and the test set forth in § 530 as to the 11 quarters at issue, the Tax Court determined that it did have jurisdiction to hear the petition for redetermination.

(T.C. Memo. 2020-114) Reflectxion Resources, Inc. v. Commissioner

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