On May 27, 2020, the Tax Court issued a Memorandum Opinion in the case of Thoma v. Commissioner (T.C. Memo. 2020-67). Although there are a number of sub-issues related to whether the petitioner-husband (PH) was an employee or independent contractor, including deductibility of medical and business expenses, the core issue in Thoma v. Commissioner boils down to the age old question of whether PH was an employee or independent contractor of an accounting firm.
Brief Background to Thoma v. Commissioner
The accounting firm of Thoma & Hjerpe (TH) paid petitioner-husband (PH) for accounting services rendered in 2010 and 2011. These biweekly payments totaled $69,156 in 2010 and $63,299 in 2011. On their tax returns for 2010 and 2011, the petitioners took the position that PH was self-employed and that the biweekly payments constituted self-employment income for each year, such that PH was liable for self-employment tax. They also claimed an income-tax deduction for one-half of the self-employment tax they reported for PH for each year.
The notice of deficiency determined that PH was not self-employed, but rather an employee. The notice of deficiency recharacterized the reported self-employment income as wages. It accordingly reduced self-employment income for each year to zero, reduced self-employment tax for each year to zero, and reduced the income-tax deduction for one-half of self-employment tax for each year to zero. Next, because PH was determined to be an employee, the business expenses claimed as a deduction were not governed by IRC § 62(a)(1) and, therefore, not deductible in arriving at AGI.
The notice of deficiency determined that PH’s expenses of working for TH were deductible only as unreimbursed-employee-business expenses under IRC § 67(b). Finally, because PH was determined to be an employee, the self-employed health insurance expenses were not properly deductible under IRC § 162(l), but only as deductions for general medical expenses under IRC § 213(a).
Employee or Independent Contractor
The Tax Court applies common law rules to determine whether a worker is an employee under IRC § 1402(d). Simpson v. Commissioner, 64 T.C. 974, 984 (1975); Pariani v. Commissioner, T.C. Memo. 1997-427, *9; IRC § 3121(d)(2); Prof’l & Exec. Leasing, Inc. v. Commissioner, 89 T.C. 225, 231 (1987), aff’d, 862 F.2d 751 (9th Cir. 1988); Simpson v. Commissioner, 64 T.C. at 984. Whether a worker is an employee is a factual question. Weber v. Commissioner, 103 T.C. 378, 386 (1994), aff’d per curiam, 60 F.3d 1104 (4th Cir. 1995). The Tax Court considers a number of factors, no one of which is determinative. This non-exhaustive list includes (1) whether the relationship between the worker and the one to whom the worker provides services (i.e., the principal) was permanent; (2) whether the worker had an opportunity for profit or loss; (3) whether the principal had the right to discharge the worker; (4) whether the principal or the worker invested in the facilities the worker used; (5) whether the work was part of the principal’s regular business; (6) whether the principal could exercise control over the details of the work; and (7) whether the worker and the principal believed that they were creating an employment relationship. Weber, 64 T.C. at 387. Four of these factors weigh decidedly against the petitioners’ argument and in favor of an employer-employee relationship.
Although the relationship because PH and his colleague, ultimately causing PH to leave the accounting firm, the Tax Court found that the relationship was more permanent than that of an independent contractor. PH had worked for the firm for many years. The relationship, which ended only with the falling out, “was as permanent as any other employment relationship.” PH was discharged from his duties at the firm based on authority vested in his colleague.
The accounting firm provided PH with professional liability insurance, office space on its business premises, and tax preparation software. PH did not have any investment in the accounting firm. The firm was in the business of accounting, and PH performed for his clients was within the scope of the accounting firm’s regular business.
Self-Employment Income
Taxpayers are subject to self-employment tax on their self-employment income during a taxable year, IRC § 1401(a) and IRC § 1401(b)(2), and are allowed to deduct as an above-the-line income-tax deduction (i.e., a deduction in arriving at AGI) an amount equal to one-half of the self-employment tax. IRC § 164(f). Self-employment income is generally defined as “the net earnings from self-employment derived by an individual”. IRC § 1402(b). “Net earnings from self-employment,” in turn, are defined as “the gross income derived by an individual from any trade or business carried on by such individual, less the deductions allowed by this subtitle which are attributable to such trade or business.” IRC § 1402(a).
Although “trade or business” in this context has the same meaning as when used in IRC § 162, in the self-employment tax context, the performance of services by an individual as an employee is not included in the term. IRC § 1402(c)(2). “Employee” is defined by the Code but developed in common law, as it is for the general employee-independent contractor test. See IRC § 1402(d).
(T.C. Memo. 2020-67) Thoma v. Commissioner
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