If the real estate market has not impacted Contractors enough. The Tax Court has concluded that workers hired by a construction company to work on various residential projects were employees.
Despite the fact that the workers were hired on a project-by-project basis, the overall facts of the case, including that the workers were controlled by the company’s sole proprietor and that they were an integral part of the business, indicated an employer-employee relationship. Accordingly, the company was liable for employment taxes for the year in dispute. This is major blow to those taxpayers that utilize a large number of “independent contractors”.
Employers and employees are subject to employment taxes under FICA (social security taxes), and employers are also subject to unemployment taxes under FUTA. Employers are required to withhold FICA tax and Federal income tax on wage payments they make to their employees, but these employment taxes do not apply to payments to independent contractors.
The law defines an “employee” as an individual who, under common law (case law) rules, has the status of an employee. The courts have found that whether an individual is a common law employee is a question of fact to be determined by applying the following factors:
- the degree of control exercised by the principal;
- which party invests in work facilities used by the individual;
- the opportunity of the individual to realize a profit or loss;
- whether the principal can discharge the individual;
- whether the work is part of the principal’s regular business;
- the permanency of the relationship; and
- the relationship the parties believed they were creating.
Here are the facts of the most recent case:
During 2005 (the year at issue), Mieczyslaw Kurek was the sole proprietor of KMA Construction, a home improvement company that engaged in installing tile, sheetrock, doors, and windows, as well as painting and carpentry. Throughout 2005, Kurek (through KMA) worked on approximately 20 to 30 residential projects in Brooklyn, New York.
Kurek hired workers throughout the year (28 were listed in the notice of determination), and he supervised them, told them what work needed to be done, and set deadlines for the jobs. All workers worked on a project-to-project basis, and they did not work under business names or advertise to the public. Kurek paid each worker a flat fee, as negotiated for a particular job on a particular project. He paid each worker every week, by personal check, according to the percentage of the work completed.
Kurek also managed the day-to-day operations of KMA Construction. He worked closely with the homeowner on each project, discussing the details of the work to be performed and the supplies needed, and negotiating the cost of the project taking into account the payments that he negotiated with the workers. The homeowners paid Kurek directly and spoke with him regarding any problems with the work.
The workers set their own hours and work schedules, provided their own transportation to the worksites, and used their own sets of small tools, with Kurek supplying larger tools. Kurek didn’t tell the workers how to do their jobs, but he would replace workers if a deadline was approaching or if a worker was holding up a job, and he would order workers to repair problems or redo work if he felt it was being done improperly. He didn’t provide training, offer employee benefits (e.g., sick pay or medical insurance), or carry unemployment insurance.
For 2005, Kurek didn’t issue Forms 1099-MISC (Miscellaneous Income) or Forms W-2 (Wage and Tax Statement) to any of the workers, and didn’t file Forms 941 (Employer’s Quarterly Federal Tax Return) or Form 940 (Employer’s Annual Federal Unemployment (FUTA) Tax Return). He didn’t pay any employment taxes or remit periodic deposits for the workers. In 2009, IRS prepared substitutes for returns (SFRs) for Kurek’s Forms 941 for all quarters in 2005 and an SFR for his Form 940 for the year, based on its determination that the workers were employees in 2005.
Workers were employees. The Tax Court analyzed each of the factors outlined above and concluded that the workers were employees during 2005:
- Kurek had control over the workers. The Court characterized the right of the principal to exercise control over the agent, regardless of whether the principal in fact does so, as the “crucial test” in analyzing for an employer-employee relationship. In this case, Kurek set the deadlines, monitored the work done, visited the worksites, instructed the workers on the work they were to do and had the right to approve its quality, paid them weekly, and was ultimately responsible for the success of the project. Overall, these facts heavily favored employee status
- Kurek supplied heavy tools and materials. The workers used their own small tools to perform most of their work, but Kurek supplied all heavy tools and purchased all materials used by the workers. This factor slightly favored employee status
- Only Kurek had opportunity for profit and risk of loss. The workers were paid a negotiated flat fee, and were thus insulated from suffering a loss or realizing a profit, and were also prevented from increasing their earnings through their efforts. This factor favored employee status
- Workers could be discharged. Although the workers were hired on a project-to-project basis, Kurek could replace any workers that failed to meet a deadline or perform to Kurek’s satisfaction. This favored employee status
- Workers were integral to the business. Without the workers, Kurek wouldn’t have been able to finish 20-30 projects, while at the same time finding new projects and working with the homeowners. This favored employee status
- Work relationship was largely transitory. The workers were hired for one project at a time, they were free to work on other projects or with other groups, and only seven of the workers actually worked for Kurek during all four quarters of 2005. This slightly favored independent contractor status…. Parties believed they created independent contractor relationship. Kurek and one of the workers credibly testified that they believed they created an independent contractor relationship, which favored independent contractor status.
The Tax Court agreed with IRS that the workers listed in the notice of determination were employees in 2005.
If you have any questions regarding the treatment of your employees or independent contractors, please do not hesitate to contact us.