Substance Over Form

The Tax Court looked today at a worker in Hollywood. He thought he was a contractor; the IRS felt he was an employee. Who was correct?

Our favorite judge of the Tax Court, Judge Mark Holmes, authored the opinion so it’s very readable. The petitioner today was upset about three things that the IRS had changed with has 2009 and 2010 tax returns. First, he filed as an independent contractor in 2008 and the IRS didn’t do anything so his 2009 and 2010 returns shouldn’t be looked at. Second, he feels he was an independent contractor. Third, if he wasn’t an independent contractor he was a statutory employee. The IRS disagrees with all of these.

Judge Holmes quickly disposes of the first issue.

Each tax year stands alone, and the Commissioner may challenge in a later year what he permitted in an earlier one. The Commissioner’s failure to challenge Quintanilla’s status for the 2008 tax year doesn’t disable him from challenging that status for 2009 and 2010.

The second issue has easy law but is difficult in application. “We’ll start with the easy part: An independent contractor is one who works for another but according to his own manner and method, free from direction or right of direction in matters relating to performance of work save as to results.” The key is what did the petitioner really do, not how did he get paid.

We find that the production companies that hired Quintanilla hired him to build sets. They expected him to provide any tools he needed to complete the job. Quintanilla has an enormous collection of tools–which he stores in two 40-foot steel containers–that travels with him to jobsites. These containers are also packed with machinery that Quintanilla uses to fabricate pieces of sets on the spot…Thus, Quintanilla might be paid by the same payroll company for six months, but actually be working on 20 or more projects run by many different production companies.

But Mr. Quantanilla received some W-2s, so he must be an employee, right?

When a production company hired Quintanilla as an individual, it would generally issue him a Form W-2, Wage and Tax Statement. And the company listed on the Form W-2 as the employer was usually a payroll company. Even a tiny bit of questioning showed that his situation is much different from most taxpayers who get a W-2 from their employer, and nobody involved in this case thinks the payroll company had any control whatsoever over how Quintanilla did his work. Indeed, Quintanilla often performed different jobs for different production companies while being paid by the same payroll company. He was hired for more than 80 different jobs by production companies in 2009, but some of these production companies hired him for multiple jobs at different times throughout the year. The same was true in 2010…

We conclude that almost all these facts favor finding that Quintanilla was an independent contractor and not an employee. The most important is that Quintanilla had a large degree of control as to how to accomplish the tasks he had to do throughout the year.

That the petitioner provided his own tools was another factor in his favor. He had a risk of economic loss, another factor in his favor. The IRS tried to argue that he was employed by various payroll companies, and that was clearly not the case. The final argument that the IRS made was that the petitioner was a union member.

Quintanilla credibly explained that he and many of his peers in the industry join unions mainly to obtain health insurance and to a lesser extent to appear on call boards. His experience was typical–he was a member of a union and received his health insurance from it. That union required Quintanilla to show a minimum number of hours to receive this insurance. But neither the union contracts nor the production companies gave him vacation days or sick time. As Quintanilla credibly explained, if he wanted a vacation he would just not answer his phone. And the union contracts even excluded fixed wages and working conditions from their coverage–they expressly reserved the power of employees to cut better deals if they could. Quintanilla testified that all of his jobs came from personal connections and not one came from a union call board…

Quintanilla credibly testified that everything in Hollywood is a negotiation, and contracts are discussed daily. At times a studio even uses another studio’s stage if the price is lower than the rate for its own stage. Continual negotiations and ever-changing contracts are evidence that the studios didn’t intend to make a permanent relationship. Employers don’t negotiate with their employees daily.

So today’s petitioner, who represented himself in Tax Court, won that he was an independent contractor, not an employee. (The statutory employee issue wasn’t reached, as the petitioner won as an independent contractor.) He’s able to take his business expenses on Schedule C rather than Schedule A as he did on his tax returns.

This case was an example of a major issue in dealing with the IRS: substance versus form. I have an ongoing issue with a client who received an information return (a 1099) in error, but the IRS refuses to believe the client. All we can provide are negatives–there was no money paid to him in the year in issue. This case is going to head to Appeals soon, and we may prevail there (Appeals now looks at the chance of prevailing in Tax Court, and with information returns the burden of proof is on the IRS, and there’s no proof other than the erroneous 1099).

Here, had the IRS actually looked at what actually was happening with the petitioner, it should have realized what he was saying was true. Unfortunately, that’s a bit too much to ask for when dealing with the IRS today.

Case: Quintanilla v. Commissioner, T.C. Memo 2016-5

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