For years, the question of whether construction workers should be treated as employees or independent contractors has been an important issue that many contractors have overlooked or chosen to ignore. However, a recent U.S. Tax Court decision highlights the need for construction contractors to focus on how they classify their workers for employment tax purposes.
The taxpayer in Kurek v. Commissioner, T.C. Memo 2013-64 (Feb. 28, 2013), was a sole proprietor who worked as the general contractor in renovating home interiors. During the tax year at issue, the taxpayer hired approximately 30 workers to assist him on various home renovation jobs. None of the workers worked full time for the taxpayer, and he paid them on a project-by-project basis. He paid each worker a weekly flat fee based on the percentage of work completed on a particular job. The workers set their own hours and work schedules. The taxpayer supervised the workers’ progress on a project and was at the worksite once a day or once every other day. Although the taxpayer permitted the workers to work simultaneously on other projects with him or with other construction groups, he would replace workers if a deadline was approaching or if a worker was holding up a job.
The workers brought their own sets of small tools, worth around $1,000, to the worksites. The taxpayer did not reimburse the workers for those tools, but he did buy or rent all larger tools, which he left at the worksites. Petitioner purchased materials needed for the projects, and the homeowners would reimburse him. Occasionally, workers purchased lightweight materials as needed during the project, and petitioner would reimburse them.
The taxpayer did not offer any employee benefits nor did the workers sign an independent contractor agreement. He did not carry unemployment insurance or workers' compensation insurance for the workers. Most importantly, the taxpayer did not issue Forms 1099-MISC or Forms W-2 to any of the workers for the tax year at issue. Following an employment tax audit, the IRS determined that the workers were the taxpayer’s employees and that he should have paid Federal Insurance Contributions Act (FICA) and Federal Unemployment Tax Act (FUTA) taxes, as well as income tax withholdings on the workers’ wages. The taxpayer appealed the IRS’s determination to the U.S. Tax Court.
Whether a worker is an employee or an independent contractor is a factual question to which common law (judge-made) principles apply. In short, the right of the principal to exercise control over the agent, whether or not the principal in fact does so, is the “crucial test” for the existence of an employer-employee relationship. Under the common law, an employer-employee relationship exists when the principal has the right to control and direct the service provider regarding the result and how the result is to be accomplished. The principal need not actually direct or control the manner in which the services are performed; the principal need only have the right to do so.
Despite the presence of several factors in favor of independent contractor status, the Tax Court concluded that the workers should be classified as the taxpayer’s employees because the taxpayer failed to prove that he did not have control over the workers. Although the workers set their own hours and provided their own small tools, the taxpayer set deadlines and monitored their work, visiting the worksite daily or every other day. The Tax Court found it important that the taxpayer: (1) had the ultimate authority in instructing the workers as to their job responsibilities, (2) had the right to approve the quality of their work, and (3) paid them weekly rather than at the end of the project. Moreover, only the taxpayer communicated with the homeowners, and he alone was responsible for the success or failure of the projects. The Court also held that the taxpayer did not qualify for alternate relief otherwise available under Section 530 because he did not file Forms 1099 for any of the workers, which is a critical element of that statutory safe harbor.