KUREK V. COMMISSIONER , T.C.

MEMO COULD SET STAGE FOR LARGER DECISIONS ON INDEPENDENT CONTRACTORS

L. MICHAEL GRACIK, JR.L. MICHAEL GRACIK, JR. is a partner with Keiter, P.C. in Richmond, Virginia. Mike is the lead partner of Keiter's tax services group and has over 37 years of experience and tax insights. His clients include closely held businesses in the real estate, home building, manufacturing, and construction industries. He can be reached at mgracik@keitercpa.com. While the exact definition of an independent contractor remains unclear, construction companies must be prepared for many different alternatives in order to follow the law and meet the needs of clients. Historically, the Internal Revenue Service has not liked independent contractors. Concerns over the collection of payroll taxes and the ability to avoid providing benefits have increased the IRS's weariness about the designation, especially in light of the Affordable Care Act of 2010. One industry that has been chastised the most by the IRS has been the construction industry. Construction companies typically use independent contractors rather than employees for projects, due to the highly uncertain nature of the business. Construction is a highly circular activity that is reliant on numerous factors including weather, project type, and complexity. Despite these obvious dilemmas, the IRS continues to relentlessly pursue construction companies with audits and other penalties, especially in recent years. The Tax Court memo Kurek v. Commissioner is a further execution of an evolving trend to hold construction companies accountable for their use of independent contractors. It is not by any means comprehensive, due to the fact that it was not a decision from the entire Tax Court, but it does illustrate a larger challenge that construction companies will need to prepare for moving forward. Before looking at the actual decision, it is essential to take a step back and examine the history behind the relationship between the IRS and independent contractors. The independent contractor designation can be traced back to the early 1900s when Congress adopted the new distinction as a way to protect workers under the New Deal. 1 Since its humble beginnings, the new distinction was never very well defined. That resulted in a very bumpy ride through the U.S. legal system in court cases across the country. Congress failed to provide any substantive guidance on how independent contracts were supposed to be treated, which was a challenge for the courts. Upon passage of the National Labor Relation Act of 1935, the National Labor Relations Board tried to better define the meaning of an independent contractor. Most notably, NLRB v. Hearst Publications in 1944 provided ambiguous language that ended up allowing independent contractors to unionize. 2 However, in the later years of the twentieth century the NLRB seemed to take a

more business-friendly approach by indicating that businesses should not be penalized for the use of these types of workers. The IRS was equally confused as courts continued to redefine and change how independent contractors were supposed to be taxed. In 1987, the IRS developed the so-called "20 Factor Test," which determined the control the business had over the independent contractor. 3 This test has set the stage for a debate that has yet to fully conclude.

Sidebar . The 20 Factor Test Each item in the following list was determined by the IRS to indicate employment status. 1. The person for whom the services are performed has the right to require compliance with instructions. 2. Worker training is required, indicating that the person for whom services are performed wants them performed in a particular manner. 3. The worker's services have been integrated into the business operations of the person for whom services are performed. 4. The services are required to be performed personally, which indicates that the person for whom services are performed is interested in the methods used to accomplish the work. 5. The person for whom services are performed hires, supervises, or pays assistants. (In the case of a worker hiring and supervising others under a contract pursuant to which the worker agrees to provide material and labor and is only responsible for the result, independent contractor status is indicated.) 6. A continuing relationship exists between the worker and the person for whom the services are performed. 7. A set of hours for the worker has been established. 8. The worker must devote substantially full time to the business of the person for whom the services are performed. 9. The work is performed on the premises of the person for whom the services are performed. 10. The worker must perform services in the order or sequence set by the person for whom services are performed. 11. The worker is required to submit regular reports. 12. The worker is paid by the hour, week, or month as opposed to by job or on commission. 13. The person for whom the services are performed pays expenses. 14. Significant tools and materials are provided for the worker. 15. The person for whom the services are performed retains the right to discharge a worker. 16. The worker has the right to terminate the relationship with the person for whom services are performed at any time without incurring liability.

Each of the remaining items typically indicates independent contractor status as viewed by the IRS. 17. There exists a significant investment in the facilities used by the worker. 18. The worker can suffer a loss or realize a profit as a result of the services, in addition to the profit or loss ordinarily realized by employees. 19. A worker performs more than de minimis services for multiple firms at the same time. 20. A worker makes his or her services available to the public on a regular and consistent basis.

Many have asked why there has been such attention drawn to the matter of independent contractors now. There are several answers. First, the Great Recession has put an enormous strain on the federal and state budgets. Despite a recovering economy, unemployment rates remain too high to sustain many of the programs that are necessary to fund a growing population. Additionally, the Affordable Care Act of 2010 carries with it several guarantees that require a certain amount of revenue to undertake. Currently, the revenues needed increase the U.S. deficit. The administration has fought to increase taxes, but the stalemate in Congress has left it with only a handful of options - one of which is this misclassification fight that has been a problem for the government for decades. The fight came to the public's attention most recently when the Government Accountability Office released a scathing report in August 2009 citing that billions of dollars of social security, unemployment, and federal payroll taxes were not being collected because of confusion related to the independent contractor designation. 4 Specifically, the construction industry was one of the industries that was cited as being a major vacuum for employment revenues. The Department of Labor pointed to construction companies as often mischaracterizing employment status with the IRS as a way of avoiding payment of employment taxes and benefits. The current administration decided that this practice had to stop and added additional resources to the IRS and Department of Labor budgets with the intent of increasing investigations into employers who misclassify their workers. The investigations have had a serious impact on the industry. Some estimates place the costs of these new investigations at anywhere between 5 and 10 percent of the company's revenues. This leads us to Kurek. Kurek v. Commissioner T.C. Memo was just a logical step in this evolution to crack down on construction companies using what the federal government has deemed to be unfair employment practices. The decision, which was released on February 28 of this year, got at the heart of the purpose of the "20 Factor Test." Mieczyslaw Kurek of KMA Construction employed approximately 30 workers at any given time to assist him on

home renovation jobs. Despite the fact that none of the workers were in fact full-time and were paid on a per-project amount, Kurek never followed the Department of Labor or IRS's guidelines for an independent contractor relationship. For example, he never had any of his workers sign an independent contractor agreement, nor did he issue Form 1099-MISC or Form W-2 to anyone he paid. As a result, there was no documentation for the IRS to examine to help him make his case for the independent contractor relationship. The employment tax audit determined that the workers were indeed employees and that Federal Insurance Contributions Act (FICA) and Federal Unemployment Tax Act (FUTA) needed to be paid. Eventually the case was sent to the Tax Court for review. The matter was not heard by the entire court because the case was not considered to be making new tax law, but the decision that was released illustrated some very clear directives of the interpretation of the "20 Factor Test." First, it was determined that Kurek had the ultimate authority in instructing the workers, since they were not advertised as independent contractors and the jobs that they worked on were under his supervision. Second, Kurek entered into relationships with his clients indicating that he alone was responsible for the quality of the work, which meant that he had the right to approve the quality of his workers' jobs. Finally, Kurek paid all of his workers weekly rather than at the end of the project, which indicated that they held jobs more similar to salaried positions rather than those of independent contractors. 5 In the end, it was clear that Kurek did not pass the "20 Factor Test," which meant he was liable for the unpaid taxes. Given that he never filed any Forms 1099-MISC or Forms W-2 either, the Court held that he did not qualify for alternate relief under Section 530. The results of this decision should not be surprising to any tax practitioner. The fact is that Kurek did not adhere to tax law in the day-to-day operations of his business. What needs to be examined is not the specifics of this decision but where the federal government and some states are heading in their enforcement of construction companies' independent contractor agreements. At the request of the administration, some states have already started passing legislation to hold construction companies accountable for misclassifications. For example, New York's Construction Industry Fair Play Act of 2010 and Pennsylvania's Construction Workplace Misclassification Act of 2011 are precursors to a larger decision from the federal government. However, that case has yet to materialize. Kurek was not a strong enough verdict to confront what the administration has deemed to be a problem. Many large business organizations and lobbying firms have tried to educate the federal and state governments on the necessity of these independent contractor arrangements. The construction industry has been at the forefront of this debate by trying to illustrate what this new pressure is doing to the industry. For example, the National Association of Home Builders put out a report emphasizing the need for this sort of labor in what they term a "lumpy demand for workers." 6 Leading Builders of America has also jumped into the fight, expressing that the new inquiries are very "troubling." 7 It is still unclear whether or not any of these efforts are resulting in progress. Congress has been so consumed with discussions over the deficit in the past year that the issue has gone somewhat dormant. The Kurek

decision has sparked some reminders in the industry but no legislation has been proposed. Despite a lack of legislation, the IRS has tried to react to this new trend through the issuance of Announcement 2012-45 and Announcement 2012-46. These expanded the qualification criteria for relief under the Voluntary Classification Settlement Program (VCSP) and offered additional relief for affected taxpayers. Specifically, they eliminated the requirement that taxpayers must agree to extend the statute of limitation and now allow taxpayers who were previously audited by the IRS or the Department of Labor concerning the classification of worker classes to be eligible for the VCSP if they are not currently contesting the classification in court. These are positive steps in the right direction to alleviate the burden on construction companies, but they do not solve the fundamental problem. Moving forward, construction companies need to hope for the best but prepare for the worst. One of the best ways to do this is to ensure that you file the 1099-MISC for all independent contractors before the January 31 deadlines. Without the proper filing of these forms, you can be defenseless in the case of an IRS worker classification audit. Additionally, document all of the factors that you are relying on to establish an independent contractor relationship rather than an employee relationship. This will help strengthen your argument in case of an audit. It is unclear what will happen over the next several years regarding the independent contractor designation. It is clear, however, that construction companies need to prepare. Given the importance of this type of labor in the industry, it will be essential that employers prepare for a variety of options in order to best meet the financial needs of their companies.
1 2 3

See Linder, M., The Employment Relationship in Anglo-American Law: A Historical Perspective. (Greenwood Press, 1989): 134. Justia, NLRB v. Hearst Publications, Inc. - 322 U.S. 111 (1944). http://supreme.justia.com/cases/federal/us/322/111/case.html. Joint Committee on Taxation, Present law and background relating to worker classification for federal tax purposes (2007).

http://www.irs.gov/pub/irs-utl/x-26-07.pdf.
4

United States Government Accountability Office, Employee misclassification: Improved coordination, outreach, and targeting could better

ensure detection and prevention (2009). http://www.gao.gov/new.items/d09717.pdf.

5

T.C. Memo 2013-64, United States Tax Court: Mieczyslaw Kurek, Petitioner v. Commissioner of Internal Revenue, Respondent (2013).

Available at: http://www.ustaxcourt.gov/InOpHistoric/kurekmemo.TCM.WPD.pdf.

6

The National Association of Home Builders, Why independent contractors are important for the construction sector (June 14, 2011).

http://eyeonhousing.wordpress.com/2011/06/14/why-independent-contractors-are-important-for-the-construction-sector/.
7

Trottman, M. and Whelan, R., U.S. hits builders with pay probe, The Wall Street Journal (Sept 8, 2011). Available at:

http://online.wsj.com/article/SB10001424053111904103404576556991282742996.html?mod=WSJ_hp_LEFTWhatsNewsCollection.

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