1973, June, Pg. 11. Employer Libility for Federal Employment Taxes 20 Questions IRS Style.

• Author: by Joseph H. Thibodeau

2 Colo.Law. 11

The Colorado Lawyer

1973.

1973, June, Pg. 11.

Employer Libility for Federal Employment Taxes 20 Questions IRS Style

11Vol. 2, No. 8, Pg. 11"Employer" Libility for Federal Employment Taxes 20 Questions IRS Styleby Joseph H. ThibodeauNAME OF THE GAME

Potential exposure to "employer" liability for federal employment taxes (FICA, FUTA and income tax withheld at source (W/T)---Internal Revenue Code §§ 3101-3126, 3301-3309, and 3401-3404 respectively)(fn1) is fast becoming a major problem for independent businesses. In the following pages this problem is explored with particular attention given to the key question upon which liability turns---the employer-employee relationship as opposed to the principal-independent contractor relationship.

The theme is not new. Some of the variations recently placed upon it by the Internal Revenue Service (IRS), however, are not only novel and intriguing, but can result in disastrous consequences for the unprepared and unsuspecting client including the closing of his business doors before he has the opportunity to litigate the merits of the proposed assessment.

The IRS has recently expressed, through greatly increased audit activity, a remarkably renewed interest and zeal in the conduct of audits in this area. The following attempts to alert the practitioner to the potential problem, define the scope of exposure, and suggest several means for coping with it should it arise---and means for avoiding it, where possible, before it does arise.

Not discussed are many technical and mechanical concerns, including the computation, withholding, and payment over of the taxes. Also omitted is discusssion of most of the Code's mind-boggling exception-upon-exception definitional provisions in this area. Although these are determinative of liability in isolated instances, they are not directly relevant to the generally applicable employee-independent contractor test. The detail required in such discussion would so obfuscate the matter as to leave the reader with few, if any, practical insights.

THE STAKES --- PARLOUSLY HIGH

To grasp some appreciation of the potential dollar impact of the problem, assume the following fact situation involving a gasoline service station. Your client is the oil jobber who supplies the station operator.

12The operator leases the premises from your client, sells gasoline on consignment, perhaps sells tires, batteries and accessories, and may have service bay capacity.

In 1973 your client pays the operator $20,000 in consignment commissions. Out of that, the operator pays an assistant, overhead, and his share of cooperative advertising and other miscellaneous expenses, all totaling $8,000. Accordingly, he has himself realized a net profit of $12,000. On audit, however, if the IRS characterizes the operator as your client's employee, it will treat him as having received $20,000 in "wages." Your client will then be stuck with an assessment for $4,600 in employment taxes, $3,800 of which (even assuming the validity of the "employment" characterization) is the employee's share of FICA and withholding on his income.(fn2)

Bear in mind that the $4,600 figure is for one "employee" only. In even a relatively small operation (e.g., 10 to 20 "employees"), under the hypothetical situation proposed we are talking about $46,000 to $90,000 in employment tax for each year. In addition, there is exposure to potential penalties (probably to a maximum of 25 percent) plus 6 percent interest. Moreover, where Forms 940 and 941 have been filed, the statute of limitations keeps retroactive assessment open for three years. Where Forms 940 and 941 have not been filed, although theoretically the period for retroactive assessment is open-ended, the IRS has indicated that the maximum period of exposure will be six years.

Thus it is not too difficult to conceive of situations in which the liability could, and does, quickly run into the hundreds of thousands and even millions of dollars.

ANY NUMBER CAN PLAY --- IRS v. YOUR CLIENTS

The scope of business activity exposure is as staggering as are the dimensions of the potential dollar impact. Whenever one engages an individual to do some kind of work or perform some service for him, he runs the risk of being characterized by the IRS as an "employer."

Some examples of workers found by the IRS to be "employees" are service station operators, truckers, truck loaders and Unloaders, automobile salesmen, insurance salesmen, securities dealers, taxi drivers, attorneys, barbers and beauticians, entertainers, doctors, court reporters, siding and roofing applicators, storm door and window installers, fishermen, salesmen and representatives of all kinds and descriptions. The entire business activity spectrum is a potential target.

THE RULES --- THEIRS

Four basic definitions control the question of employer liability: "employment," "wages," "employer," and "employee." Satisfaction of all four is prerequisite to liability.

The focal point of this discussion is the last of the four definitions: "employee." Each of the other three does, however, warrant some general observation.

EmploymentFICA (§ 3121(b)). "Employment" is any service performed by an "employee" for the person employing him, irrespective of the citizenship or residence of either, when such service is performed within the United States or, under certain circumstances, outside of the United States. The statute enumerates specific kinds of excepted services (§ 3121(b)(1)-(19)).

Thus, although services may be performed by an "employee," they may in some cases not constitute "employment," and will not be subject to "employer" liability.

FUTA (§ 3306(c)). "Employment" is generally the same as for FICA. Likewise, there are similar kinds of excepted services (§ 3606(c)(1)-(18)).

W/T (§ 3401 (a)). "Employment," as such, is not defined. However, the definition of "wages" indirectly affords the same definition as for FICA and FUTA.

13WagesFICA (§ 3121(a)). "Wages" are "[a]ll remuneration for employment including the cash value of all remuneration paid in any medium other than cash...." This definition is currently subject to the annual limitation of $10,800 ($12,000 after 12/31/73). Payment is deemed made when the "wages" have been actually or constructively reduced to the "employee's" possession.

FUTA (§ 3306(b)). The definition is generally the same as for FICA. The present annual limitation is $4,200.

W/T (§ 3401(a)). "Wages" are "all remuneration (other than fees paid to a public official) for services performed by an employee for his employer, including the cash value of all remuneration paid in any medium other than cash...." This is generally the same as for FICA and FUTA. Similarly, there are instances of specific inclusion and exclusion which parallel the FICA and FUTA provisions.

EmployerFICA (Treas Reg. § 31.3121(d)-2). Every person is an "employer" if he employs one or more "employees." Neither the number of employees nor the period of employment is material. The term "employer," therefore, is effectively defined by the definitions of "employee," "wages," and "employment."

An employer may be...