Corporate Officer Can't Avoid Employee Classification for Employment Tax Purposes

(Parker Tax Publishing April 2022)

The Tax Court held that a corporation, which was organized by an individual as a vehicle to offer online courses on real estate development, was liable for employment taxes on the remuneration paid to that individual because, as an officer of the corporation, the individual qualified as an employee under Code Sec. 3121(d)(1). The court rejected the corporation's assertion that the individual performed services in dual capacities as both an officer-employee and an independent contractor and found that the minor services exception of Reg. Sec. 31.3121-1(b) did not apply. The REDI Foundation, Inc. v. Comm'r, T.C. Memo. 2022-34.

Background

Richard Abraham has over 40 years of experience as a real estate developer and has written multiple books on real estate development. From 1973 to 1980, Abraham held seminars on real estate development throughout the country as a sole proprietor. In 1980, Abraham founded and incorporated The REDI Foundation, Inc. (REDI) to serve as a vehicle to offer his seminars on real estate development. REDI operated as a Code Sec. 501(c)(3) tax exempt organization.

Abraham served as a member of the board of directors and a corporate officer of REDI. Abraham's wife, Jacqueline, also served as a corporate officer of REDI. REDI was inactive almost every year from 1980 to 2010 and offered Abraham's seminar only in 1980 and 1990. In 2010, Abraham developed an online course on real estate development which was offered to the public through REDI. Abraham had complete control over all aspects of the online course and was its only teacher. Abraham frequently worked over 60 hours a week on matters related to the online course, including instruction and mentoring students. REDI's only activity during the quarters ending June 30, September 30, and December 31, 2014 (the periods at issue) was the online course. REDI's sole source of income during the periods at issue was from tuition charged for enrollment in the online course. Abraham regarded REDI as a mere vehicle to offer the online course and testified that REDI was indistinguishable from himself. Abraham was compensated by REDI pursuant to an unwritten contract that required REDI to pay Abraham on the basis of overall student enrollment in the online course.

REDI filed a Form 990, Return of Organization Exempt From Income Tax, for the tax year ending May 31, 2015, on June 9, 2015. On its Form 990 REDI reported total revenue of $255,605 and salaries, other compensation, and employee benefits of $91,918. Abraham signed REDI's Form 990 in the box provided for the signature of the officer and identified himself as REDI's treasurer. REDI issued Abraham a Form 1099 - MISC, Miscellaneous Income, which reported that REDI paid Abraham $91,918 during 2014. Abraham received from REDI a total of $120,000 during the periods at issue in 2014. REDI did not file a Form 941, Employer's Quarterly Federal Tax Return, for any of the periods at issue. The IRS subsequently prepared substitutes for returns (SFRs) for the Forms 941 that were not filed for the periods at issue. From REDI's incorporation to the present, REDI did not file any employer tax returns reporting any payments to Abraham as salary or wages for services provided by or on behalf of REDI as an employee.

The IRS selected REDI's Form 990 return for employment tax examination. The IRS mailed a Form 4564, Information Document Request, to REDI in connection with REDI's treatment of Abraham as an independent contractor. In that letter, the IRS also requested that REDI provide information on whether it had met the requirements under Section 530 of the Revenue Act of 1978 (i.e., Act Section 530) for employment tax relief. In response, REDI asserted that Abraham was never an employee of REDI and that Act Section 530 relief was thus inapplicable to REDI's circumstances.

Following the employment tax examination, the IRS mailed to REDI a notice of determination. The notice of determination determined that Abraham was to be legally classified as an employee for purposes of federal employment taxes and that REDI was not entitled to relief from that classification under Act Section 530 with respect to Abraham. Enclosed with the notice of determination was a schedule setting forth REDI's employment tax liabilities, as well as additions to tax under Code Sec. 6651(a)(1) and (2). REDI took its case to the Tax Court.

Under Code Sec. 3121(d)(1), the term "employee" is defined for purposes of employment taxes to include "any officer of a corporation." Reg. Sec. 31.3121(d)-1(b) and -1(f) generally provide that an officer of a corporation is an employee of the corporation unless (1) the officer does not perform any services, or performs only minor services, and (2) neither receives nor is entitled to receive any remuneration. REDI argued that Abraham performed services in dual capacities, both as an officer-employee and as an independent contractor. REDI further argued that the scope of Abraham's employment as an officer was limited to only minor administrative duties for which he received no remuneration, thereby coming within the minor services exception of Reg. Sec. 31.3121(d)-1(b). In addition, REDI contended that Abraham could not be its employee because REDI exercised no control over him or the online course. REDI asserted that the payments to Abraham constituted royalty payments for the use of his real estate book in the online course. Alternatively, REDI argued that it was entitled to relief under Act Section 530, which provides relief from common law worker classification determinations, because REDI had a reasonable basis for treating Abraham as an independent contractor due to a purportedly longstanding industry practice.

Analysis

The Tax Court held that (1) Abraham was an employee of REDI for employment tax purposes, (2) REDI was not entitled to Act Section 530 relief, and (3) REDI was labile for additions to tax under Code Sec. 6651(a)(1) and (2).

First, the court quickly dispensed with REDI's argument that the payments to Abraham were royalties given the weight of the evidence establishing that Abraham provided extensive services to the corporation and received payments in the nature of compensation for those services. Turning to REDI's first argument, the court found there was no evidence that Abraham worked for or was engaged by REDI in a capacity other than as an officer. In the court's view, the only evidence of an independent contractor relationship was the Form 1099-MISC and Abraham's own testimony that he served REDI in a dual capacity. The court said that without support from other evidence - such as a written service contractor agreement between REDI and Abraham - such evidence carried little weight. In the court's view, Abraham was the sole person in charge of overseeing and executing the online course (REDI's only business activity) and provided a wide variety of services to REDI, including managerial decisions about the content, marketing, and enrollment of the online course. The court saw no clear distinction between Abraham's role as a corporate officer and his provision of services to the corporation. Therefore, the court concluded that REDI failed to establish that Abraham was engaged in dual roles as both an employee and an independent contractor.

Next, the court found that Abraham's employment did not fall within the minor services exception. According to the court, it was clear that Abraham performed significantly more than minor services for REDI, considering that Abraham worked on all aspects of the online course, which was REDI's only activity and source of income during the periods at issue. The court also noted that Abraham was compensated pursuant to an unwritten contract requiring REDI to pay him on the basis of the number of students enrolled in the online course and that during 2014, REDI paid Abraham $120,000 for his services.

The court was similarly unpersuaded by REDI's argument that it did not control Abraham. The court noted that the right to control is a common law classification factor and that REDI's attempt to rely on it as determinative of statutory employee status was misplaced. In the court's view, by operating his real estate course through the corporate vehicle of REDI, Abraham chose to accept both the benefits and the burdens of the corporate form, including its separate tax identity. Respecting the distinctness of that corporate form, the court said, requires careful scrutiny of payments made by a closely held corporation to an officer who performs substantial services, regardless of the characterization of the payments by the corporation.

The court also rejected REDI's alternative argument that it qualified for Act Section 530 relief. The court pointed out that such relief applies only to common law worker classification determinations and Abraham was a statutory employee under Code Sec. 3121(d)(1). Finally, the court determined that REDI did not have a reasonable basis for failing to file its employment tax returns and timely pay the employment taxes it owed and therefore, the additions to tax under Code Sec. 6651(a)(1) and (2) applied.

For a discussion of determining employee status for employment tax purposes, see Parker Tax ¶210,110.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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