July 29, 2020
Santos v. Commissioner, Tax Court Memo 2020-88
In a recent case, the Tax Court applied a facts and circumstances test to determine no employer-employee relationship existed when a cleaning company challenged a determination that its workers were employees subject to employment taxes. The Tax Court plainly stated which factors influenced the decision. This opinion should function as a roadmap for managers and business planners in classifying whether their workers are independent contractors or employees.
What are the stakes in this kind of case? Typically the employer prefers independent contractor status with the following results: (1) employer avoids having to pay and provide fringe benefits and (2) employers avoids payroll taxes. However, under the new Section 199A tax regime, an employer may prefer to have employee status and wages in order to assist the Employer in qualifying for the lower tax rates under Section 199A.1 Employers should simply beware; getting this status wrong can be very costly.
The Taxpayer, Leticia C. Santos, was born and raised in Brazil and later moved to the United States. Santos owned an unincorporated apartment cleaning business in the United States called Campos Cleaning Co. (Campos Cleaning).2 Campos Cleaning had contracts to clean apartment complexes’ common areas, and contracts for “Unit Turnover Cleaning” for recently vacated apartments. On audit, the IRS challenged Santos’s classification that her workers were independent contractors rather than employees. In performing the contracts, Santos did not usually participate in the cleanings herself, rather, she hired workers. For apartment common areas, clients would pay Campos Cleaning weekly fixed amounts ranging from $510 - $780, and a weekly fixed rate of $90 - $120 for vacated units. Santos paid her workers weekly, and only hired workers with cleaning experience. Santos never provided training to her workers. The workers brought their own cleaning supplies and provided their own transportation. They were free to hire their own assistants if needed. Santos did not provide paid leave or vacation. Santos did not provide health insurance or retirement benefits. Santos did not guarantee a fixed amount of work. Santos did, however, maintain commercial general liability (CGL) insurance and workers’ compensation insurance at the request of her apartment clients.
When a client needed cleaning services, the client would contact Santos who would send a worker. Most of the workers were non-English speaking, so Santos would relay any specific instructions from the property manager to the workers. Upon arriving at a job site, the workers were directed to the apartment that needed cleaning and given a key by the property manager. Santos rarely attended the cleanings and never instructed the workers how to perform. Santos did not supervise the workers and did not perform inspections. Santos’s only involvement after sending the worker was instructing the workers to return to the job site if the client reported a deficiency. Santos never formally discharged or terminated any workers. Santos did not prepare Forms W-2, Forms 940, or Forms 941 for the workers. Santos’s accountant prepared Forms 1099-MISC, for 26 workers in 2008, 17 workers in 2009, and 5 workers in 2010. These forms were issued to the workers, but it is unclear whether the forms were filed with the IRS.
The Tax Court applies certain factors to determine whether an employer-employee relationship exists.3 No one factor is determinative.4 The Tax Court must consider all facts and circumstances.5 In this case, two authorities were cited. First, the Santos Court cited relevant Treasury Regulations:
"[An employer-employee] relationship exists when the person for whom services are performed has the right to control and direct the individual . . . [ I ]t is not necessary that the employer actually direct or control the manner in which the services are performed; it is sufficient if he has the right to do so. The right to discharge is an important factor indicating that the person possessing the right is an employer. Other factors . . . are the furnishing of tools and the furnishing of a place to work . . . . In general, if an individual is subject to the control or direction of another merely as to the result to be accomplished by the work and not as to the means and methods for accomplishing the result, he [or she] is an independent contractor."6
The Santos Court also stated factors from Weber v. Commissioner7. The Weber factors are included below:
"Relevant factors this court considers include: (1) the degree of control exercised by the principal over the worker; (2) which party invests in the work facilities used by the worker; (3) the worker’s opportunity for profit or loss; (4) whether the principal can discharge the worker; (5) whether the work is part of the principal’s regular business; (6) the permanency of the relationship; and (7) the relationship the parties believed they were creating."8
Factors Persuasive to the Tax Court
The Tax Court plainly discussed which factors applied in coming to its decision. Importantly, the right to exercise control over the worker was the “crucial” test in determining the work relationship.9 In addition to the control factor, the Santos Court relied on the following:
- Santos did not have the right to control the manner and means by which the cleaning work would be accomplished; instead, Santos acted as a dispatcher or “financial and linguistic intermediary” between apartment complexes and the workers, who were mostly non-English speaking.
- The workers were already experienced cleaners.
- The workers were not required to accept any particular jobs.
- The workers took Santos’ directions as to the ultimate goal of specific jobs, but used their discretion as to how to accomplish a given job.
- The workers were free to hire their own assistants at their own cost.
- The workers used their own cleaning supplies.
- Santos did not guarantee the workers a minimum amount or frequency of work.
- The workers did work for businesses other than Campos Cleaning.
- The workers were given Forms 1099-MISC.
- Santos did not have long term relationships with the majority of her workers.
- Santos believed she was creating an independent contractor relationship.
- The testimony of Santos and three workers who worked for Campos Cleaning.
Factors Not Persuasive to the Tax Court
Santos’s obligation to maintain CGL insurance and worker’s compensation insurance under her contracts with apartment complexes was not determinative. The insurance contracts in question were exclusively concerned the relationship between Campos Cleaning and the apartment complexes. The Santos Court went as far as to say that the CGL policy and Worker’s Compensation policy “had no bearing” on the petitioner’s relationship with her workers.10 Furthermore, even though Santos has the ability to send workers back to the cleaning site to remedy deficiencies in their work, the Tax Court still determined there was no employer-employee relationship.
Businesses with questions about employment classification of workers should consult appropriate tax counsel and pay close attention to the Santos Court. Importantly, the right to exercise control over workers should be a central topic for classification planning. Under Santos, businesses with independent contractors should be less concerned about whether CGL policies and worker’s compensation policies will be used against them. Furthermore, businesses with certain linguistic challenges should take notice that the Santos Court allowed Ms. Santos to be a “financial and linguistic intermediary” between the clients and her company without being classified as their employer.
The Santos opinion should function as a roadmap for employers determining worker employment classification. A business seeking independent contractor status should pay close attention to each of the factors articulated in Santos to avoid an improper classification. Employers who improperly designate workers may be responsible for back FICA taxes, certain fringe benefits, interest, and penalties. Furthermore, businesses seeking to classify workers as employees should also adjust their policies to stay in compliance with Santos or risk losing section 199A deductions.
This Insight is intended only to provide an overview of the matters addressed herein and does not constitute legal advice. If you have any questions regarding a specific issue, please seek appropriate legal counsel.
1 I.R.C. § 199A(b)(2)(B)(applying W-2 wages to calculate deduction).
2 Santos v. Commissioner, T.C. Memo 2020-88
3 Santos, T.C. Memo 2020-88 at *12 (citing Weber v. Commissioner, 103 T.C. 378, 386 (1994) aff’d per curiam, 60 F.3d 1104 (4th Cir. 1995)).
4 Weber, 103 T.C. at 387.
6 Treas. Reg. § 31.3121(d)-1
7 Weber, 103 T.C. at 387.
8 Weber, 103 T.C. at 387.
9 Santos, T.C. Memo 2020-88 at *12; see also Casey v. Dep’t of Health & Human Servs., 807 F.3d 395, 405 (1st Cir. 2015); see also Alt. Coast Masonry, Inc., v. Commissioner, T.C. Memo 2012-233 at *15 (“[A]n employer-employee relationship exists when the principal retains the right to direct the manner in which the work is to be done, controls the methods to be used in doing the work, and controls the details and means by which the desired result is to be accomplished.”)(citing Ellison v. Commissioner, 55 T.C. 142, 152-53 (1970)).
10 Santos, T.C. Memo 2020-88 at *14-15 (“Although the contracts obligated Campos Cleaning to maintain commercial general liability insurance and worker’s compensation insurance (which it did), we do not find this to be definitive evidence that petitioner had the requisite degree of control over her workers. These contracts governed only the relationship between Campos Cleaning and the apartment complexes; they had no legal bearing on petitioner’s relationship with her workers.”)