June 3, 2018

The Statutory Employee Classification Post-TCJA

Houston Tax Attorney Blog

Houston Tax Attorney

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The Tax Cuts and Jobs Act (“TCJA”) made several changes to our tax laws. One such change is that employees are no longer able to deduct unreimbursed expenses incurred as an employee. Given this change, employers and their workers may need to re-evaluate their relationship. For some workers, this may mean re-evaluating whether the worker is a “statutory employee.” The recent Fiedziuszkok v. Commissioner, T.C. Memo. 2018-75 provides an opportunity to consider these rules.

The Facts & Procedural History

The facts and procedural history for the case are as follows. The taxpayer is a semiretired aerospace engineer. He landed a consulting gig through a temporary employment agency. The gig lasted approximately one year.

He worked primarily from home producing reports and components for his employer. The employer made weekly deposits into the taxpayer’s checking account. The employer withheld Federal income tax as well as Social Security and Medicare taxes. It issued a Form W-2 to the taxpayer and checked the statutory employee box for 2011, but it did not check the box for 2012.

The taxpayer filed his Form 1040 for 2012 reporting the wages and expenses for his work on Schedule C rather than deducting his unreimbursed employee expenses on Schedule A.

The IRS concluded that the taxpayer was not a statutory employee and should have reported his expenses on Schedule A. Litigation ensued.

The Statutory Employee Rules

Generally, the law makes a distinction between an employee and an independent contractor. The following factors are considered in determining whether a worker is an employee or contractor:

  • The degree of control exercised by the principal,
  • Which party invests in work facilities used by the individual,
  • The individual’s opportunity for profit or loss,
  • Whether the principal can discharge the individual,
  • Whether the work is part of the principal’s regular business,
  • The permanency of the relationship, and
  • The relationship the parties believed they were creating.

While no one factor is determinative, the courts usually focus on the first factor.

The statutory employee falls somewhere between an employee and independent contractor. It is a worker that is closer to being a contractor than an employee who is either:

  1. An agent-driver or commission-driver who distributes meat products, vegetable products, fruit products, bakery products, or beverages (other than milk), or who picks up or delivers laundry or dry-cleaning for his or her principal.
  2. A full-time insurance salesperson.
  3. A home worker who performs work according to specifications of the person for whom the services are being performed, on materials or goods furnished by the person. The work product must be returned to the person or someone designated by him or her.
  4. A traveling or city salesperson engaged on a full-time basis in the solicitation on behalf of a principal of orders from wholesalers, retailers, contractors, or operators of hotels, restaurants, or similar establishments for merchandise for resale or supplies for use in their business.

If the worker qualifies, they report unreimbursed employee expenses on Schedule C rather than Schedule A. This can be helpful for the worker as Schedule A expenses are limited. As mentioned at the start of this article, starting in 2018, Schedule A expenses like these are no longer deductible at all.

For the employer, they are required to withhold and pay Social Security and Medicare tax from the workers pay, but not income tax.

The Court’s Take on Statutory Employees

The courts usually apply a two step analysis for determining whether a worker is a statutory employee. They consider (1) whether the worker is an employee under the employee vs. contractor factors and, if not found to be an employee, (2) whether the contractor meets the statutory employee rules.

Other than applying the mechanical categories (i.e., home worker, sales person, etc.), this later determination focuses on the employer and employee’s intent. This intent is usually manifested in whether the employer checks the “statutory employee” box on the Form W-2.

This was the problem in the Fiedziuszkok case. The employer had classified the taxpayer as a statutory employee in one year and not as a statutory employee in the second year.

The court concluded that not checking the box in the second year was a mistake, as the taxpayer was more akin to a contractor than an employee.

Going Forward…

Employees who fit within the four statutory employee categories should take the time educate their employers about these rules. This is particularly true given the new TCJA rules.

Having the employer fill out the Form W-2 can go a long way in avoiding an IRS audit and adjustment like in the Fiedziuszkok case.

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