Ritter, L. David, Jr.

English

The Catholic University of America Columbus School of Law

Catholic University Law Review Volume 9 Issue 2 Article 4 1960 The Use of Indepedendent Contractors to Minimize Employment Taxes – The Doubtful Cases L. David Ritter Jr. Follow this and additional works at: https://scholarship.law.edu/lawreview Recommended Citation L. David Ritter Jr., The Use of Indepedendent Contractors to Minimize Employment Taxes – The Doubtful Cases, 9 Cath. U. L. Rev. 97 (1960). Available at: https://scholarship.law.edu/lawreview/vol9/iss2/4 This Comments is brought to you for free and open access by CUA Law Scholarship Repository. It has been accepted for inclusion in Catholic University Law Review by an authorized editor of CUA Law Scholarship Repository. For more information, please contact edinger@law.edu. COMMENTSof disenfranchisement and unless the applicant is found to be "qualified under statelaw to vote".Citizens concerned with the civil rights cause can only hope that the 1960legislation will make possible a more complete Negro franchise, and will nothamper future efforts to achieve better legislation if the hope is unfulfilled. Thefundamental problem of state qualification laws has not been tackled. The pro-cedures established under the 1960 legislation are not sleek, simple or swift. Itcannot be said now that the proposed law represents a significant advance, althoughin practice it may prove better than it seems.JOSEPH P. JOSEPHSONTHE USE OF INDEPENDENT CONTRACTORS TO MINIMIZEEMPLOYMENT TAXES-THE DOUBTFUL CASESThe social security and unemployment taxes due from proprietors are basedupon wages paid employees. If services are performed by independent contractorsthe compensation afforded is free of these taxes.' The 1958 amendments to theFederal Insurance Contributions Act (FICA) increased the amount due from bothemployer and employee to 3% of the wages paid.2 Unemployment taxes whichare paid by the employer remained at 2.7% to the state and .3% to the federalgovernment.8This increasing tax and ever-constant bookkeeping burden can be alleviatedif the individual performing the services could be placed on an independent con-tractor basis. The independent contractor would thereupon be liable to pay 4 %126 U.S.C. (I.R.C. 1954) 5 3306.226 U.S.C. §§ 3101, 3111 as amended 1958. The Federal Insurance Contributions Actrequires that a certain amount (currently 3%) be withheld from wages paid employees andthat an equal amount be contributed by the employer toward the Social Security Fund.S The Federal Unemployment Tax Act (FUTA) 26 U.S.C. § 3301 requires that anamount equal to 3% of wages paid be deposited in the federal fund but a credit up to 90%of that due is given to contributions made to state unemployment funds that qualify underfederal standards. All states enacted the requisite unemployment tax laws and the 2.7% dueto state funds became uniform. Many state laws so passed gave a more restrictive definitionof independent contractors so that some individuals might be exempt from FUTA taxes butliable under the state unemployment tax acts (SUTA).1960]CATHOLIC UNIVERSITY LAW REVIEWof his income under the Self Employment Contributions Act of 1951,' for whichhe will receive social security benefits. This shift of tax responsibility will bemore in accord with those conservative objections to the Social Security Act of1935 which stated that the burden should rest more directly on those benefitting.Unemployment taxes and benefits do not apply to independent contractors at all.The basic distinction between an independent contractor and an employeeis that as to an employee the proprietor has the right to interfere and supervisethe manner of performance but may only govern the results produced by theindependent contractor. More simply, if the businessman has the right to controlnot only what is to be done but how it shall be done, the one rendering the serviceis an employee. Note that if the right to interfere is retained, the employeerelationship is established regardless of actual interference. This is the commonlaw test and other distinctions, such as ownership of tools and supplies, are usedas aids by the court in arriving at the control test when the intentions of theparties are difficult to ascertain.The common law test is the sole criterion used in judging the relationshipfor federal payroll tax purposes.5 Additional tests required to be met for unem-ployment tax purposes in some states will be discussed later. In passing on thisquestion in 1947,6 the Supreme Court used one of these court-developed aids.Some critics supposed that the Court had narrowed the concept of independentcontractor. The Court said that an employee is "dependent as a matter of economicreality upon the business to which he renders service and not upon his own busi-ness as an independent contractor." On the basis of the decision the TreasuryDepartment proposed to issue a regulation that would have reduced independentcontractors to employees if the individual's work was an integral part of thebusiness to which he rendered service, if there was not sufficient investment inthe facilities for work nor opportunity for profit and loss, or if there was notsufficient skill required.7 As proposed, the more restrictive regulation would haveequated independent contractors to independent businessmen with a certainamount of assets and freedom from reliance on one large account.Congress did not admit that the decision had altered the common lawdefinition and prevented the issuance of the regulation by passage over a presi-dential veto of a joint resolution to re-establish the status quo if such had beendisturbed.8 The control test thereby remained definitive for federal employmenttax purposes regardless of interpretation of the Supreme Court decision.4 26 U.S.C. 5 1401.5 Benson v. Social Security Board, 172 F.2d 682, 685 (C.A. 10th, 1949).6 United States v. Silk and Harrison v. Greyvan Lines, Inc., 331 U.S. 704 (1947).7 Senate Report No. 1255 and House Report No. 1314, Feb. 3, 1948 (To accompanyH. J. Res. 296).8 Joint Resolution of June 14, 1948, 62 STAT. 438.[Vol. IXCOMMENTSIn performing a legal check up for a business client the practitioner mighthave occasion to advise that some individuals on the payroll do not require controlof the manner of their performance. The lawyer can suggest an independentcontract relationship with these individuals and a written agreement will be inorder. The considerations that are to be drafted into the contract will vary withspecific jobs. There is little reported law on the borderline cases and the subjectmust be approached by speculating how the courts will look at each arrangement.Many doubtful cases come to mind such as nurses, musicians, music teachers,watchmen, chefs, tutors and janitors. Each must be treated in the light of his owncircumstances. For illustrative purposes the janitor's situation is the most strikingbecause of the apparent incongruity for someone performing such menial tasks tobe considered an independent contractor. The Commission ruled janitors to beemployees in 1937,1 but the decision did not involve any attempt on the part ofthe taxpayer to contract away the right to control the means of performance.A janitor case was adjudicated during 1959 and is worthy of note. The tax-payer was an owner of a number of apartment houses which were cared for bypersons who received in return for their services all or a part of the rent for theapartments which they occupied. The Director of Internal Revenue assessedfederal social security and unemployment taxes against the property owner onthe theory that the caretakers were employees and not independent contractors,the fair value of rent afforded them being compensation for such employment.These taxes, aggregating about $6700, were paid under protest and a claim wasmade for refund. The claim was rejected and this action was brought for recovery.The District Court denied relief and the United States Circuit Court of Appealsfor the 8th Circuit affirmed.10After considering the facts of the case the court could not include the janitorshere in its definition of an independent contractor as "one who engages to performa certain service for another according to his own manner and method free fromthe control and direction of his employer in all matters connected with the per-formance of the service except as to the result of the work." The decision neednot be questioned. The fact that the services were not paid for in cash is imma-terial to the assessment of the federal social security and unemployment taxeshere involved. There is a body of law not to be analyzed here that determines thetaxability, mostly for income purposes, of board and lodging. Lodging is generally9 S.S.T. 172, 1937-2 Cum. Bull. 385. Janitors who serve several property owners,attending to furnaces, cleaning halls, etc., of apartment buildings, and who are unrestrictedas to the hours they work but are engaged to give the necessary attention to such duties, areemployees of the persons for whom they perform services within the meaning of Title VIIIand IX of the Social Security Act.10 Beatty v. Halpin, 267 F.2d 561 (C.A. 8th, 1959).1960]CATHOLIC UNIVERSITY LAW REVIEWnon-taxable if it is required by the proprietor as a condition of service for theconvenience of the one providing it rather than the one enjoying it."Considering the independent contractor aspects of the decision the case ismost valuable for its negative implication, i.e., the taxpayer would have avoidedliability if the right to control the manner of performance had not been retained.The performance of services was isolated and the janitor of each building wasprobably "his own boss" in a practical analysis. It is submitted that the right tocontrol could have been contracted away without real jeopardy to the business.Anticipating that the court will look through such a contract to ascertain thereal situation, attention must be given to certain aspects that courts have examinedin the past.The fact that a businessman intends the contract as a tax saving measure isnot a serious difficulty. In speaking of the Social Security Act a New York Federalcourt in 1954 stated: "It is not unlawful to conduct business through independentcontractors to avoid impact of this chapter." " The fact that payment is in theform of a periodic salary is no real barrier either. The Treasury Department inCircular E (Revised Jan. 1960) under Section 4A "Who Are Employees" stated:"It does not matter how the payments are measured or how they are paid orwhat they are called. Also it does not matter whether the individual is employedfull or part time."The courts sometimes looked to whether the individual rendering the servicehas provided the tools and supplies necessary 12 and it would be helpful to includethe provision in the contract although it does not appear to be essential to thecontrol test. In the janitor situation, however, it would not be feasible consideringthe initial expense to the janitor of power mowers, hedge clippers, floor waxers,and such gadgets. Since maintenance needs are tailored to the building these itemscome with it and supplies are obtained on the owner's account at a nearby storein normal business practice. This tools and supplies aspect could be used to thetaxpayer's advantage in the case of nurses or musicians.However, two of the tests developed by the courts do go to the essence ofthe relationship and must be considered in drafting the contract. If personal per-formance is demanded by the proprietor,"3 control of the means is retained to acertain extent in that limitation of the labor to one person will serve to assurea manner of performance consistent with past performances of that individual.The second test concerns the right to summary discharge 1 and goes to the natureof the "contractor" aspect rather than the "independent" modification. It raises"126 C.F.R. (INT. REV. CODE, 1954) 1.119-1 (b).I" Silver v. United States, 131 F. Supp. 209 (N.D.N.Y. 1954).12 26 C.F.R. 31.3121 (d)-1.'s Treasury Department Circular E (Revised Jan. 1960) S 4B."4Norling v. Johnston, 205 Or. 315, 283 P.2d 994 (1955).[Vol. IXCOMMENTSthe question of whether the intent to assume contractual obligations and theinherent liability for termination of the relationship without cause exist at all.It would be advisable that demands for personal performance and the right tosummary discharge be expressly denied in the contract. In the janitor situationthe owner should be able to discharge only for cause but the janitor may terminatethe relationship without it. Such termination should be accompanied by a noticeperiod, e.g., two weeks. Lacking cause the owner may terminate without liabilityonly at a certain time as when the contract is automatically renewable annuallyif the owner does not give notice of termination sixty (60) days prior to theanniversary date. Of prime concern to landlords is the sobriety and general con-duct of the janitors but, mindful of the common law test, cause to discharge mustnot stem from inadequate manner of performance. To assure proper conduct itcould be stipulated that one of the janitor's many duties specified in the agreementis to promote the apartment house owner's good will both as to tenants and thepublic.By way of summary then the proposed contract with the janitor will beexplicit on the following points. The janitor is charged to maintain good willwith the tenants and the public. The apartment house owner has no right tocontrol the manner in which the janitor fulfills his duties. The janitor is notunder an obligation to perform the work himself. Termination of the relationshipby the apartment house owner without cause and notice will render him liablefor damages.The provisions outlined above are merely suggested for consideration. Eachcase must be decided in the light of its individual circumstances. A ruling shouldbe requested from the Internal Revenue Service by submission of all the attendantcircumstances on Form SS-8. A photostat of any executed contract can be attachedto the request. Being satisfied that the independent contractor relationship hasbeen established for FICA and FUTA tax purposes, the state requirements mustbe considered to determine whether the proprietor might yet be liable under theparticular state's unemployment tax act. This is a major consideration since thestate liability constitutes 90% of the unemployment tax or an amount equal to2.7% of the payroll.Popular concepts of independent contractors that motivated the SupremeCourt to decide as it did in 1947 also caused some states to require certain tests inaddition to that of the common law. One such test requires that the independentcontractor perform services outside the usual course of the employer's businessor outside the employer's place of business. Another test requires that he beestablished in an independent business. Kansas adds the former and Indiana,Oregon, Pennsylvania, and Wisconsin add the latter requirement to the controltest. Oklahoma and Virginia require control and either additional test. Twenty-five19601CATHOLIC UNIVERSITY LAW REVIEWmore states"s require all three tests to be met. It would be difficult for the janitorto meet either of these additional tests. New York says merely that employmentmeans service under any contract of employment for hire, express or implied,written or oral, without defining independent contractor. In the remaining statescontrol of the manner of performance remains the sole test and an attempt toobtain a ruling similar to the federal procedure would seem to be indicated inthese states for the doubtful situations.L. DAVID RITrnR, JR.15 Alaska, Delaware, Georgia, Hawaii, Illinois, Louisiana, Maryland, Maine, Missouri,Montana, Nebraska, Nevada, New Hampshire, New Jersey, New Mexico, North Dakota,Ohio, Rhode Island, South Carolina, Tennessee, Utah, Vermont, Washington, West Virginiaand Wyoming.

The Use of Indepedendent Contractors to Minimize Employment Taxes – The Doubtful Cases

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The Use of Indepedendent Contractors to Minimize Employment Taxes – The Doubtful Cases

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