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Lessons from the Tax Court: Case of the independent spouse

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in Small Business Tax

Should an outside worker be treated as an independent contractor or an employee? Generally, an employer prefers to treat workers as independent contractors, to avoid payroll taxes and paying for employment benefits. But the IRS may disagree, so these cases often end up in court.

Traditionally, the courts use these seven key factors to decide the outcome:

  1. Degree of control exercised by the principal
  2. Which party invests in work facilities used by the individual
  3. The opportunity of the individual to realize a profit or loss
  4. Whether the principal can discharge the individual
  5. Whether the work is part of the principal’s regular business
  6. Permanency of the relationship
  7. Relationship the parties believed they were creating.

New decision: Darryl Jones owned a law firm, while his wife Tarri owned and operated a business services company. In 2003, Darryl enlisted Tarri to work on two large cases, giving her as much freedom as possible. But they agreed that Darryl could discharge Tarri if the arrangement wasn’t working.

One of the cases involved a protracted criminal investigation of an eccentric client. The client got along well with Tarri, so Darryl used her to keep him calm and focused. Tarri also performed basic legal research relating to the client.

Although Tarri claimed independent contractor status, the IRS said Tarri was an employee and imposed payroll taxes on the firm for 2003 and 2004.

Based on the seven factors, the Tax Court sided with the taxpayer. (Jones, TC Memo 2014-125, 6/23/14)

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