by Steve Kampa, Tax Manager
The Court of Appeals for the Sixth Circuit in Peno Trucking Inc. v. Comm’r, 102 AFTR 2d 2008-XXXX (CA6), 10/3/08 has upheld the Tax Court’s opinion that a trucking company’s drivers were common law employees, but reversed the Tax Court’s position regarding relief from employment tax liabilities under section 530 of the Revenue Act of 1978.
Background: Robert Peno, Sr. and Joann Peno were the sole shareholders and officers of Peno Trucking, Inc. (Peno), a business that transports steel and other freight. Peno owned 15 tractor-trailers which it leased to Ohio Transport Corp. (Ohio) pursuant to written lease agreements. Under the leases, Peno was required to provide drivers to operate the trucks to transport freight for Ohio. The company received 75 percent of the amount paid to Ohio for each load hauled by a leased truck. Peno entered into an agreement with each of its truck drivers. The agreements expressly provided that the drivers were independent contractors and not employees.
Despite the fact that the truckers entered into written agreements stating they were independent contractors, the degree of control exercised by Peno, the company’s substantial investment in equipment, the truckers’ lack of assumption of risk of loss, the ability of Peno to discharge the truckers, the integration of the truckers into the business, and the permanency of the relationship between Peno and the truckers all indicated that an employer-employee relationship existed. Thus, the Tax Court ruled that the truck drivers were common law employees and payments to them constituted wages subject to employment (FICA and FUTA) taxes.
Section 530: When the Tax Court made its decision, Peno argued that the company should be entitled to relief under section 530 of the Revenue Act of 1978 from “overly zealous pursuit and assessment of taxes and penalties against employers who had, in good faith, misclassified their employees as independent contractors.” One requirement for section 530 relief is that the employer must have a reasonable basis for not treating the individuals as employees. Mr. Peno claimed to have a reasonable basis for this treatment because he had relied on “judicial precedent.” Namely, the Ohio Industrial Commission (OIC) and the Bureau of Workers’ Compensation (BWC) had denied workers’ compensation injury claims to some of Peno’s truck drivers because they were independent contractors. The Tax Court denied section 530 relief, finding that there was no reasonable basis for treating Peno’s truckers as independent contractors, in part because Peno’s classification occurred before the OIC and BWC decisions were made and there was no evidence that OIC and BWC had made any attempt to investigate or question the company’s classification by applying Federal law. Mr. Peno appealed this decision.
The Appeal: The Court of Appeals agreed with the Tax Court that there were sufficient elements of control, assumption of risk, etc. to establish that Peno’s truck drivers were indeed common law employees. However, the court believed that Peno had clearly established a prima facie case that it was reasonable not to treat the truckers as common law employees.
The court disagreed with the IRS’s determination that Peno’s reliance on OIC’s and BWC’s decisions was not relevant, and held that Peno indeed had a reasonable basis for treating the drivers as independent contractors. Although the final were compensation decisions were made after Peno’s initial classification, OIC made a decision in 1995 to classify one worker as an independent contractor, in time for Peno to make its classification decision for the tax years in question, 1997-1999. The court further pointed out that the Ohio BWC uses a 20-factor common law test, similar to the IRS’s, to evaluate the status of workers, thus negating the IRS’s contention that the state boards have no particular standards about classifying workers. Nor did the court agree with the IRS’s comparison of Peno’s case to an earlier case (Nu Look Design, Inc. v. Comm’r, 85 TCM 927 (2003)), because Nu Look based its arguments on previously decided cases it was not a party to, while Peno relied on two official determinations which involved Peno’s drivers.
The court noted, and agreed with the finding of the Tax Court, that Peno had consistently treated its drivers as independent contractors, and had consistently provided timely-filed federal tax Forms 1099-MISC treating the drivers and independent contractors. Since Peno met all the requirements for section 530 relief, the burden of proof then shifted to the IRS to demonstrate that Peno did not qualify for relief under section 530—which it could not show to the satisfaction of the court. The court therefore concluded that pursuant to section 530, Peno was eligible for relief from the employment tax liabilities imposed by the IRS.
Note: Relief under section 530 of the Revenue Act of 1978 allows the employer to avoid having to treat workers as employees for federal employment tax purposes in prior years. Thus Peno was relieved from employment tax obligations during the years in question. The relief does not apply to ongoing federal tax treatment of workers. Also, for other purposes of the tax code, such as the qualified retirement plan coverage and nondiscrimination rules, the common law employees may have to be covered by the plan.
Often, the largest exposure for the employer is from risk of assessment of state payroll tax liabilities. Section 530 relief applies only to federal employment taxes. Many states offer a similar statute. However, depending upon the specific state involved, there may not be any relief available. This could result in assessment of state employment taxes for prior years as well as ongoing treatment of the worker as an employee for state employment tax purposes.
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