Taxpayer Was a Statutory Employee, Expenses Deductible on Schedule C

One of the issues in the case of Fiedziuszko v. Commissioner, TC Memo 2018-75, was whether the taxpayer, who received a Form W-2 for his work for 2012, was a “statutory employee.”

The statutory employee definition is found at IRC §3121(d)(3).  The first requirement to be a statutory employee is that the individual not be a common-law employee of the service recipient.  Next, the taxpayer must perform services for pay in one of the following four categories:

  • As an agent-driver or commission-driver engaged in distributing meat products, vegetable products, fruit products, bakery products, beverages (other than milk), or laundry or dry-cleaning services, for his principal;
  • As a full-time life insurance salesman;
  • As a home worker performing work, according to specifications furnished by the person for whom the services are performed, on materials or goods furnished by such person which are required to be returned to such person or a person designated by him; or
  • As a traveling or city salesman, other than as an agent-driver or commission-driver, engaged upon a full-time basis in the solicitation on behalf of, and the transmission to, his principal (except for side-line sales activities on behalf of some other person) of orders from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar establishments for merchandise for resale or supplies for use in their business operations.

Finally, IRC §3121 provides the following additional conditions:

…[T]he contract of service contemplates that substantially all of such services are to be performed personally by such individual; except that an individual shall not be included in the term “employee” under the provisions of this paragraph if such individual has a substantial investment in facilities used in connection with the performance of such services (other than in facilities for transportation), or if the services are in the nature of a single transaction not part of a continuing relationship with the person for whom the services are performed…

In Revenue Ruling 90-93 the IRS provided that such individuals are treated as employees only for certain withholding taxes.  The taxpayers are not treated as employees with regard to deduction of expenses related to the trade or business of the individual under IRC §§62 and 67.

As a consequence, the Revenue Ruling notes:

Therefore, A may use Schedule C of the Form 1040 to determine A's net profit or loss from doing business as a full-time life insurance salesman. Further, A's trade or business expenses related to being a full-time life insurance salesman are not subject to the 2-percent floor for miscellaneous itemized deductions.

In this case, the Court was faced with the following facts:

In 2012 Mr. Fiedziuszko was a semiretired aerospace engineer and worked as a consultant for Space Systems Loral (Loral). Mr. Fiedziuszko found work as a consultant by attending conferences and traveling to visit potential clients. He entered a contract to provide consulting services to Loral through West Valley Engineering Co. (West Valley), a temporary employment agency used by Loral to hire consultants. Mr. Fiedziuszko's contract with Loral began in 2011 and ended in July 2012. He worked primarily from home on a satellite development project, Flexible Satellite, producing reports and components for Loral. West Valley made weekly deposits into petitioners' checking account under the entry “West Valley Engi Payroll”, which included a date that was two days before the actual deposit and the last four digits of Mr. Fiedziuszko's Social Security number. Thus, the deposit made on January 13, 2012, included a date “120111”. Most weeks the deposit was $2,649, although there was some variation. The last deposit was made on August 3, 2012.

West Valley processed Mr. Fiedziuszko's pay for his work for Loral and withheld Federal income tax as well as Social Security and Medicare taxes. West Valley did not offer medical or dental insurance, paid vacation leave, or reimbursement of Mr. Fiedziuszko's expenses, but it did offer a deferred compensation plan.

West Valley checked the statutory employee box on Mr. Fiedziuszko's 2011 Form W-2, Wage and Tax Statement, to indicate that he was a statutory employee for 2011. But West Valley did not check the box on Mr. Fiedziuszko's 2012 Form W-2 to indicate that he was a statutory employee for 2012.

The IRS challenged the taxpayers’ above the line deduction of expenses related to the work for West Valley in 2012, pointing out that his W-2 did not indicate that he was a statutory employee.  The taxpayers argued this was a mistake by West Valley in preparing the W-2s and that, in fact, he was just as much a statutory employee in 2012 as he was in 2011.

The taxpayer was doing the “home work” described in IRC §3121(d)(3)(C), so the only issue was whether he was a common-law employee.  If he was a common law employee, then he would be an employee for purposes of IRC §§62 and 67, and he could not deduct such expenses in computing has adjusted gross income. 

Rather such expenses would have to be treated as employee business expenses, a miscellaneous itemized deduction.  Such expenses would be subject to the then-applicable 2% of adjusted gross income limitation and would not be deductible at all for computing alternative minimum taxable income.

The Court concluded that, in fact, the taxpayer was not a common-law employee:

We find on the record before us that Mr. Fiedziuszko was not a common law employee of Loral and that he is instead a statutory employee. While his Form W-2 for 2012 did not indicate that he was a statutory employee, we believe this to be a mistake. Mr. Fiedziuszko's Form W-2 for 2011 indicated that he was a statutory employee. Nothing changed between 2011 and 2012: Mr. Fiedziuszko was providing services under the same consulting contract with Loral in 2012 as he was in 2011. Further, Mr. Fiedziuszko worked primarily from his home office rather than Loral's offices and produced reports and patents according to his assignments from Loral. We therefore find that Mr. Fiedziuszko's employment status did not change from 2011 to 2012.

We also conclude that both Mr. Fiedziuszko and Loral intended to form an independent consulting relationship rather than a common law employee-employer relationship. Mr. Fiedziuszko advertised his services to several satellite companies and was hired by Loral through the temporary employment agency, West Valley, with which Loral works. Their relationship was a temporary assignment that terminated in July 2012.

The evidence in the record weighing against statutory employee status appears consistent with an error by West Valley in classifying Mr. Fiedziuszko. The weekly payroll deposits into his checking account and West Valley's withholding Federal and State income taxes and Social Security and Medicare taxes from Mr. Fiedziuszko's pay are consistent with a consulting contract for services. We conclude, therefore, that the totality of the circumstances indicates that Mr. Fiedziuszko was a statutory employee pursuant to section 3121(d)(3) for the 2012 tax year. Thus, petitioners were entitled to report business income and expenses on Schedule C of their Form 1040.

For 2018 this issue will become even more significant—statutory employees will continue to be able to deduct the expenses related to their work, while common-law employees will no longer be able to claim any benefit from such expenses.