Barrett Business Services, Inc. ("Barrett") operates as a professional employer organization (PEO) and is not a certified PEO pursuant to I.R.C. § 7705. The company provides employment-related services to small and mid-sized businesses across the United States. Barrett's standard services for its clients—the "worksite employers"—include onboarding worksite employees into its payroll system, processing and paying wages, and handling the withholding, payment, and reporting of all applicable federal, state, and local employment taxes. Critically, while Barrett manages human resources and payroll functions, "Barrett does not supervise the day-to-day activities of the worksite employees". Instead, the worksite employers direct and supervise the employees' day-to-day activities at the clients' respective sites.

For the tax years 2017 through 2020, Barrett claimed the Work Opportunity Tax Credit (WOTC) under I.R.C. § 51 and the Empowerment Zone Employment Credit (EZEC) under I.R.C. § 1396 on its corporate returns for qualifying worksite employees. The Commissioner issued a Notice of Deficiency to Barrett, disallowing the claimed WOTC and EZEC on the grounds that Barrett was not a common law employer of the worksite employees.

Taxpayer's Request for Relief

Following the Notice of Deficiency, Barrett filed a petition in the United States Tax Court challenging the Commissioner's determinations. Through cross-motions for partial summary judgment, Barrett sought relief by arguing that limiting the WOTC and EZEC to common law employers would "thwart Congressional intent". Barrett's primary legal position was that it was entitled to the credits because it qualified as a "statutory employer pursuant to section 3401(d)(1)". Additionally, the taxpayer requested relief under the theory that it could claim the credits as an agent of the employer under I.R.C. § 3504, and alternatively, under the plain meaning of the third-party employment rules outlined in I.R.C. § 51(k)(2).

Court's Analysis of the Law

Judge Buch, writing for the Tax Court in Barrett Business Services, Inc. v. Commissioner, 166 T.C. No. 7 (2026), systematically rejected the petitioner's statutory and agency arguments. The Court began its analysis by noting that I.R.C. §§ 51, 1396, and 1397 do not define the term "employer" for the purposes of these specific credits. Without a specific statutory definition, the Court relied on established Supreme Court precedent, stating that "where Congress uses terms that have accumulated settled meaning under the common law, a court must infer, unless the statute otherwise dictates, that Congress means to incorporate the established meaning of those terms" (Nationwide Mut. Ins. Co. v. Darden, 503 U.S. 318, 322–23 (1992)). Therefore, the Court looks to common law concepts and a multifactor test to determine the existence of an employer-employee relationship (Matthews v. Commissioner, 92 T.C. 351, 360 (1989); Weber v. Commissioner, 103 T.C. 378, 387 (1994)).

The Court then addressed Barrett's I.R.C. § 3401(d)(1) statutory employer argument, pointing out a fundamental flaw in cross-applying definitions between distinct subtitles of the Internal Revenue Code. The Court emphasized that § 3401(d)(1) is located in Subtitle C, which governs employment taxes, whereas the WOTC and EZEC provisions are located in Subtitle A, governing income taxes. The Court ruled: "We see no reason to substitute a term that is defined for purposes of employment taxes into provisions that determine income tax credits. We read 'employer' to mean 'common law employer,' i.e., the employer receiving services from the individuals the credit is intended to help.".

Turning to Barrett's argument that it qualified for the credits as an agent under I.R.C. § 3504, the Court found that even if Barrett were an agent, it would not be entitled to the credits. Section 3504 subjects an agent to provisions of law applicable "in respect of an employer". The Court clarified this limitation: "We interpret this to mean with respect to employers in their capacity as employers. The WOTC and the EZEC are income tax credits; they are not other provisions of law applicable with respect to employers in their capacities as such.".

Finally, the Court dismantled Barrett's interpretation of I.R.C. § 51(k)(2). Barrett argued that this section's text clearly contemplates a three-party arrangement where the "employer" paying the remuneration is distinct from the common law employer receiving the services. The Court dismissed this logic, stating, "The mere performance of services for a third party does not mean that the third party becomes the common law employer.". Looking to the legislative history, the Court noted that Congress drafted this specific provision "to prevent employers from lending or donating the services of individuals on their payroll to tax-exempt or other organization which do not have sufficient tax liability to take advantage of the credit" (H.R. Rep. No. 98-861, at 1254).

Application of the Law to the Facts

Applying the law to the facts, the Court found that Barrett's business model failed to meet the necessary criteria to claim the WOTC and EZEC. Although Barrett assumed responsibility for processing payroll, paying wages, and remitting employment taxes, it functioned solely as a PEO. Because the worksite employers supervised the day-to-day operations and directed the worksite employees, Barrett lacked the requisite control to be classified as a common law employer.

The Court further applied the legislative intent behind the credits to Barrett's facts, noting that Congress enacted these incentives to encourage entities to hire disadvantaged individuals and to revitalize economically distressed areas. Barrett simply provided administrative payroll services to its clients. Consequently, the Court found that "Barrett is not the entity that is providing the work opportunity for disadvantaged individuals or in distressed economic areas. A statutory employer who pays wages for services provided to another person is not Congress’s intended beneficiary of these credits.".

Conclusions

The Tax Court reached a definitive conclusion regarding the eligibility of PEOs and statutory employers to claim these specific general business credits. The Court held: "Common law employers are eligible for WOTC; statutory employers and agents of common-law employers are not," and "common law employers are eligible for the EZEC; statutory employers and agents of common law employers are not.".

Summarizing its findings, the Court concluded that "The text of the provisions authorizing these credits, backed up by the legislative history, points toward the credits’ being available only for common law employers.". As a result, the Court granted the Commissioner's Motion for Partial Summary Judgment and denied Barrett's Motion.

Prepared with assistance from NotebookLM.