Carnell Specks, et ux. v. Commissioner, TC Memo 2012-343 ,
Code Sec(s) 469; 1401; 1402; 6662; 7491.
CARNELL SPECKS AND CHERYL SPECKS, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent.
Case Information:
Code Sec(s):
469; 1401; 1402; 6662; 7491
Docket: Dkt.
No. 1956-11.
Date Issued:
12/11/2012.
Judge: Opinion by
Kroupa, J.
Tax Year(s):
Disposition:
HEADNOTE
1.
Reference(s): Code Sec. 469; Code Sec. 1401; Code Sec. 1402;
Code Sec. 6662; Code Sec. 7491
Syllabus
Official Tax Court Syllabus
OPINION
We need to decide whether Mr. Specks, a police officer, who
provided services to the third parties during off-duty hours, is an employee or
an independent contractor of the third parties. We also must decide whether Mr.
Specks is a real estate professional taking into account the amount of time he
spent [*5] in the rental activity. Finally, we need to address whether
petitioners are liable for the accuracy-related penalty.
I. Worker Classification We first address respondent's
determination that amounts Mr. Specks received from the third parties were
subject to self-employment tax. Generally, the Commissioner's determinations
are presumed correct, and the taxpayer bears the burden of proving that those
determinations are erroneous. Rule 142(a);Welch v. Helvering, 290 U.S. 111, 115
[12 AFTR 1456] (1933). This principle applies to the Commissioner's
determinations of worker classification as an employee or independent
contractor. Boles Trucking, Inc. v. United States, 77 F.3d 236, 239-240 [77
AFTR 2d 96-909] (8th Cir.1996); Ewens & Miller, Inc. v. Commissioner, 117
T.C. 263, 268 (2001). The burden of proof shifts to the Commissioner in certain
situations under section 7491(a). Petitioners
do not argue that the burden of proof shifts to respondent and have not shown
that the threshold requirements have been met. Therefore the burden of proof
remains with petitioners.
Petitioners contend that Mr. Specks was an employee of the
third parties and thus the amounts paid to him by the third parties were not
subject to self- [*6] employment tax. 4 A tax is imposed on a taxpayer's
self-employment income. Sec. 1401.
Self-employment income consists of gross income derived by an individual from any
trade or business carried on by the individual.
Sec. 1402(a). The self-employment tax, however, does not apply to
compensation paid to an employee. Sec. 1402(c)(2).
Whether an individual is an employee or an independent
contractor is a question of fact determined by applying common law
principles. Secs. 1402(d), 3121(d)(2); Nationwide Mut. Ins. Co. v.
Darden, 503 U.S. 318, 322-324 (1992); Prof'l & Exec. Leasing, Inc. v.
Commissioner, 89 T.C. 225, 232 (1987), aff'd, 862 F.2d 751 [63 AFTR 2d 89-427]
(9th Cir. 1988); Kaiser v. Commissioner, T.C. Memo. 1996-526 [1996 RIA TC Memo
¶96,526], aff'd without published opinion 132 F.3d 1457 [81 AFTR 2d 98-383]
(5th Cir. 1997); sec. 31.3401(c)-1(d), ,
Employment Tax Regs. Relevant factors in determining whether a worker is an
employee or an independent contractor include (1) the degree of control
exercised by the principal over the details of the work, (2) which party
invests in the facilities used in the work, (3) the opportunity of the
individual for profit and loss, (4) whether the principal has the right to
discharge the individual, (5) whether the work is part of the principal's
regular business, (6) the permanency of the 4
We note petitioners conceded at trial and in their
post-trial brief that the security services Mr. Specks performed for the third
parties were not part of his employment as a HPD police officer. [*7]
relationship and (7) the relationship the parties believe they are creating.
Weber v. Commissioner, 103 T.C. 378, 387 (1994), aff'd, 60 F.3d 1104 [76 AFTR 2d 95-5782] (4th Cir.
1995); Rosato v. Commissioner, T.C. Memo. 2010-39 [TC Memo 2010-39]. 1. Right
To Control An employment relationship is indicated when the service recipient
has the right to control the details and means by which the worker performs the
services. Sec. 31.3401(c)-1(b),
Employment Tax Regs. In contrast, independent contractor status is indicated
where the opposite is true. Id. This factor is generally critical in
determining the nature of a working relationship. See Clackamas
Gastroenterology Assocs., P.C. v. Wells, 538 U.S. 440, 448 (2003); Leavell v.
Commissioner 104 , T.C. 140, 149-150 (1995); Weber v. Commissioner, 103 T.C. at
387. Petitioners did not demonstrate that the third parties maintained the
requisite right to control Mr. Specks in the performance of the security
services. Consequently, this factor weighs in favor of independent contractor
status. 2. Investment in Facilities Independent contractor status is indicated
when a worker provides his or her own tools or supplies used for work. Ewens
& Miller, Inc. v. Commissioner 117 , T.C. at 271 (citing Breaux &
Daigle, Inc. v. United States, 900 F.2d 49, 53 [65 AFTR 2d 90-1133] (5th Cir.
1990)). Mr. Specks wore his HPD uniform and carried his personal firearm [*8]
when performing the security services for the third parties. Additionally, the
record does not reflect that the third parties trained, supplied or equipped
Mr. Specks. This factor weighs in favor of independent contractor status. 3.
Opportunity for Profit or Loss The opportunity for profit or loss indicates
independent contractor status. Simpson v. Commissioner , 64 T.C. 974, 988
(1975). Earning an hourly wage or fixed salary indicates an employment
relationship. See Weber v. Commissioner, 103 T.C. at 390-391; Kumpel v.
Commissioner , T.C. Memo. 2003-265 [TC Memo 2003-265]. Citation and O'Quinn
paid Mr. Specks an hourly wage for his services. The record does not reflect
whether Finger Furniture paid Mr. Specks an hourly wage or under some other
arrangement. Accordingly, there is no evidence that he otherwise had any
opportunity for profit or risk of loss in the services he provided. This factor
weighs in favor of employee status. 4. Right To Discharge The principal's
retaining the right to discharge a worker indicates an employment relationship.
See Weber v. Commissioner, 103 T.C. at 391; Colvin v. Commissioner, T.C. Memo.
2007-157 [TC Memo 2007-157], aff'd, 285 Fed. Appx. 157 [102 AFTR 2d 2008-5301]
(5th Cir. 2008). The third parties retained the right to discharge Mr. Specks
at will. This factor weighs in favor of employee status. [*9] 5. Integral Part
of Business An employment relationship is indicated when the worker is an essential
part of the taxpayer's normal business. See Simpson v. Commissioner 64 T.C. at
989; , Rosemann v. Commissioner, T.C. Memo. 2009-185 [TC Memo 2009-185]. The
record does not reflect that the security services Mr. Specks provided to the
third parties were an essential part of their business. This factor weighs in
favor of independent contractor status. 6. Permanency of the Relationship A
continuing relationship indicates an employment relationship, while a
transitory relationship may indicate independent contractor status. Ewens &
Miller, Inc. v. Commissioner, 117 T.C. at 273. The extended working
relationships Mr. Specks had with Citation and O'Quinn weigh in favor of
employee status. The record is unclear how much time Mr. Specks spent performing
security services for Finger Furniture. The Court infers, however, that it was
a short duration because the amount paid to Mr. Specks was small. Accordingly,
this factor weighs in favor of independent contractor status with respect to
Finger Furniture. [*10] 7. Relationship Contemplated by the Parties Providing
benefits such as health insurance, life insurance, paid vacations and
retirement plans indicates an employment relationship. Weber v. Commissioner,
103 T.C. at 393-394. The record does not reflect that the third parties
provided employee benefits to Mr. Specks during 2008.
Additionally, the record reflects that the third parties did
not withhold employment taxes from the amounts paid to Mr. Specks and issued
him Forms 1099-MISC for his services. Thus, even if Mr. Specks did not consider
himself an independent contractor, the third parties did. The record also does
not reflect that Mr. Specks ever attempted to correct the third parties'
classification of him as an independent contractor, indicating that Mr. Specks
viewed himself as an independent contractor. This factor weighs in favor of
independent contractor status. 8. Weighing of the Employee Classification
Factors The relationships between Mr. Specks and the third parties have some
aspects characteristic of an employer-employee relationship and others
characteristic of a principal-independent contractor relationship. After
weighing the above factors, giving greater weight to the right of control
factor, we conclude that petitioners failed to meet their burden of proof to
establish Mr. Specks' status [*11] as an employee with respect to the third
parties. Accordingly, we sustain respondent's determination that Mr. Specks is
liable for self-employment tax on the amounts the third parties paid to him.
II. Real Estate Professional Classification We now address
respondent's contention that the claimed rental loss for 2008 is subject to the
passive activity loss limitations under
section 469. 5 The deduction of passive activity losses is generally
suspended. Sec. 469(a). A passive activity loss is the excess of the aggregate
losses from all passive activities over the aggregate income from all passive
activities for the taxable year. Sec.
469(d)(1). A passive activity includes the conduct of any trade or business in
which the taxpayer does not materially participate. Sec. 469(c)(1). A rental
activity generally is treated as a per se passive activity. Sec.
469(c)(2), (4). A taxpayer may, however,
avoid having his or her real estate activity classified as a per se passive
activity if the taxpayer is a qualifying real estate professional and satisfies
the material participation requirements of
section 469(c)(1). A taxpayer will qualify as a real estate professional
if (1) more than one-half of the personal services performed in trades or
businesses by the taxpayer 5
Respondent first raised the rental loss issue in the answer
and therefore bears the burden of proof. See Rule 142(a); Welch v. Helvering,
290 U.S. 111 [12 AFTR 1456] (1933). [*12] during the taxable year are performed
in real property trades or businesses in which the taxpayer materially
participates, and (2) such taxpayer performs more than 750 hours of service
during the taxable year in real property trades or businesses in which the
taxpayer materially participates. Sec.
469(c)(7)(B). A taxpayer's material participation is determined separately with
respect to each rental property, unless the taxpayer makes an election to treat
all interests in real estate as a single rental real estate activity. Sec. 469(c)(7)(A); sec. 1.469- 9(e)(1), Income
Tax Regs.; see Jafarpour v. Commissioner, T.C. Memo. 2012-165 [TC Memo
2012-165]. Respondent concedes that, for 2008, petitioners may treat their
rental properties as a single activity. A taxpayer may establish his or her
participation in an activity by any reasonable means. Sec. 1.469-5T(f)(4),
Temporary Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988). This Court has
acknowledged that "reasonable means" is interpreted broadly and that
the temporary regulations may not provide precise guidance. Goshorn v.
Commissioner, T.C. Memo. 1993-578 [1993 RIA TC Memo ¶93,578]. Nevertheless, a
postevent "ballpark guesstimate" will not suffice. See Lee v.
Commissioner, T.C. Memo. 2006-193 [TC
Memo 2006-193]; Goshorn v. Commissioner, T.C. Memo. 1993-578 [1993 RIA TC Memo
¶93,578].
Where, as here, a joint return has been filed, the foregoing
real estate professional requirements are satisfied if either spouse separately
satisfies those [*13] requirements. Sec. 469(c)(7)(B). Petitioners concede that
Ms. Specks was not involved with the rental activity during 2008. Thus,
petitioners' rental activity is not per se passive, and the normal passive
activity loss rules of section 469(c)(1)
will apply only if Mr. Specks meets the foregoing requirements. We now consider
whether Mr. Specks qualifies as a real estate professional.
Mr. Specks stipulated that he worked less than 750 hours in
the rental activity. Mr. Specks also stipulated that he worked 2,171.50 hours
as an HPD officer and 618.50 hours for Citation. Accordingly, Mr. Specks cannot
satisfy either prong of the test. Consequently, the rental activity was per se
passive. 6 We therefore hold that the rental loss is subject to the passive
activity loss limitations under section 469. 6
Even if taxpayers fail to qualify as real estate
professionals under sec. 469(c)(7) and
must therefore treat losses from their rental properties as passive activity
losses, they may still be eligible to deduct a portion of their losses
under sec. 469(i)(1). A taxpayer who
actively participates in a rental real estate activity may deduct a maximum
loss up to $25,000 per year related to the activity. Sec. 469(i). The deduction is phased out as
adjusted gross income, modified by sec. 469(i)(3)(E), exceeds $100,000, with a
full phaseout occurring when modified adjusted gross income equals $150,000.
Sec. 469(i)(3)(A). Respondent concedes that, in 2008, Mr. Specks actively
participated in the real estate activity and is entitled to deduct a portion of
the rental loss to the extent allowed under
sec. 469(i). [*14] III. Accuracy-Related Penalty Finally, we address
respondent's determination that petitioners are liable for an accuracy-related
penalty under section 6662(a) for 2008. A taxpayer is liable for an
accuracy-related penalty on any part of an underpayment attributable to, among
other things, a substantial understatement of income tax. See sec. 6662(a) and (b)(1) and (2); sec. 1.6662-2(a)(1) and (2),
Income Tax Regs. There is a substantial understatement of income tax if the
amount of the understatement exceeds the greater of either 10% of the tax
required to be shown on the return, or $5,000. Sec. 6662(a), (b)(2),
(d)(1)(A); sec. 1.6662-4(a) and (b), Income
Tax Regs.; see Jarman v. Commissioner, T.C. Memo. 2010-285 [TC Memo 2010-285].
The Commissioner has the burden of production with respect
to the accuracy-related penalty. Sec. 7491(c); Rule 142(a); see Higbee v.
Commissioner, 116 T.C. 438, 446-447
(2001). We find that respondent has met his burden of production if Rule 155
computations show petitioners have a substantial [*15] understatement of income
tax for 2008. 7 See Higbee v. Commissioner, 116 T.C. at 446; Jarman v.
Commissioner, T.C. Memo. 2010-285 [TC Memo 2010-285]. A taxpayer is not liable
for an accuracy-related penalty, however, if the taxpayer acted with reasonable
cause and in good faith with respect to any portion of the underpayment. Sec.
6664(c)(1); sec. 1.6664-4(a), Income Tax
Regs. The determination of whether a taxpayer acted with reasonable cause and
in good faith depends on the pertinent facts and circumstances, including the
taxpayer's efforts to assess his or her proper tax liability; the knowledge,
experience and education of the taxpayer, and the reliance on the advice of a
professional. Sec. 1.6664-4(b)(1),
Income Tax Regs. Generally, the most important factor is the extent of the
taxpayer's effort to assess the proper tax liability. Id. The taxpayer has the
7
Respondent determined in the alternative that petitioners
are liable for the accuracy-related penalty on the portion of the underpayment
attributable to negligence or disregard of rules or regulations.
"Negligence" includes the failure to make a reasonable attempt to
comply with provisions of the Code as well as any failure by the taxpayer to
keep adequate books and records or to substantiate deductions and credits
claimed on the return. See sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs.
The term "disregard" includes any careless, reckless or intentional disregard.
See sec. 6662(c).
Petitioners failed to substantiate Mr. Specks' status as an
independent contractor of the third parties and their entitlement to the rental
loss. We find therefore that respondent has satisfied his burden of productin
for imposing the accuracy-related penalty for negligence or disregard of rules
or regulations. [*16] burden of proving the reasonable cause and good-faith
exception applies. Sec. 7491(c); Rule
142(a); see Higbee v. Commissioner, 116 T.C. at 446-447.
Petitioners assert they relied on a return preparer to
complete their joint individual income tax return for 2008. We have found that
reliance on a tax professional demonstrates reasonable cause when a taxpayer
selects a competent tax adviser, supplies the adviser with all relevant
information and consistent with ordinary business care and prudence, relies on
the adviser's professional judgment as to the taxpayer's tax obligations. Sec.
6664(c)(1); Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000),
aff'd, 299 F.3d 221 [90 AFTR 2d 2002-5442] (3d Cir. 2002). All facts and
circumstances are considered in determining whether a taxpayer reasonably
relied in good faith on professional advice, including the taxpayer's
education, sophistication and business experience. Sec. 1.6664-4(a) and (b), Income Tax Regs.
Petitioners did not establish that the return preparer was a
competent professional with significant expertise to justify reliance or that
petitioners provided the return preparer all relevant information. We therefore
do not find that petitioners have shown that it was reasonable to rely on the
return preparer. Furthermore, petitioners failed to otherwise show that their
underpayment was due to reasonable cause and was in good faith. [*17] Based on
the entire record, we find that petitioners failed to establish that they acted
with reasonable cause and in good faith with respect to the underpayment for
2008. Accordingly, petitioners are liable for the accuracy-related penalty on
the underpayment for 2008 as reflected in the Rule 155 computation.
We have considered all arguments the parties made in
reaching our holding, and, to the extent not mentioned, we find them irrelevant
or without merit.
To reflect the foregoing and respondent's concession that
petitioners are entitled to deduct a portion of the rental loss to the extent
allowed under section 469(i),
Decision will be entered under Rule 155.
1
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