Mar 03, 2011

'S' Corporations and Employees, Round 2

A recent Tax Court decision (Donald G. Cave a Professional Law Corp., TC Memo 2011-48) reminds us once again of employment tax considerations associated with "S" corporations and their shareholders, as well the more general topic of distinguishing between employees and independent contractors.

In this case, the law corporation reporting entity did not view associate attorneys working for the firm as employees, but instead considered them independent contractors, and issued them Forms 1099-MISC for the years in question. And the same went for a law clerk. Further, even though the sole corporate shareholder worked actively in the business, the corporation issued to him neither a Form W-2 nor a 1099-MISC, thus allowing all of the bottom line to flow to his personal return as "S" corporation dividend distributions, presumably thereby escaping employment taxation altogether.

The age old issue of who is an employee as opposed to an independent contractor is not without guidance in the literature. Specifically, the Fifth Circuit (which would govern if an appeal ensues from the Tax Court's decision) considers the following primary factors as relevant to the question:

1. The degree of control the principal has over the worker
2. The worker's investment in the tools of his trade
3. The worker's opportunity for profit or loss resulting from his efforts
4. The permanence of the relationship between worker and master
5. The skill required of the worker

The bottom line for the Tax Court, relative to the classification of the associate attorneys and the law clerk, was the conclusion that all of these folks were "common law employees," to whom Forms W-2 should have been provided, and regarding whom appropriate employment taxes should have been considered.

And as for the sole corporate shareholder, the corporation's president, who made virtually all corporate decisions, for which he was compensated, the same conclusion ensued: employee status.

Bottom line -- corporation shells out the employment taxes for the years in question, plus the usual penalties, of course!