Businesses that treat workers in a single tax year as both a W-2 employee and a 1099 independent contractor (IC) typically raise red flags at the IRS and state workforce agencies. Only in rare cases do agencies or the courts countenance a worker being classified simultaneously as both an employee and an IC for the same taxpaying business. The recent Tax Court case of Ramirez v Commissioner (May 20, 2013) is one of those rare cases that we collect and catalogue in our IC compliance database and pull out for use when a client is challenged before an agency or in court for a dual IC/employee classification.
The Facts of the Ramirez Case
During 2007 Mr. Ramirez was employed by Univision Radio Broadcasting as an on-air personality and program director for radio station KXTN in San Antonio. He hosted a radio program six days a week; worked as an announcer; attended staff meetings; and promoted the station by meeting with entertainment people and making off-air appearances. There was no dispute that he was an employee for these duties.
When the station began struggling financially, Mr. Ramirez decided to find additional radio sponsors who would pay him personally for his services. He established direct, personal relationships with sponsors. He set the amount of his fees without input from KXTN. There were no written contracts, just handshake agreements with the sponsors. Mr. Ramirez promoted the sponsors’ products both during on-air broadcasts and off-air appearances at their sites. KXTN had no direct input in the contents of the advertising campaign scripts, although it did ensure that that the scripts did not contain fraudulent material and that he did not use language that would jeopardize the station’s broadcasting license.
The fees that he charged his sponsors corresponded to his popularity and his show’s ratings. These charges were included as a line item in Univision’s monthly invoice to the sponsors, with the result that the sponsors paid Univision, and Univision included the fees collected for Mr. Ramirez’s services in his paycheck. The Tax Court characterized that arrangement as using Univision as a conduit for the payment of Mr. Ramirez’s promotional services to his sponsors. On each earnings statement his compensation was bifurcated between his salary and his “talent & remote.” Univision withheld income tax and payroll taxes for both categories. Mr. Ramirez attached a letter from Univision to his income tax return, which letter noted that his W-2 form included income paid thorough KXTN for his talent services provided to clients and advertisers as an IC.
The Tax Court noted that the fact than an individual is an employee in one capacity does not foreclose the possibility that the individual may be an IC with the same employer in another capacity. The Court looked at the traditional factors, starting with the “crucial” test of the degree of control exercised by the employer. It concluded that Mr. Ramirez was not under the control of Univision with respect to the sponsors’ products, analogizing to the recent Tax Court case of Robinson v Commissioner, in which a full-time university professor who was classified as a W-2 employee was also held to be a 1099 IC with respect to the corporate seminar services that he conducted in his spare time, sometimes through the university’s executive education program held in university classrooms.
Takeaways and Best Practices
Businesses that dual-classify workers as both ICs and employees run a higher than ordinary risk of audit and legal challenge. As the Tax Court noted in Ramirez, though, there are limited circumstances where a dual-IC/employee classification is valid.
Where a business has a bona fide basis for issuing both a Form W-2 and a Form 1099 to an individual, extra care should be taken to document the IC relationship. IC agreements that are tailored to the specific situation and use state-of-the-art terminology substantially enhance the likelihood that the IRS or a state workforce agency will validate the dual-classification.
All too often, though, the IC relationship is in the gray area – somewhere between a bona fide IC and a common law employee. In that typical instance, businesses may wish can enhance the likelihood of a successful defense to an audit or court challenge by using diagnostic and treatment tools available to companies using ICs. The IC Compliance Scale™ and 48 Factors-Plus™ measure and evaluate a company’s level of IC compliance for 1099ers including any that may be dual-classified as ICs and employees. Those tools are part of the IC Diagnostics™ system (as described in my White Paper) that offer businesses proven means to re-structure, re-document, and re-implement IC relationships to enhance compliance with federal and state IC laws.
Your comments are invited.
Written by Richard Reibstein.