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Professional & Executive Leasing (Tax Court)
United States Tax Court
PROFESSIONAL & EXECUTIVE LEASING, INC.,
Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
Date of Decision: August 3, 1987
89 TC 19
Filed August 3, 1987.
Petitioner corporation seeks a declaratory judgment that its
pension and profit-sharing plans qualify under sec. 401, I.R.C.
1954. Petitioner leases management and professional personnel
(Workers) to commercial businesses and professional practices
(Recipients). During the plan years in issue, almost all of the
Workers who entered into a contract of employment with petitioner
previously were employed by the Recipients to which they were
leased. In addition, almost all the Workers had an equity or
ownership interest in the Recipient to which they were leased.
Recipients provide the equipment, tools and office space for the
Workers. Each Worker controls the details of his or her performance
of services, including selection of assignments. Recipients pay
petitioner a setup fee, a monthly service fee and compensation for
the Workers in accordance with a schedule adopted for each Worker.
Petitioner prepares the Workers' paychecks and performs all
withholding functions.
HELD, Workers are not "employees" of petitioner leasing
organization under common law principles and respondent's
regulations. Therefore, petitioner's plans violate the "exclusive
benefit" rule of sec. 401(a)(2), I.R.C. 1954.
Thomas G. Walker, Jr., for the petitioner.
Paul S. Horn, for the respondent.
OPINION
STERRETT, CHIEF JUDGE: This case is before the Court upon a
petition for declaratory judgment pursuant to section 7476 /1/ and
Rule 211 alleging that petitioner's pension and profit-sharing
plans qualify under section 401(a). The case was submitted without
trial on the basis of the pleadings and the facts recited in the
jointly stipulated administrative record filed with the Court on
September 9, 1986.
The issue presented for our decision is whether petitioner's
pension and profit-sharing plans fail to qualify under section
401(a) because such plans cover individuals who are not employees
of petitioner.
The administrative record is incorporated herein by reference.
Any evidentiary facts or representations contained therein are
assumed to be true for the purposes of this proceeding. The
following facts relevant to our decision are drawn from the
administrative record.
Petitioner, Professional & Executive Leasing, Inc., is a
corporation organized under the laws of Idaho and has its principal
place of business at 184 Second Street West, Twin Falls, Idaho.
Petitioner submitted its defined benefit plans and money purchase
plans for determination to respondent during 1984 and 1985. On or
about February 24, 1984, a request for determination with respect
to the qualified status of the Rodney D. Swartling, M.D., Money
Purchase Pension Plan & Trust Agreement was filed with the
District Director in Seattle, Washington. /2/ On or about April 23,
1984, a request for determination with respect to the qualified
status of the Rodney D. Swartling, Defined Benefit Plan was filed
with respondent. On or about March 19, 1985, a request for
determination as to amendments to both the Rodney D. Swartling,
M.D., Money Purchase Pension Plan & Trust Agreement and the
Rodney D. Swartling, Defined Benefit Plan were filed with
respondent.
Petitioner describes itself in its promotional materials (under
its prior name of MAS Enterprises, Inc.) as a corporation organized
primarily for the purpose of leasing management personnel to
commercial businesses and licensed professionals to operating
professional practices. Its promotional materials describe the
benefits of its program as follows:
Since its inception on November 1, 1982, MAS Enterprises has
been able to obtain significant discounts in the purchase of
various insurance products. In addition, MAS Enterprises continues
to seek out providers of goods and services willing to take into
consideration the benefits of selling to a large upscale group.
Further, as an employee of MAS Enterprises, the small business
manager or professional practitioner can obtain a very liberal
fringe benefit package and retirement plan for himself. Since each
individual subscribing to the leasing program will be, for all
purposes, an employee of MAS Enterprises, he will be eligible to
participate in all of the leasing company's benefit programs. Other
employees of the operating entity or practice will not be covered
under these programs, but rather will continue to be covered under
the benefit programs, if any, made available by the operating
company or practice entity. MAS Enterprises has established an
extremely flexible benefit package which enables each employee to
have his program tailored to his particular needs and desires.
The individuals covered by petitioner's plans are professionals
and executives consisting of medical doctors, lawyers, dentists,
veterinarians, and business operators. Petitioner has entered into
an arrangement entitled "Contract of Employment" (COE) with these
individuals (Workers). /3/ Petitioner has also entered into an
arrangement with the operating businesses and professional
practices (Recipients) for which the Workers provide their services
entitled "Personnel Lease Contract" (PLC).
Workers under a COE with petitioner participate in a money
purchase pension plan, a defined benefit plan, and an extensive
fringe benefit program as adopted by petitioner for that Worker.
The money purchase pension plans provide for: (1) a non-integrated
employer contribution equal to 7-1/2 percent of covered
compensation; (2) immediate participation; and (3) full and
immediate vesting. The defined benefit plans provide for
contributions determined in accordance with generally accepted
actuarial principles. Contributions have been made each year in
accordance with the terms of the plans.
The fringe benefit program in effect as of November 1983
permitted Workers to elect to participate in a financial planning
and asset management program, group health and accident insurance,
a medical expense payment and reimbursement plan, life insurance,
disability insurance, prepaid group legal services, dependent care
assistance, athletic and health club membership, survivor's death
benefit, vacation pay, and severance pay.
The COE allows Workers the option to defer the payment for their
services which they provide to the Recipients. Workers are given
the opportunity under the COE to take purported loans from
petitioner, the security for which consists of the Workers' future
or deferred compensation. /4/ Petitioner prepares the Workers'
paychecks and withholds Federal and state income taxes and pays
Social Security and Federal unemployment taxes for each Worker. In
addition, petitioner pays workmen's compensation premiums and state
unemployment insurance premiums on behalf of all Workers.
On August 24, 1984, petitioner had 52 Workers in COE
arrangements. /5/ In August 1985, petitioner had 73 Workers in COE
arrangements. As of November 19, 1985, petitioner had 61 workers in
COE arrangements. Of the 73 Workers in a COE arrangement in August
1985, almost all had a pre-existing ownership or equity interest in
the Recipient to which they were "leased." /6/ The PLC provides
that, if any Worker was employed by a Recipient prior to execution
of the PLC, the employer-employee relationship shall be definitely
terminated prior to the contract's effective date. Each of the
Workers with a prior ownership or equity interest provided services
to the same Recipient for which the Worker previously performed
services. No Worker having an equity or ownership interest in a
Recipient performed services for any other Recipient.
The only review of the qualifications of the workers that
petitioner undertakes is to determine whether the Workers are
licensed under state or local law to engage in their particular
professions or businesses. Petitioner retains the apparent right
under the COE to terminate a Worker's services or reassign a Worker
to another Recipient. Petitioner has terminated the services of one
Worker but has made no reassignments. The PLC provides that
petitioner and the Recipient may, at any time, increase or decrease
the compensation paid to a Worker for the provision of his
services. The COE provides that petitioner and the Worker may, at
any time, increase or decrease the Worker's compensation.
Recipients provide the equipment, tools and office space for the
Workers. In appropriate instances the PLC requires that the
Recipient furnish the Worker with malpractice insurance and that
petitioner be named as an insured.
Under the PLC, the Recipient agrees to pay a setup fee of $1,500
for each position staffed by petitioner and a service rate payment
of $110 per month for each position staffed. In addition, the
Recipient agrees to pay petitioner the compensation for the Workers
in accordance with a schedule of compensation adopted for each
Worker.
The COE provides that the Worker shall not have the right to
make any representations on behalf of or to bind petitioner to any
contract, obligation or transaction but no such restriction applies
to the Worker vis-a-vis the Recipient. The COE provides that
petitioner shall not infringe on the Worker's exercise of his
professional judgment in rendering services to the public. Each
Worker controls the details of his or her performance of services,
including selection of assignments. Petitioner or the Worker may
terminate the COE by giving the other party written notice.
On May 27, 1986, respondent issued a final adverse determination
letter for the plan years ended October 31, 1982, 1983, 1984 and
1985 with respect to the Rodney D. Swartling, M.D., Money Purchase
Pension Plan & Trust Agreement, the Rodney D. Swartling,
Defined Benefit Plan, and the other defined benefit plans and the
money purchase plans adopted by petitioner for the other
Workers.
Petitioner has notified all interested parties pursuant to
section 7476(b)(2) and has exhausted all available administrative
remedies within the Internal Revenue Service pursuant to section
7476(b)(3). Petitioner's defined benefit plans and money purchase
plans have been put into effect within the meaning of section
7476(b)(4). Petitioner timely commenced this declaratory judgment
action on June 9, 1986.
Respondent determined in his final adverse determination letter
of May 27, 1986 that petitioner's money purchase plans and defined
benefit plans do not meet the requirements of section 401. The
basis of respondent's determination is that a Worker who performs
services pursuant to petitioner's leasing arrangement is not an
"employee" of petitioner. Therefore, respondent concludes that
petitioner's plans violate the "exclusive benefit" requirement of
section 401(a)(2). /7/ See also secs. 1.401-1(a)(3)(ii) and
1.401-1(b)(3), Income Tax Regs.
In order to be entitled to tax exempt status under section
501(a), a retirement plan /8/ must meet all the requirements of
section 401(a). That section provides in relevant part as
follows:
SEC. 401. QUALIFIED PENSION, PROFIT-SHARING, AND STOCK BONUS
PLANS.
(a) Requirements for Qualification. -- A trust created or
organized in the United States and forming part of a stock bonus,
pension, or profit-sharing plan of an employer for the exclusive
benefit of his employees or their beneficiaries shall constitute a
qualified trust under this section --
* * *
(2) if under the trust instrument it is impossible, at any time
prior to the satisfaction of all liabilities with respect to
employees and their beneficiaries under the trust, for any part of
the corpus or income to be (within the taxable year or thereafter)
used for, or diverted to, purposes other than for the exclusive
benefit of his employees or their beneficiaries * * *.
It is respondent's position that the plans in issue here fail to
establish the existence of an employer-employee relationship
between petitioner and the Workers. Rather, respondent maintains
that the Workers either remain self-employed or employees of their
own professional service corporations for which they worked before,
and continued to work after, entering into the purported leasing
arrangement with petitioner. Specifically, respondent argues that
the form of the COE and the PLC does nut reflect the substance of
the relationships among the parties. /9/
Petitioner argues to the contrary that a valid employment
relationship exists between petitioner and the Workers and that the
dealings among the Workers, petitioner and the Recipients are
governed by the terms of the COE and the PLC. Petitioner bears the
burden of proving that respondent's adverse determination is in
error. Rule 217(c)(1)(i). In reviewing respondent's determination,
we must look solely to the evidence contained in the administrative
record. Tamko Asphalt Products, Inc. v. Commissioner, 71 T.C. 824,
837 (1979), affd. 658 F.2d 735, 738-739 (10th Cir. 1981); Rule
217(a).
To determine the existence of an employer-employee relationship
we must look to common law concepts. /10/ See Edward L. Burnetta,
O.D., P.A. v. Commissioner, 68 T.C. 387, 397 (1977); Packard v.
Commissioner, 63 T.C. 621, 629 (1975). Sec. 31.3121(d)-1(c)(2),
Employment Tax Regs., defines the common law employer-employee
relationship as follows:
(2) Generally such relationship exists when the person for whom
services are performed has the right to control and direct the
individual who performs the services, not only as to the result to
be accomplished by the work but also as to the details and means by
which that result is accomplished. That is, an employee is subject
to the will and control of the employer not only as to what shall
be done but how it shall be done. * * *
Section 220 of 1 Restatement of Agency 2d (1958), provides a
similar definition:
A servant [employee] is a person employed to perform services in
the affairs of another and who with respect to the physical conduct
in the performance of the services is subject to the other's
control or right to control.
Whether or not an employer-employee relationship exists is a
question which must be determined on the basis of the specific
facts and circumstances involved. Simpson v. Commissioner, 64 T.C.
974, 984 (1975); Ellison v. Commissioner, 55 T.C. 142, 152 (1970);
Hand v. Commissioner, 16 T.C. 1410, 1414 (1951). Sec.
31.3121(d)-1(c)(3), Employment Tax Regs. While the cases which deal
with the common law factors usually involve a determination of
whether a person is an employee or an independent contractor, the
principles are equally applicable to determine by whom an
individual is employed. /11/ See Bartels v. Birmingham, 332 U.S.
126, 132 (1947).
Among the factors to which the courts have looked in determining
the existence of an employment relationship are the following: (1)
the degree of control exercised over the details of the work; (2)
investment in the work facilities; (3) opportunity for profit or
loss; (4) whether the type of work is part of the principal's
regular business; (5) right to discharge; (6) permanency of the
relationship; and (7) the relationship the parties think they are
creating. United States v. Silk, 331 U.S. 704, 716 (1947); Simpson
v. Commissioner, supra at 985; Ellison v. Commissioner, supra at
153. Although no one factor is controlling, the test usually
considered fundamental is "whether the person for whom the work is
performed has the right to control the activities of the
individuals whose status is in issue, not only as to results but
also as to the means and method to be used for accomplishing the
result." Packard v. Commissioner, supra at 629; see also Alsco
Storm Windows, Inc. v. United States, 311 F.2d 341, 343 (9th Cir.
1962).
A contract purporting to create an employer-employee
relationship will not control where the common law factors (as
applied to the facts and circumstances) establish that the
relationship does not exist. In Bartels v. Birmingham, supra, the
Supreme Court was asked to determine whether certain orchestra
members were employees of the orchestra leader or of the operators
of various dance halls where they performed. After applying the
common law rules to the facts of the case, the Court held that the
orchestra leader was the employer (and therefore responsible for
the employment tax) despite the formal contractual agreement
designating the proprietors of the dance halls as the employers.
Similarly, in Edward L. Burnetta, O.D., P.A. v. Commissioner,
supra, this Court held that certain individuals who worked in the
offices of two professional corporations were the common law
employees of those corporations rather than of a separate payroll
service corporation that maintained the workers' records and issued
their paychecks.
An application of the relevant common law factors to the facts
disclosed by the administrative record demonstrates the absence of
the requisite employer-employee relationship. Pervading a
consideration of all the relevant factors as they apply herein is
the fact that almost all of the Workers had an ownership or equity
interest in the Recipient for which they provided services.
First, petitioner exercised minimal, if any, control over the
Workers. As noted, the Workers were "assigned" to perform services
for the entity in which each had a pre-existing ownership or equity
interest. The COE purports to give petitioner exclusive control
over the Workers including the authority to reassign Workers to
other Recipients. /12/ However, it strains credulity to believe
that a Worker would comply with an assignment to a Recipient in
which he had no interest. Rather, the Worker would merely terminate
his relationship with petitioner and continue working for his
professional corporation or other entity.
In addition, each Recipient and the Worker controlled the
details of when and how work was to be performed as well as the
selection of assignments. Most of the Workers were professionals
and obviously petitioner was unqualified to supervise or evaluate
the performance of professional services. While we are cognizant
that the alleged employer need not "stand over the employee and
direct every move that he makes," Atlantic Coast Life Ins. Co. v.
United States, 76 F.Supp. 627, 630 (E.D.S.C. 1948); Simpson v.
Commissioner, supra at 985, and that an employer's control over the
manner in which professional employees conduct the duties of their
positions "must necessarily be more tenuous and general than the
control over nonprofessional employees," James v. Commissioner, 25
T.C. 1296, 1301 (1956), we remain unpersuaded that even a "tenuous
and general" control exists in the case before us. See also Azad v.
United States, 388 F.2d 74, 77 (8th Cir. 1968). Rather, it is
apparent that the Recipient and the Worker control the terms of the
arrangement.
Second, petitioner has no investment in the work facilities. The
Recipients provide the office space as well as all necessary tools
and equipment. Third, petitioner has no opportunity for profit or
loss except for the amounts received from the Recipient as a setup
fee and monthly service rate payments. The profit earned from the
efforts of the Worker in the Recipient's business belongs solely to
the Recipient. Fourth, like petitioner's purported right to
reassign Workers, petitioner's right to discharge Workers as
provided by the COE is, in the context of the Worker's equity
interest in the Recipient, illusory. Finally, while the parties
have labeled the arrangement created by the COE and PLC as an
employment relationship between petitioner and the Worker, the
objective economic reality of the relationship is that petitioner
merely performs a bookkeeping and payroll service function while
the Worker remains either self- employed or the employee of the
Recipient. /13/ The existence of a contract specifying that an
employer-employee relationship exists is only one factor to be
considered. Bartels v. Birmingham, supra at 129. In accordance with
long established precedent, we find that the transactions embodied
in the COE and PLC lack objective economic substance and are not
controlling for tax purposes. See Frank Lyon Co. v. United States,
435 U.S. 561, 573 (1978); Knetsch v. United States, 364 U.S. 361,
367 (1960); Commissioner v. Court Holding Co., 324 U.S. 331, 334
(1945); Falsetti v. Commissioner, 85 T.C. 332, 347 (1985).
Thus, after a careful review of the administrative record and
for the reasons discussed above, we hold that the Workers are not
common law employees of petitioner. Therefore, petitioner's plans
do not meet the "exclusive benefit" rule of section 401(a)(2).
Accordingly, respondent's determination that petitioner's plans be
denied qualified treatment pursuant to section 401(a) is sustained.
/14/
An appropriate decision will be entered.
FOOTNOTES
/1/ Unless otherwise indicated, all section references are to
the Internal Revenue Code of 1954, as amended, and all Rule
references are to the Tax Court Rules of Practice and
Procedure.
/2/ The May 27, 1986 final adverse determination letter covered
120 plans. Due to the numerous identical plans with different
effective dates adopted by petitioner for various individuals, and
by agreement of the parties, the administrative record in this case
consists of the materials applicable to the representative defined
benefit plan and the representative money purchase plan with
respect to Dr. Rodney D. Swartling. The term "administrative
record" is defined in Rule 210(b)(11).
/3/ Because the issue in this case is whether individuals who
entered into these "Contracts of Employment" with petitioner are,
in fact, "employees" of petitioner, we will refer to such
individuals in our discussion herein by the neutral term "Workers"
and will refer to the entities using the services of such Workers
as "Recipients." See sec. 414(n).
/4/ The Schedule of Compensation of the COE states that the
Worker shall be paid once each year during the term of the contract
and that such payment shall be made on or before December 31. It
also provides that the Worker shall have the right to obtain loans
from petitioner which shall be repaid on or before December 31 of
each year.
/5/ The Workers included 36 medical doctors, 3 lawyers, 1
dentist, 2 veterinarians and 10 independent consultants and
executives.
/6/ Of the 52 Workers under contract on August 24, 1984, all but
3 were former employees of the Recipients to which they were
"leased" and all but 4 had an ownership or equity interest in the
Recipient to which they were leased. During a conference on
November 19, 1986, petitioner's representative told respondent's
representatives that he had been mistaken and that of the total 73
Workers that had participated in the leasing program, 55 had not
been leased back to the entity by which they previously had been
employed. Petitioner explained this discrepancy by stating that
many of the Workers reorganized their professional corporations
and/or partnerships for which they had worked at the time the COE's
and PLC's were signed. Thus, a new legal entity came into existence
to lease its owner back from petitioner.
The stock in petitioner is not owned, directly or indirectly, by
any Worker except Thomas G. Walker, Jr., who is the sole
shareholder.
/7/ Petitioner states on brief that it --
is not arguing that section 414(n)(5) of the Code is applicable
regardless of the employment status of the Leased Employees.
Petitioner merely submits that because Petitioner's Leased
Employees are its common-law employees, the safe harbor provisions
created by section 414(n)(5) of the Code apply.
We interpret this statement as a concession. Therefore, despite
respondent's treatment of this legal issue in the Technical Advice
Memorandum accompanying the May 27, 1986, adverse determination
letter and on brief, we do not address the question whether the
safe harbor provisions of sec. 414(n)(5) apply even though the
Workers are not common law employees of petitioner.
/8/ We use the term "retirement plan" in its generic sense to
include the money purchase pension plans and defined benefit plans
at issue here.
/9/ On brief, respondent describes the arrangement herein as a
"blatant attempt to circumvent the coverage and antidiscrimination
rules" of secs. 401 and 410. This ground was not relied on by
respondent in his adverse determination letter. If this were purely
a legal ground the Court would consider it and respondent would
bear the burden of proof with respect to it. Rule 217(c)(1)(ii).
However, such ground has significant factual elements which do not
appear in the record. Therefore, we do not address it. See Ralph
Gano Miller Corp. v. Commissioner, 76 T.C. 433, 436 (1981).
We also note that despite petitioner's lengthy treatment of
certain perceived issues on brief, respondent does not challenge
petitioner's existence as a viable corporate entity or pursue an
assignment of income theory.
/10/ In defining the term "employee" for self-employment tax
purposes, sec. 1402(d) refers us to sec. 3121(d) which defines the
term for purposes of the Federal Insurance Contributions Act. Sec.
3121(d)(2) provides that the term "employee" means "any individual
who, under the usual common law rules applicable in determining the
employer-employee relationship, has the status of an employee * *
*."
/11/ Sec. 31.3401(c)-1(c), Employment Tax Regs., provides that
generally "physicians, lawyers, dentists, veterinarians, * * * and
others who follow an independent trade, business or profession in
which they offer their services to the public, are not employees."
Rather, such professionals are generally regarded as self-employed
where they hold themselves out to the public in their individual
capacities. Where, however, professionals have established their
own professional operating practices, they may be regarded as
employees of such entities.
/12/ The COE provides that:
The [Worker] shall be under the exclusive charge and control of
the [petitioner] and shall not be subject to the control of the
Recipient, excepting as to results. The [petitioner] shall have the
sole and exclusive right to discharge the [Worker]. * * *
* * * [T]he [Worker] agrees that the [petitioner] shall have the
sole and exclusive discretion to determine the Recipient to which
[the Worker] will be assigned.
/13/ Clearly, the Workers were not dependent on petitioner for
their compensation because the source of their income was the
Recipient whose interests were coextensive with those of the
Worker. We note, however, that petitioner was, nevertheless,
responsible for withholding Federal employment taxes for the
Workers because it had control of the payment of the wages. See
Otte v. United States, 419 U.S. 43, 50-51 (1974).
/14/ While the record suggests that there may be a few Workers
who do not own equity or ownership interests in the Recipients to
which they are leased, no facts appear in the administrative record
which would permit a different conclusion with regard to the
application of the common law factors as to them. Thus, our
decision herein must result in the disqualification of all the
plans submitted for determination.
Last Modified
11/02/02
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