Uber Driver Failed To Report Income

I am reading a case concerning an Uber driver who ran afoul of Form 1099 requirements.

The amounts at issue were impressive.

           Tax                          $193,784

           Penalties                  $ 85,354

Robert Nurumbi drove for Uber in 2015. He ran the business through a single-member LLC and used two bank accounts. Business was doing well. He bought multiple cars which he rented out to family and friends who drove for Uber through him. The twist to the tale is that all Uber payments were paid to the LLC’s bank account - meaning Nurumbi’s bank account, as he was the LLC - and he in turn would pay his family and friends.

Sounds like he established a small business, with employees and all.

Except that he treated his drivers as independent contractors, not employees. I get it: Uber is gig economy.

Every week Uber would pay Nurumbi. He would transfer the family-and-friends portion to a second bank account. He would sometimes pay them by electronic transfer; at other times he paid in cash. He did not keep documentation on these payments, and he further muddied the waters by also paying nondriver expenses from the second bank account.

He filed his 2015 personal tax return showing wages of approximately $19 grand.

Uber meanwhile issued him two 1099s totaling approximately $543 thousand.

The IRS saw a case of unreported income.

It is not clear to me how Nurumbi prepared his tax return, as a self-employed does not receive a W-2 from himself. He should have filed a Schedule C with his return, as Schedule C reports self-employed business activity. I would have expected his C to report gross receipts of approximately $543 grand, with a bunch of expenses reducing the net to approximately $19 thousand. The IRS would have matched Uber’s 1099 to the gross receipts on the Schedule C and spared us the drama.

However, Nurumbi did not prepare his taxes this way.

Dumb, I am thinking, but not necessarily fatal. Nurumbi would submit a Schedule C (or a facsimile thereof) and argue his point.

But the damage had been done. Nurumbi had spotted the IRS gross income of $543 grand. He next had to show expenses bringing his net income down to $19 thousand. This gave the IRS the chance to say: prove it.

Which is why we keep records: invoices, bank statements, cancelled checks, QuickBooks files and so forth.  

Nurumbi had a problem. He kept next to no records. He had not issued 1099s. His records in many cases were inadequate to even calculate a 1099.

Nurumbi played a wild card.

There is a court-created exception to the customary documentation requirements. It is called the Cohan rule, and it refers to the person and case that prompted the exception decades ago. The rule has two key requirements:

(1)  One must prove that the expenditure occurred, and

(2)  One must prove that the expenditure relates to and was incurred in one’s trade or business.

Even then, the exception will probably not yield the same result as keeping records. The Court may spot you something, but that something is likely to be much less than what you actually incurred.

Nurumbi’s records were so feckless that it would have been unsurprising if the Court allowed nothing.

Except …

Remember that he sometimes paid his drivers electronically from the second bank account.

The Court spotted him a deduction of approximately $157 grand for those payments.

What about the cash payments to his drivers?

No dice.

Let’s summarize the damage.

The IRS increased his 2015 income from $18 to $543 thousand.

The Court allowed a deduction of approximately $157 thousand.

There was another significant deduction that we did not discuss: the fee paid to Uber itself. That was approximately $163 thousand.

That still leaves a bump to income of almost $205 grand.

I believe that Nurumbi paid the money to his family and friends.

But there was no tax deduction.

To be fair, he is the one who decided to keep the payments under-the-table. While not stated, I suspect this … flexibility … was a key factor in the Court’s decision.

Our case this time was Nurumbi v Commissioner, TC Memo 2021-79.

The Gig Economy

Say that I retire. Perhaps my wife wins the lottery or marries well.

I get bored. Perhaps I would like a little running-around money. Maybe I flat-out need extra money.

I find a website that connects experienced tax practitioners to people needing tax services. There might be specializations available: as a practitioner I might accept corporate or passthrough work, for example, but not individual tax returns. I could work as much or as little as I want. I might work Friday and Saturday afternoons, for example, but not accept work on weekdays. I could turn down or fire clients. I could take time off without fear of dismissal.

There would have to be rules, of course. Life is a collection of rules. I might have to provide my state license to substantiate my credentials. I might have to post an E&O policy. It seems reasonable to expect the website to impose standards, such as for professional conduct, client communications, timeliness of service and so on

How would I get paid?

I am thinking that I would bill through the website. An advantage is that the website can devote more resources than I care to provide, making the arrangement a win-win-win for all parties involved. The website would collect from the client and then electronically deposit to my bank account.

Here is my question: is the website my employer?

Don’t scoff. We are talking the gig economy.

The issue has gained notoriety as states – New Jersey and California come to mind – have gone after companies like Uber and Lyft. From these states’ perspective, the issue is simple: if there is more than a de minimis interdependence between the service recipient and provider, then there must be an employment relationship between the two. Employment of course means FICA withholding, income tax withholding, unemployment insurance, disability insurance (in some cases), workers compensation and so on.

Let us be honest: employment status is Christmas day for some states. They would deem your garden statue an employee if they could wring a dollar out of you by doing so.

New Jersey recently hit Uber with a tax bill for $650 million, for example.

The employee-independent contractor issue is a BIG deal.

What in the world is the difference between an employee and an independent contractor?

People have been working on this question for a long time. The IRS has posited that employment means control – of the employer over the employee – and also that control travels on a spectrum. As one moves to the one end of the spectrum, it becomes increasingly likely that an employer-employee relationship exists.

The IRS looks at three broad categories:

(1)  Behavioral control

(2)  Financial control

(3)  Relationship of the parties

The IRS then looks at factors (sometimes called the 20 factors) through the lens of the above categories.

·        Can the service recipient tell you what, where, when and how to do something?

·        Is the service recipient the only recipient of the provider’s services?

·        Is the service relationship continuing?

Answer yes to those three factors and you sound a lot like an employee.

Problem is the easy issues exist only in a classroom or at seminar. In the real world, it is much more likely that you will find a mix of yes and no. In that event, how may “yes” answers will mean employee status? How many “no” answers will indicate contractor status?

Answer: no one knows.

Some states have taken a different approach, using what is called an “ABC” test. There was a significant case (Dynamex) in California. It interpreted the ABC test as follows:

(1)  The service provider is free from the direction and control of the service recipient in connection with the performance of the work.

(2)  The service provider performs work outside the usual course of the service recipient’s business.

(3)  The service provider is customarily engaged in the independent performance of the services provided.

I get the first one, but I point out that it is rarely all or nothing. If we here at CTG Command bring on a contractor CPA – say for the busy season or to collaborate on a tax area near the periphery of our experience – we would still have expectations. For example,

·        our office hours are XXX

·        reviewer turnaround times to tax preparers are XXX

·        responses to client calls are to occur with XXX hours or less

·        responses to me are to occur within X hours or less

·        drop-dead due dates are XXX

How many of these can we have before we fail the A in the ABC test?

Let’s look at B.

We are a CPA firm. Odds are we are interested in experienced CPAs. It is quite unlikely that we will have need of a master plumber or stonemason.

Have we automatically failed the B in the ABC test?

And what does C even mean?

I am a 30+ year tax CPA. I am a specialist and have been for many years. I would say that I am “customarily engaged” in tax practice. Do I have “independent performance,” however?

If I interpret this test to mean that I have more than one client, it somewhat makes sense, although there are still issues. For example, upon semi-retirement, I would like to be “of counsel” to a CPA firm. I have no intention of working every day, or of being there endless hours during the busy season. No, what I am thinking is that the firm would call me for specialized work – more complex tax issues, perhaps some tax representation. It would provide a mental challenge but not become a burden to me.

Would I do this for more than one firm?

Doubt it. I point to that “burden” thing.

Have I failed the C test?

I am still thinking through the issues involved in this area.

Including non-tax issues.

If I take an Uber and the driver gets into an accident – injuring me – do I have legal recourse to Uber? Seems to me that I should. Is this question affected by the employee-contractor issue? If it is, should it be?

This prompts me to think that the law is inadequate for a gig economy.

There is, for example, always some degree of control between the parties, if for no other reason than expectation is a variant of control. Not wanting to lose the gig is – at least to me – an incident of control to the service recipient. Talk to a CPA firm partner with an outsized client about expectation and control.

Why cannot CTG Command gig an experienced tax professional – say for a specific engagement or issue - without the presumption that we hired an employee? I can reasonably assure you that I will not be an employee when I go “of counsel.” You can forget my attending those Monday morning staff meetings.

Am I “independently performing” if I have but one client? What if it is a really good client? What if I don’t want a second client?

Problem is, we know there are toxic players out there who will abuse any wiggle room you give them. Still, that is no excuse for bad tax law. Not every person who works – let’s face it – is an employee. The gig economy has simply amplified that fact.

A Twist On A Penalty

I am looking at a tax case. There is no suspense or twist, but there was something at the end that caught my attention.

The case involves an Uber driver.

He deducted the following:

(1)  Vehicle expenses of $44,729

(2)  Travel expenses of $6,915

(3)  Repairs and maintenance of $5,345

(4)  Insurance of $3,349

(5)  Cleaning expenses of $751

I am not seeing a whole lot of technical here. Hopefully he kept documentation and receipts. Just sort, label, copy and provide to the IRS.

But the story goes chippy.

(1) The travel expenses were for trips to Florida seeking medical treatment.

COMMENT: So this is not a business deduction. It instead is a medical deduction, which he might not be able to use if he doesn’t have enough to itemize.

               He provided no documentation for these trips.

(2)  He had nothing to support the repairs and maintenance.

Odd. One would have thought he had a primary garage, and that garage could provide a printout. It might not account for every dollar deducted, but it should be a good chunk.

(3)  He did not provide documentation for the insurance, not even the name of the insurance company.

This is getting strange. I am beginning to wonder if he is a protester.

(4)  It turns out that the cleaning was dry cleaning. That may or may not be deductible, hinging on whether he was dry-cleaning a uniform. I am, for example, unable to deduct my dry cleaning, but then I do not wear a uniform.

Again, he offered no documentation.

(5)  I am curious about the vehicle expenses. Forty-four grand is a lot.

Turns out he deducted approximately 70,000 miles.

Problem is, he drove only 9,439 miles as an Uber driver.

Oh, oh.

On top of that he deducted both actual expenses and mileage.

No can do.

The IRS wanted almost $18,000 in tax.

I am not surprised, considering that the disallowance of the deductions swelled both his income tax and self-employment tax simultaneously.

The IRS also wanted a substantial-understatement penalty of almost $3,600.

COMMENT: This penalty applies when the additional tax due is more than the larger of $5,000 or 10% of the corrected tax liability (before any payments). The penalty is 20%, and it hurts.

Frankly, I am thinking he is doomed. He does not have a prayer, having provided no documentation for his expenses, even the easy documentation.

Twist: this penalty has to be approved by an IRS supervisor.

Happens all the time.

But the IRS failed to submit evidence to the Court that it was approved.

The IRS tried to reopen the record to submit said evidence.

Too late. The taxpayer had the right to object.

What would you do?

Of course. You object.

So did the taxpayer.

Without the evidence the Tax Court bounced the substantial accuracy penalty.

Mind you, he still owed tax of almost $18,000, but he did not owe the penalty.

The case for the home gamers is Semere Misgina Hagos v Commissioner.