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.

We Recently Lost An Employee

What I do for a living can be demanding.

I am thinking about it because we have lost another employee.

Mind you, there is always a good reason to leave: a larger firm, a smaller firm, someone wants to go private and get away from any firm, more predictable hours, a geographic move, … it is endless.

The auditors complain about the insane paper chase that has become their corner of the profession. They spend as much time completing checklists as actually doing any meaningful work. It truly takes an idiot to think that we can prevent the next Enron by checking a box on page 64 of a 98-page checklist.

Let me clue you in: by page 64 the auditor has zoned out.

The key to audit fraud is experience – the one thing the giant firms are not geared to provide. Their economics are based on 1 to 4-year accounting graduates. That is no country for old men. Or women.

Tax has fared no better.

It used to be that accountants would stagger year-ends for their business clients. Some would be June, some would be October. This helped to balance the workload and keep accountants from being crushed. Congress – reminding us that the truly useless become politicians – decided years ago that calendar year-ends were the way to go. They allowed a few exceptions, but the majority of closely-held businesses were herded to a calendar year-end.

BTW individuals also end their tax year on December.

So we have this insane crowding of work into two or so months. Granted, much is extended, meaning that the crowding occurs again when the extensions run out. There is no real reason for it, other than government whim and profligacy.

Why, no … gasp! We cannot possibly allow other-than-December year-ends because that would cause a one-time hit to the Treasury. Ignore the fact that there previously was a one-time boon to the Treasury when businesses went to December. The very pillars of society would fall!

Uh huh.

Congress continues its quest to have every economic transaction in American society reported to the government via a Form 1099 or its equivalent. Oh, and if you would be so considerate to do all this by January 31.

We tie-up at least three paraprofessionals for a good chunk of January with 1099s and payroll reporting. Let’s not go Boston University stupid and pretend this is not an indirect (but substantial) tax on business activity. A tax heaved on us by sociopaths who make $174,000 annually, live in one of the most expensive cities in the country but somehow become multimillionaires on a routine basis.

Uh huh.

Take an IRS that has sought for years to do more with less, meaning that more and more of what it does is automated. This returns us to all those 1099s the government wants, with its computer matching and automated notices.

I would be curious to know how many millions of man-hours are wasted every year by BS notices the IRS sprays out. Some of this used to be resolved internally before mailing a notice, as an IRS employee maybe … just maybe … actually looked at the file. Ah, how innocent we were then.

There are consequences to all this nonsense.

I had a conversation very recently with a CPA firm owner. We are similar in age and background. He was telling me how it is becoming almost impossible to hire, as there either is no one available or what is available is simply not hireable. Given our immediate needs, this was not good news.

Our conversation then expanded to the question of why a young person would pursue the career we ourselves chose years ago. There are so many more career paths now providing competitive income levels without depriving someone of 4 to 5 months of their life. Every year.

He did not want his kids to be accountants. They didn’t.

It is showing up in different ways. Accountancy, for example, remains a popular college major and graduation rates are strong. However, interest in pursuing a CPA credential is declining.

The CPA credential of course is closely associated with a CPA firm. When I was coming through there was a career point one could not pass if one did not have his/her CPA. One could make senior accountant, for example, but not manager without the certificate.

My CPA was not optimistic, arguing that our generation – his and mine – might be the last of its kind. 

I am hearing this opinion repeated by more and more practitioners. It is not uniform, mind you, but it is common.

I do not do gloom, but I also believe that the next generation of accountants will demand more life balance that we - the 50-and-60-year-old crowd – did when it was our turn.

Good for them.

What will it do to the giant CPA firms and their churn-and-burn business models? What will it do to the accounting governing bodies, who seem to represent the largest while seemingly having little interest in entrepreneurial and closely-held businesses the vast majority of CPAs – me included - represent? How about Congress? What if they passed a tax law in December and CPAs refused to work 24/7 for their incompetence?

I wish some of this had happened earlier in my career.

Travel Expenses And Your “Tax” Home

I have a friend who used to commute from northern Kentucky to San Francisco.

He has a unique skill set, and the California employer wanted that skill set badly enough to allow him to work a  week there and a week here.

While his employer paid for his commute - and his lodging and meals while in California - let us frame a tax question for more ordinary taxpayers like you and me:

   Can you deduct your expenses while working out of town?

We will use the Collodi decision to walk through this issue.

Mario Collodi lived in northern California - Paradise, California, to be precise. In 2011 he was working for an employer in southern California. He would work a week of 12-16 hour workdays, and then he would return home for a week off. His wife and children lived in Paradise year-round. He was not trying to find work closer to home.

When he filed their 2011 tax return he claimed almost $30 thousand in travel expenses.

The IRS pulled their return and disallowed his travel expenses.

Off to Tax Court they went.

Let's go through Collodi's argument:

• He was a motor hand on an oil rig, meaning that he took care of the motors on the rig.
• The uncertainty of his job made it unreasonable to relocate the family.
• Which meant that he had to travel for work.

He makes a certain amount of sense. 

The IRS fired back with the following:

• The Code allows a taxpayer to deduct ordinary and necessary expenses, including traveling expenses while away from home.
• Which means that one has to determine the location of the taxpayer's home.
• Which is not what you would immediately think. The Code considers your tax home to be where you work, not where you live. For most of us, that is one and the same, but that was not the case for Collodi. He lived in northern California but worked in southern California.

COMMENT: It is odd to think of one's tax home that way, but it makes more sense if you consider that the term "home" is being used in an income-tax context. If one's purpose to tax your income, then it makes sense that “home” would be redefined to where you earn that income.

• Collodi immediately had a problem, as his work-home was in southern - not northern - California. He cannot be away from home under this definition.
• But there is an exception: if you can expect to start and end that out-of-town job in a year or less, the IRS will consider you to be temporarily away from your home, now defined to mean where your wife and kids are. That would cover, for example, the consultant constantly on the road.
• The flip side is that - if you expect to be there more than a year - then you are hosed. You are considered "indefinitely" away from home, meaning your tax home moved with you and there are no travel deductions.

It all came down to this: how long was Collodi in southern California?

He started in 2010, worked all through 2011 and ended in October, 2012.

More than a year, way more than a year. He was not "temporary." He was "indefinite" and did not qualify for any travel deduction.

At least the Court did not pop them for penalties, reasoning that they relied on a tax professional to prepare the return.

OBSERVATION: The professional should have known better, though. While not said, I wonder whether he/she drew a preparer penalty.

Circling back to my commuting friend, he would not have been able to deduct his northern Kentucky - California travel expenses as he worked there for well over a year. He would have been deemed "indefinite," meaning his tax home moved with him when he traveled to San Francisco.

Why did he not move?

His wife refused.

How did the story turn out?

He changed jobs eventually. The commute and hassle wasn't worth it.

How Much Would A Worker Have To Work Before The IRS Believes They Were Really Working?

Can you own and work at a company but have the IRS consider it to be a “passive activity” for tax purposes?

The question seems odd to me, as I have never worked somewhere where I wasn’t unquestionably “materially participating.” There isn’t much choice, given what I do. I would like to someday, though. It’s on my bucket list.

What do these terms mean?

The terms entered the tax Code in 1986, and they were a (mostly successful) effort to battle tax shelters. To trigger the issue one had to have invested in a business activity, and one’s share (whether large or small) wound up on one’s personal tax return. This means – generally – that one is invested in a partnership, LLC or S corporation. One receives a Schedule K-1 for his/her ownership interest, and those numbers are included with one’s other income (a W-2, for example) on the personal return.

Make those numbers negative and you understand the mechanics of a tax shelter.

Congress said that one had to separate those activities into two buckets. The first was a “material participation” bucket, for activities where you actually worked. Those numbers went on your tax return whether they were positive or negative. Congress saw little risk of a tax shelter if one actually worked at the place.

The second was the “passive activity” bucket. Congress put stringent limits on the ability to use negative numbers from this bucket to offset other income. Congress wasn’t going to allow negative numbers from the passive activity bucket to offset positive numbers from one’s actual job.

You can anticipate that the definition of “material participation” was critical.

There are seven tests to qualify as material participation. They are found in Reg. 1.469-5T and are as follows:

·  The taxpayer works 500 hours or more during the year in the activity.

·  The taxpayer does substantially all the work in the activity.

·  The taxpayer works more than 100 hours in the activity during the year and no one else works more than the taxpayer.

·  The activity is a significant participation activity (SPA), and the sum of SPAs in which the taxpayer works 100-500 hours exceeds 500 hours for the year.

·  The taxpayer materially participated in the activity in any 5 of the prior 10 years.

·  The activity is a personal service activity and the taxpayer materially participated in that activity in any 3 prior years.

·  Based on all of the facts and circumstances, the taxpayer participates in the activity on a regular, continuous, and substantial basis during such year.  However, this test only applies if the taxpayer works at least 100 hours in the activity, no one else works more hours than the taxpayer in the activity, and no one else receives compensation for managing the activity.

The key one is the first – the 500 hour test. That is the workhorse, and the one practitioners prefer to use. The 5-out-of-10 years test allows one to retire, as does the any-3-prior- years test. The SPA test is goofy, and should it be a one-person business, then the substantially-all-the-work test bypasses any reference to hours worked.

Then there is the last one – “facts and circumstances.” This is a fallback, in case one cannot shoehorn into one of the other tests. Tax practice being unpredictable, one would have expected a substantial body of precedence on what comprises “facts and circumstances.” We have had more than 25 years, after all. One would have been wrong, as the IRS prefers to proceed as though this test did not exist.

Now we have the Wade case.

Charles Wade owned stock in two corporations: Thermoplastic Services, Inc. (TSI) and Paragon Plastic Sheeting, Inc. (Paragon). He started these companies in 1980 to address the environmental impact of plastic waste materials. TSI acquired waste from chemical companies and converted it into useable products. Paragon bought raw materials from TSI and used them to make building and construction materials. Sounds green.

In 1994 his son (Ashley) came on board, and eventually wound up managing the companies.

This freed up his dad. Wade could be more involved with the customer relationships and less with the day-to-day stuff. This gave dad (and mom) a chance to move to Florida. He could still call and schmooze customers from Florida. I too would like the opportunity to work from Florida, especially as we get closer to winter.

Fast forward another fourteen years, and in 2008 the companies were struggling for their financial lives. Dad decided to step it up. He did the following:

·        Made 273 phone calls to the plant in 2008

·        Travelled to the plant three times to motivate and reassure employees that the companies would continue

·        Intensified his R&D efforts, resulting in

o   A new technique for fireproofing polyethylene partitions

o   A new method for treating plastics to destroy common viruses and bacteria on contact

·        Guaranteed a new line of credit

Wow! This man did everything short of stepping into a phone booth and coming out as Superman.

But 2008 was a tough year. His losses from the companies (including one other, which need not concern us here) was $3.8 million.

This created a net operating loss (NOL) on his personal return. Truthfully, a negative $3.8 million would create an NOL for pretty much all of us. He did what we would do: he carried back the NOL as allowed, which is to the prior two years. Any amount not used there can be carried forward 20 years. Why would he do that?

To obtain a refund of the taxes he paid in 2006 and 2007, that’s why.

Of course, the IRS did not like this at all. They argued that TSI and Paragon were passive activities to Wade, and there is no NOL from passive losses. In fact, there is no “loss” from passive losses, as the best passive activities can do (generally) is get to zero.

And both parties are bound for Tax Court.

The Court looks and notes that Wade has a couple of arguments. The first is that he spent more than 500 hours working at TSI and Paragon.

Now, this can be messy to prove, unless one is actually in the building every day. Time sheets or records would be great. This is an area where keeping good records is key.

The Court continued. Wade also argued that he worked on a “regular, continuous and substantial basis” in 2008. This is the last test from Reg. 1.469-5T, and is the one the IRS likes to ignore.

The Court decided it liked that one. Maybe it did not want to go through time records, which is understandable. 

It looked at the facts and said “duh!” to the IRS. Wade easily spent more than 100 hours just calling the plant (100 hours is the minimum under the facts-and-circumstances test). He developed new technology, called every day, visited the facilities several times, secured financing. Good grief IRS, what more did you want the guy to do?

The Court decided for Wade, noting:

TSI and Paragon are complex businesses that Mr. Wade built from the ground up and in which he continued to play a vital role. He was not merely a detached investor, as has often been the case when we have found that a taxpayer did not materially participate.”

So Wade won. The IRS would have to issue him refunds from his NOL carryback.

But the IRS made their point: they remained skeptical of anyone who wants to prove material participation by means of facts and circumstances.

Of course, a $3.8 million dollar NOL carryback undoubtedly did a lot to spotlight that facts-and-circumstances claim.