The Tax Court has ruled that cosmetologists, nail technicians, and massage therapists (“service providers”) who performed their services at a spa were independent contractors, rather than employees [Cheryl Mayfield Therapy Center v. Commissioner, TC Memo 2010-239, Dkt. No. 9156-07, 10/28/10].
The facts. The taxpayer was the owner of a spa. The service providers who worked at the spa received no set salary, wages, or fringe benefits. As a general rule, the spa charged each service provider weekly “booth rent” equal to the greater of approximately $80 “base rent,” or 25% of the gross revenues that the service provider generated during the week. The service providers set their own hours. Some of them worked full time; others were part-time workers who were students or had jobs elsewhere. They generally provided their own supplies. Each service provider purchased his or her own work clothing. The spa's clients paid for services at a central point as they left the spa, rather than paying the service provider directly.
The spa did not file W-2 forms for any of the service providers. Nor did it report any compensation payments to employees during the years at issue on Forms 941, Employer's Quarterly Federal Tax Return, or Forms 940, Employer's Annual Federal Unemployment (FUTA) Tax Return. The IRS issued assessments against the spa for employment taxes and penalties, as the IRS believed that the service providers should have been classified as employees.
The law. IRC §3121(d)(2) defines an “employee” for employment tax purposes as “any individual who, under the usual common law rules applicable in determining the employer-employee relationship, has the status of an employee.” Under common law rules, the most important consideration in determining an employer-employee relationship is generally whether the person for whom the services are performed has the right to direct and control the method and manner in which the work is to be completed.
The 20-factor test. The IRS has published a standard list of 20 factors (commonly known as the common-law test or 20-factor test) for businesses to consider when determining whether a worker is a common-law employee or an independent contractor.
The following factors in the 20-factor test supported the spa's contention that the service providers were not employees: (1) The spa generally charged, and the service providers generally paid, weekly rent of at least $80. (2) The service providers were compensated on a straight commission basis, with no minimum guaranteed level of payment. (3) The spa did not pay service providers' business or travel expenses. (4) Many of the massage therapists made significant investments in outfitting and decorating their massage rooms. Thus, the service providers bore the risk of suffering net losses. (5) Several service providers believed that they had a non-employee relationship with the spa. (6) The spa did not tell the service providers how to provide their services to the clients. The service providers were all licensed professionals, possessing skills as required by their licensing. They set their own hours. Although the spa posted prices for various services, the service providers were free to charge less and sometimes provided services for free.
The following factors supported the IRS's contention that the service providers should have been classified as employees: (1) Their services were integrated into the spa's operations. (2) They provided their services mostly on the spa's premises. (3) The spa provided at least some informal training to new service providers. (4) There was no indication that the service providers made their services available to the general public regularly and consistently (other than when working at the spa). (5) The spa provided assistance to the service providers in booking appointments. (6) The spa's clients paid the spa rather than the service providers. (7) The spa kept the payments until it distributed the service providers' weekly checks.
Other factors in the 20-factor test did not conclusively support a finding of employee or independent contractor.
The ruling. The Tax Court said that it was a close call, but the factors supporting the service providers' autonomy predominated over those indicating the spa's control over their work. Accordingly, it held that the service providers were independent contractors, rather than employees.