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Taxpayer Was Independent Contractor, Notwithstanding Employee Status Indicated on Form W-2

(Parker Tax Publishing June 2018)

The Tax Court held that an aerospace engineer who provided consulting services to a company through a temporary employment agency was a statutory employee, even though he received a Form W-2 indicating that he was a common law employee, and thus could report business income and expenses on Schedule C and avoid the Schedule A limitations on the deduction of unreimbursed employee business expenses and the phaseout of itemized deductions. However, the Tax Court disallowed the taxpayer's deductions for business and other expenses due to the taxpayer's failure to adequately substantiate the expenses. Fiedziuszko v. Comm'r, T.C. Memo. 2018-75.

In 2012, Slawomir Fiedziuszko was a semiretired aerospace engineer who worked as a consultant for Space Systems Loral (Loral). Fiedziuszko found consulting work by attending conferences and traveling to visit potential clients. He provided services to Loral through West Valley Engineering Co., a temporary employment agency. Fiedziuszko's contract with Loral began in 2011 and ended in July 2012. He worked primarily from home on a satellite development project.

West Valley processed Fiedziuszko's weekly pay and withheld income, social security and Medicare taxes. West Valley did not offer any benefits other than a deferred compensation plan. On Fiedziuszko's 2011 Form W-2, West Valley checked the box indicating that he was a statutory employee. However, West Valley did not check that box on Fiedziuszko's 2012 Form W-2.

Mr. Fiedziuszko and his wife, Alicia, filed a joint tax return for 2012 on Form 1040, which they prepared themselves. The Fiedziuszkos took the position that Mr. Fiedziuszko was a statutory employee and claimed deductions on Schedule C, Profit or Loss from Business, for expenses related to Mr. Fiedziuszko's consulting business. These expenses included $2,000 for supplies, $5,000 for travel (including meals and lodging), $9,500 for insurance, and $2,000 for advertising. They also claimed a deduction of $29,000 for self-employed health insurance.

Mrs. Fiedziuszko was diagnosed with morbid obesity in 2011; Mr. Fiedziuszko was also considered obese and displayed prediabetic indications. On the advice of their doctor, the Fiedziuszkos entered a medically supervised weight loss program designed by Health Management Resources (HMR) and administered through a healthcare provider. The Fiedziuszkos reported approximately $16,000 of deductible medical expenses for the cost of the HMR program, as well as expenses for other medical services. In total, the Fiedziuszkos claimed over $19,000 of medical expense deductions for 2012.

The Fiedziuszkos also claimed charitable contribution deductions in 2012 of $2,800 in cash contributions and over $27,000 in noncash contributions. Mr. Fiedziuszko claimed he made cash contributions to a church and noncash contributions to Goodwill consisting of furniture, clothing, and miscellaneous household goods.

The Fiedziuszkos received pension and annuity payments in 2012 totaling over $72,000 and reported on Forms 1099-R, Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. They included only $37,000 of the payments in income, although the Forms 1099-R indicated that all of the income was taxable.

The IRS issued a notice of deficiency in 2015 determining a deficiency of over $31,000 and applying a substantial underpayment penalty of $6,200. The IRS determined that Mr. Fiedziuszko was not a statutory employee for 2012, and therefore could not report business income and expenses on Schedule C. All of the Fiedziuszkos' deductions were disallowed on the basis that they were not adequately substantiated. The notice further determined that the Fiedziuszkos failed to report all of their pension income, and applied a Code Sec. 6662(a) penalty for a substantial understatement. The Fiedziuszkos challenged the notice in the Tax Court.

To substantiate the Fiedziuszkos' expenses, Mr. Fiedziuszko prepared for trial statements of fact outlining his business expenses. He also prepared a statement listing the dates and amounts of payments for the HMR weight loss program. Mr. Fiedziuszko's cash contributions to the church were documented by calendar pages with handwritten notes, some of which were illegible. A list of the items donated to Goodwill showed each item's claimed fair market value, which was simply the listed sale price for a similar item on EBay or Amazon as of October 2014.

The Tax Court held that Mr. Fiedziuszko was a statutory employee in 2012 and thus was entitled to report business income and expenses on Schedule C and avoid the Schedule A limitations on the deduction of unreimbursed employee business expenses and the phaseout of itemized deductions. However, the court denied all of the Fiedziuszkos' claimed business and medical expense deductions due to lack of substantiation. The court also held that Mr. Fiedziuszko's pension income was includible in income, and upheld the substantial understatement penalty.

The court found that the totality of the circumstances showed that Mr. Fiedziuszko was a statutory employee in 2012. The fact that his Form W-2 did not indicate he was a statutory employee was, in the court's view, a mistake. His Form W-2 for 2011 indicated he was a statutory employee and the court found that nothing changed between 2011 and 2012, because Mr. Fiedziuszko was providing services under the same contract. Further, the facts showed that Mr. Fiedziuszko and Loral intended to form an independent consulting relationship. Mr. Fiedziuszko worked out of his home office, advertised his services to several companies, and was hired through a temporary staffing agency. The relationship was a temporary assignment, and the weekly payroll deposits and withholdings were consistent, in the court's view, with a consulting contract.

The court, however, disallowed all of Mr. Fiedziusko's business expenses due to lack of substantiation. Mr. Fiedziuszko's travel, lodging and meal expenses did not meet the heightened substantiation requirements of Code Sec. 274(d) because the court found that the calendar and statement of facts provided by Mr. Fiedziuszko did not provide a sufficient basis for determining the amounts of the expenses. Moreover, while Mr. Fiedziuszko provided a total amount he claimed he spent on supplies, he did not provide any supporting documentation other than checking account statements, which did not specify for what services the payments were made or allocate between business and personal use.

The Tax Court also found that, while the Fiedziuszkos incurred expenses for medical care under Code Sec. 213, they failed to adequately substantiate the expenses. In the court's view, a statement that Mr. Fiedziuszko prepared for trial was not an itemized statement from the medical care provider as requested by the IRS. Nor was his statement and testimony sufficient substitutes for an itemized statement, because there was no additional corroborating documentation for the payments.

The court found that the Fiedziuszkos failed to substantiate their charitable contributions. They produced no evidence of the cash contributions other than cryptic calendar entries. The Fiedziuszkos also failed to present reliable written records of their noncash contributions or evidence of the condition of the items donated. With respect to the clothing and household items, the court found that the Fiedziuszkos did not establish that their condition was in good used condition or better.

The court found that Mr. Fiedziuszko's pension income that the couple received was taxable in full based on the Forms 1099-R. The Tax Court also held that the Fiedziuszkos did not show reasonable cause for the underpayment of tax and upheld the assessed penalty because they failed to explain the understatement or to adequately substantiate their expenses.

For a discussion of determining employment status, see Parker Tax ¶210,110. For a discussion of substantiation requirements of expenses, see Parker Tax ¶91,130. For a discussion of the penalty for a substantial understatement of tax, see Parker Tax ¶262,120.10.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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