Doctor Was Employee, Not Independent Contractor, Tax Court Says

October 2, 2009

The Petitioner in this case is a medical doctor and specializes in head and neck surgery, otolaryngology, and facial plastic surgery. During 2004 he provided medical services to patients through a medical corporation that I’ll call (DHN).

On July 1, 2001, the doctor an employment agreement with DHN effective until June 30, 2004. Thereafter, the employment agreement would be automatically renewed for additional 1-year terms unless the employee resigned, died, became disabled, or was terminated by DHN. The employment agreement expressly identified the doctor as an “employee” of DHN and provided that he agreed to serve as an officer and member of the board of directors. The terms of the employment agreement provided:

the Employee shall, under the supervision of the physician members of the Corporation’s Board of Directors, devote his working time, skill and experience to advancing and rendering profitable the interests of the Corporation * * *.

The employment agreement placed additional requirements on the doctor relating to: (1) Maintaining and improving DHN’s standing within the community; (2) maintaining telephone service and other appropriate equipment at his residence; (3) attending annual continuing education courses; and (4) maintaining hospital staff privileges. The employment agreement provided that DHN would reimburse petitioner for the costs of continuing education courses, hospital staff dues, professional societies, professional publications, and other professional expenses in accordance with policies established by the board of directors. The employment agreement also provided for paid vacation leave for petitioner and required DHN to maintain malpractice insurance on the doctor.

For 2004 the doctor received a Form W-2, Wage and Tax Statement, from DHN reporting $409,300 in compensation paid to the doctor as “Wages, tips, other compensation” in box 1. DHN did not check the box on the Form W-2 to indicate that petitioner was a statutory employee. In 2004 DHN withheld Federal, State, and local income taxes and Social Security and Medicare taxes from the compensation paid to petitioner. Petitioner did not pay any self-employment taxes for 2004. Petitioner did not receive compensation from any other source during 2004 for providing medical services, and petitioner did not perform medical services for a fee outside of his relationship with DHN.

For 2004 petitioner filed a Form 1040, U.S. Individual Income Tax Return, and left blank line 7 “Wages, salaries, tips, etc.” He attached Schedule C to his 2004 return and reported “physician” as his principal business or profession. On the Schedule C he reported gross receipts or sales of $409,300, the wage amount shown on the Form W-2 DHN issued. He then checked the box to incorrectly indicate that the statutory employee box was checked on his Form W-2.

Turns out that in 2004 the doctor paid legal fees of $22,155 in connection with a lawsuit filed against him, among others, for medical negligence. In 2004 he settled the lawsuit for $1.4 million with his malpractice insurer’s agreeing to pay $400,000 and the agreeing to pay $1 million. He paid the $1 million settlement during 2005. During 2004 petitioner paid membership dues of $440 to the American College of Surgeons Professional Association. Petitioner reported total expenses of $24,615, consisting of legal fees of $24,175 and professional dues of $440, on the Schedule C.

In September 2006 the doctor requested that DHN issue an amended Form W-2 for 2004. DHN’s business manager informed him that the issuance of an amended Form W-2 was not appropriate, and as such the doctor did not receive the requested amended Form W-2 from DHN. For the years 2001 to 2003 and 2005 to 2006 the doctor received Forms W-2 from DHN reporting his compensation as “Wages, tips, other compensation” and the withholding of Federal, State, and local income taxes and Social Security and Medicare taxes. For 2001 to 2003 petitioner reported the compensation received from DHN on Form 1040, line 7, “Wages, salaries, tips, etc.”, on Form 1040 and did not file a Schedule C with his returns. For 2005 petitioner reported the compensation received from DHN on line 7 “Wages, salaries, tips, etc.” and attached a Schedule C to the return. The Schedule C did not report any gross receipts or sales but claimed expenses of over $1 million, including the $1 million settlement payment for the medical negligence lawsuit. For 2006 the doctor attached a Schedule C to his return and reported gross receipts and sales of $507,944, which is $50 less than the amount shown as compensation on his Form W-2 from DHN and claimed expenses of $992. He checked the box on line 1 of the 2006 Schedule C to incorrectly indicate that his Form W-2 identified him as a statutory employee.

The doctor is contending that he is an independent contractor for Federal income tax purposes and is entitled to deduct business expenses on Schedule C.

An individual performing services as an employee may deduct expenses incurred in the performance of services as an employee as miscellaneous itemized deductions on Schedule A, Itemized Deductions, to the extent the expenses exceed 2 percent of the taxpayer’s adjusted gross income. An individual who performs services as an independent contractor is entitled to deduct expenses incurred in the performance of services on Schedule C and is not subject to the 2-percent limitation imposed on miscellaneous itemized deductions.

Employment Classification

The IRS contends that the doctor was an employee of DHN because he was under the common law definition of employee. According the Court, factors that are relevant in evaluating whether a worker is a common law employee or an independent contractor include: (1) The degree of control the principal exercised; (2) which party invests in work facilities the worker used; (3) the worker’s opportunity for profit or loss; (4) whether the principal can discharge the worker; (5) whether the work is part of the principal’s regular business; (6) the permanency of the relationship; and (7) the relationship the parties believed they were creating.

Degree of Control The doctor maintained that Ohio State law prohibits DHN from exercising control over him in matters relating to patient care and treatment. DHN did not control or supervise petitioner’s medical judgment, including patient diagnoses, what medications to prescribe, or what treatments or procedures to perform. He had discretion to schedule the length of his patient appointments, to consult with physicians outside of DHN, and to determine whether to continue to treat a patient. He also maintained the ability to choose outside pathologists, laboratories, and other medical services and to choose the hospitals or surgical centers where he would maintain hospital privileges. He also chose the hospital personnel to assist him, but neither petitioner nor DHN paid the hospital staff.

The Court did not agree that the doctor was not subject to DHN’s control. He was required to work 4-1/2 days during office hours DHN set. Although he chose his half-day off, he did not have the flexibility in his schedule that is indicative of an independent contractor. The employment agreement provided that he would render medical services “under the supervision of the physician members” of DHN.

Although the doctor exercised his medical judgment when rendering medical services, his methods were directed by professional standards set by the medical community. Because of the lower measure of control applicable to professionals, the fact that DHN did not control his patient diagnoses and treatments does not preclude a finding that DHN exercised sufficient control over petitioner to establish an employment relationship.

Investment in Facilities The fact that a worker provides his own equipment indicates independent contractor status. The doctor testified that he provided some specialized equipment that he used to treat patients. According to the Court, any investment by the doctor is offset by DHN’s investment in office locations and equipment. Moreover, the doctor did not use the equipment to provide medical services for a fee outside of his relationship with DHN. This factor supports employment status.

Opportunity for Profit or Loss An opportunity for profit or loss indicates nonemployee status. The doctor received bonuses based on the annual net profits of DHN and not on the amount of medical fees he personally generated. As such, his opportunity for profit was as a shareholder of DHN rather than from rendering medical services. Further, the doctor did not perform any medical services for a fee outside of his relationship with DHN where he could have an opportunity for profit.

Right To Terminate the Relationship In determining employment status, courts consider the manner in which the relationship can be terminated; i.e., by one or both parties, at any time, with or without notice. The right to discharge a worker, and the worker’s right to quit, at any time indicate employee status. Under the terms of the shareholder and employment agreements DHN had the right to discharge the doctor by vote of all except one of the shareholders with or without cause and without notice.

Integral Part of Regular Business Integration of a worker’s services into the business operations of the alleged employer indicates employee status. DHN is in the business of providing medical services. The doctor, as a physician member, is integrally involved in that business.

Permanency of Relationship A continuing relationship indicates an employment relationship while a transitory relationship weighs in favor of independent contractor status. In contrast, a relationship established to accomplish a specified objective is indicative of an independent contractor relationship. The doctor acknowledged that the he and the other doctors at DHN intended a long-lasting relationship but argued this fact was not significant. However, he had a long-term relationship with DHN – he joined DHN as a shareholder in 1999. The employment agreement contemplated an initial 3-year term with automatic 1-year renewals thereafter.

Intent of the Parties The parties clearly intended to create an employment relationship. The employment agreement expressly identified the doctor as an employee of DHN. DHN reported the doctor’s compensation on Form W-2 and withheld income, Social Security, and Medicare taxes consistent with this expressed intent. DHN provided employment benefits to the doctor, including paid vacation and holidays, medical and disability insurance, participation in a retirement plan, and malpractice insurance. DHN also agreed to reimburse him for the cost of continuing education classes.

Conclusion

Based on the facts above, the Court held that the doctor was a common law employee of DHN. [Walter N. Maimon v. Commissioner; T.C. Summ. Op. 2009-53; No. 8008-07S]

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