Principal attorneys and directors of law firms should be aware that the United States Tax Court reclassified contract attorneys of a personal-injury law firm as employees of the firm, and therefore subject to the employment tax provisions of the Internal Revenue Code. The ruling against the professional corporation law firm was for more than $150,000.00 in tax and approximately $10,000.00 in penalty. The law firm appealed the decision to the 5th Circuit Court of Appeals on June 6, 2011.
The law firm failed to meet its burden of proving the officer of the firm, the three associates, and a law clerk were true independent contractors. The Court analyzed the facts using the factors identified by the 5th Circuit in deciding whether the lawyers were common law employees: (1) The degree of control the principal has over the worker, (2) the worker’s opportunity for profit or loss, (3) the worker’s investment in facilities, (4) the permanence of the relationship, and (5) the skill required in the operation. While the factors vary in wording and number from circuit to circuit, they are substantially similar.
Degree of Control. The Court noted that “[W]hether petitioner had the right to control the details of the associate attorneys’ work is an intensely factual question.” On one hand, the firm provided minimal training and supervision. On the other hand, the firm officer “controlled the assignment of cases to the associate attorneys and determined whether the associate attorneys would be reimbursed for case-related and other work-related expenses.” The Court concluded “that the analysis regarding control tips in favor of an employer-employee relationship. Petitioner’s ability to affect the course of litigation by its decisions regarding the funding of litigation, work assignments, and working conditions, including the supervision of associate attorneys who worked on cases generated by petitioner and/or Donald Cave, weighs in favor of an employer-employee relationship.”
Opportunity for Profit and Loss. Attorney compensation was based on a percentage of the gross fees petitioner collected in the cases they handled. The percentage varied depending on who secured the case. The associates bore little, if any, risk of loss from the cases and clients that they handled, even if they brought them into the firm. The Court considered this factor neutral.
Investment in Facilities. The Court decided this factor indicated an employer-employee relationship because the firm provided all of the tools and facilities necessary for the associates to complete their work, including office space, office furniture, computers, telephones, fax machines, copying machines, office supplies, secretarial services, telephone and Internet service, and access to petitioner’s computer server, law library, and online legal research services.
Permanence of the Relationship. All of the associates had long-term relationships with the law firm—three, ten, and twelve years. There were no written contracts of employment or covenants not to compete. Further, there was no evidence that any of the associate attorneys ever provided or offered to provide services to another law firm or directly to the public during the periods at issue. These indicated and employer-employee relationship.
Skill Required in Operation. The Court noted that the associates were “highly educated professionals.” Considering the issues from another angle, though, the Court opined “the associate attorneys, who were newly licensed lawyers when first hired by petitioner, were not specialists called in to solve a particular problem but instead performed the essential, everyday professional tasks in petitioner’s business. This factor is neutral.”
While it should be clear to all that the firm director is and was a statutory employee of the professional corporation for the two years at issue, this ruling clarifies that practicing attorneys who could otherwise hang out their own shingle will probably be considered employees on IRS audit, even under normal circumstances. One possible and legitimate solution would be for contract attorneys to form their own professional corporations, offer services to other firms and the public, and comply with federal, state, and local return-filing and tax-paying statutes.
David A. Sprecace is a solo practitioner in Denver, providing legal services in federal (I.R.S), state, and local tax controversy and litigation; business and bankruptcy litigation; and business planning, formation, and operation.