Editor: Valrie Chambers, Ph.D., CPA
Typically, fees paid to corporate directors who perform minor or no services for the corporation are reported on a Form 1099-MISC, Miscellaneous Income, and are subject to self-employment tax because such directors are not employees of the corporation, as described in Regs. Sec. 31.3121(d)-1(b):
Generally, an officer of a corporation is an employee of the corporation. However, an officer of a corporation who as such does not perform any services or performs only minor services and who neither receives nor is entitled to receive, directly or indirectly, any remuneration is considered not to be an employee of the corporation. A director of a corporation in his capacity as such is not an employee of the corporation.
Occasionally, however, a corporate director may exhibit characteristics of both an employee and a nonemployee. The Tax Court in Blodgett, T.C. Memo. 2012-298, provided useful information to determine income classification when the initial answer may be unclear.
In Blodgett, one of the petitioners served as a corporator and trustee of a local mutual community savings bank. The bank was owned by members of the community who were represented by a board of corporators, which oversaw the actions of the bank’s board of trustees and elected its new members. Blodgett received fees for his services as a trustee, which were reported as “nonemployee compensation” on line 21 of his 2008 Form 1040, U.S. Individual Income Tax Return. However, no self-employment tax was paid relative to the trustee fee income. The IRS issued a notice of deficiency to the taxpayer for failure to pay the self-employment tax, asserting that Blodgett’s position as trustee was essentially the same as a director at a bank with a board of directors, so he was not an employee of the bank. Blodgett argued that his position was not analogous to that of a bank director and that his duties were more like those of an officer of a bank and thus he should be considered an employee.
The Tax Court found that it must determine if Blodgett was an employee of the bank under the common law rules. In determining whether Blodgett was an employee under the common law rules, the Tax Court, citing its opinion in Weber, 103 T.C. 378 (1994), evaluated seven areas: (1) extent of control maintained by the bank; (2) responsibility for providing work facilities; (3) the opportunity for the trustee to receive a profit or loss; (4) the ability of the bank to fire the trustee; (5) the trustee duties as part of the bank’s regular business activities; (6) the permanency of the bank-trustee relationship; and (7) the intent of the bank-trustee relationship. The court found that the bank and corporators did not maintain any significant control over the trustees, which would support their nonemployee status. All trustees were corporators as well and could be removed from their trustee position only by a vote by the corporators (which had never happened in the history of the bank). The bank provided trustees with meeting rooms, office supplies, and other items necessary to fulfill their duties, supporting employee status. The trustees were compensated primarily for attendance at board meetings, with no additional opportunities for profit or loss, thereby indicating that they might be employees. Only the corporators could terminate trustees, indicating that the trustees were not employees. The court found that the trustees’ duties were primarily related to oversight and that they were not involved in the bank’s day-to-day operations, indicating that they might not be classified as employees.
Regarding the permanency of the relationship, the court noted that Blodgett was reelected to his position for more than 10 consecutive three-year terms. In contrast, the management of the bank was appointed only for one-year terms, indicating that the permanency of the bank-trustee relationship favored an employee status. Finally, the bank stated that there was no intent to forge an employee-employer relationship with the trustees and it consistently sent Forms 1099-MISC rather than Forms W-2, Wage and Tax Statement, to all trustees. Based on that information, the court agreed with the IRS that the bank intended to create a nonemployee relationship.
Of the seven factors, the court found that three supported employee status, and four supported nonemployee status. However, following Supreme Court precedent and prior Tax Court decisions, the court did not take a scorecard approach and placed the most weight on the first factor, extent of control maintained by the principal (see Clackamas Gastroenterology Assocs., P.C. v. Wells, 538 U.S. 440 (2003), and Rosato, T.C. Memo. 2010-39). In this case, that factor supported nonemployee status. After considering all of the facts presented, the court ruled in favor of the IRS, upholding the deficiency for self-employment tax.
With this in mind, CPAs should perhaps reexamine whether their clients in similar situations have any deductible costs associated with maintaining such positions, which could reduce both income tax and self-employment tax.
Valrie Chambers is a professor of accounting at Texas A&M University–Corpus Christi in Corpus Christi, Texas. Jacob Gatlin is an assistant professor of accounting at Athens State University in Athens, Ala. Mr. Gatlin is a member of the AICPA IRS Practice & Procedures Committee. For more information about this column, contact Prof. Chambers at firstname.lastname@example.org..