Professional Employer Organization Isn't Eligible for Employment-Related Credits

(Parker Tax Publishing April 2026)

The Tax Court held that because a professional employer organization was a statutory employer and not a common law employer, it was ineligible to claim the Work Opportunity Tax Credit (WOTC) and the Empowerment Zone Employment Credit (EZEC) for its clients' employees. After reviewing the legislative history, the court concluded that a statutory employer who pays wages for services provided to another person or business was not Congress's intended beneficiary of these credits and thus only common law employers are eligible for these credits. Barrett Business Services, Inc. v. Comm'r, 166 T.C. No. 7 (1026).

Facts

Barrett Business Services, Inc. (Barrett) is a professional employer organization. Its clients (worksite employers) hire workers (worksite employees) who provide services for, and at the direction of, the worksite employer. Barrett handles payroll and employment tax reporting on behalf of its clients.

The worksite employers supervise the day-to-day activities of the worksite employees. Although the specific services provided to any particular client may vary, Barrett's services always include: (1) onboarding worksite employees into Barrett's payroll system; (2) processing and paying wages; and (3) withholding, paying, and reporting all applicable federal, state, and local taxes and unemployment contributions with respect to such wages, where required. Barrett might also (1) provide and administer employee benefits including retirement programs for worksite employees; (2) manage the costs of employment and employee benefits; and (3) advise on human resources issues. Barrett does not supervise the day-to-day activities of the worksite employees.

On its 2017 through 2020 tax returns, Barrett claimed the Work Opportunity Tax Credit (WOTC) under Code Sec. 51 and the Empowerment Zone Employment Credit (EZEC) under Code Sec. 1396 with respect to its clients' worksite employees. According to Barrett, it qualified, under Code Sec. 3401(d)(1), as an "employer" for purposes of Code Secs. 51, 1396, 1397 (relating to definitions and special rules for certain employment-related credits) and was thus eligible to claim the WOTC and EZEC as either a statutory employer or a Code Sec. 3504 agent of the common law employer.

Observation: Where the person for whom services are performed does not have legal control over the payment of wages, then the person actually controlling the payment of wages assumes the withholding responsibilities of an employer. Under Code Sec. 3401(d)(1), this person is generally referred to as the statutory employer.

The IRS disagreed with Barrett, arguing that the provisions in the WOTC and the EZEC and the legislative history showed Congress's intent to provide the credits to common law employers and neither Code Sec. 3401(d)(1) nor Code Sec. 3504 shift the "employer" away from the common-law employer for purposes of the WOTC and EZEC. The IRS determined that Barrett was not eligible for the WOTC because it was not a common law employer of the worksite employees and it was not a statutory employer pursuant to Code Sec. 3401(d)(1). The IRS also determined that Barrett could not claim the EZEC because it was not an employer that paid or incurred qualified zone wages and because the services performed by qualified zone employees were not provided within an empowerment zone. The IRS thus issued a Notice of Deficiency disallowing Barrett's claimed WOTCs and EZECs.

Barrett challenged the IRS's determinations in the Tax Court -- specifically, the IRS's assertion that Barrett was not a statutory employer. Barrett argued that the Code Sec. 3401(d)(1) definition of a statutory employer should be applied to Code Secs. 51, 1396, 1397 because those provisions do not define "employer" for purposes of claiming the WOTC and the EZEC and thus courts may look to a definition provided in a related statute dealing with similar subject matter.

According to Barrett, since Code Sec. 3401 addresses tax payment obligations arising from the payment of wages, and Code Secs. 51, 1396, 1397 address tax credits arising from the payment of wages, statutory interpretation supported interpreting the term "employer" as used in those provisions to include statutory employers as defined in Code Sec. 3401(d). Barrett also contended that limiting the WOTC and EZEC to common law employers would thwart Congressional intent and pointed to Code Sec. 51(k)(2) in support of its argument that a statutory employer is the "employer" for purposes of these credits.

Code Sec. 51(k)(2) provides that for treatment of employees performing services for other persons, "[n]o credit shall be determined under this section with respect to remuneration paid by an employer to an employee for services performed by such employee for another person unless the amount reasonably expected to be received by the employer for such services from such other person exceeds the remuneration paid by the employer to such employee for such services." Barrett argued that this provision uses "employer" in the context of a three-party employment arrangement, and accordingly "employer" for purposes of the credits should not be limited to a common law employer. Thus, Barrett concluded, an employer other than the common law employer can claim the credit.

The IRS asked the Tax Court to conclude that a statutory employer under Code Sec. 3401(d)(1) is not entitled to claim the WOTC or the EZEC with respect to wages paid on behalf of its clients' workers.

Analysis

The Tax Court agreed with the IRS and held that Barrett, as a statutory employer, was not eligible to claim either the WOTC and/or the EZEC with respect to its clients' employees.

Regarding Barrett's argument about the Code Sec. 51(k)(2) provision using the term "employer" in the context of a three-party employment agreement, the court said Barrett was pointing in the wrong direction. Code Sec. 3401(d)(1), the court observed, is found in subtitle C, which relates to employment taxes, chapter 24, which relates to the collection of income tax at the source of wages. But Code Sec. 3401(d)(1) provides that the term "employer" is defined for purposes of "this chapter." Code Secs. 51, 1396, 1397 are in subtitle A, which relates to income taxes, chapter 1, which relates to normal taxes and surtaxes. The court saw no reason to substitute a term that is defined for purposes of employment taxes into provisions that determine income tax credits. It thus concluded that the term "employer" in this case means "common law employer," i.e., the employer receiving services from the individuals the credit is intended to help.

The court also noted that its reading of "employer" was supported by the legislative history. Congress enacted these credits, the court said, to encourage employers to hire disadvantaged individuals who live and provide services in economically distressed areas. Congress intended the credit to help these disadvantaged individuals and to revitalize these economically distressed areas. Barrett, the court observed, provides employment-related services to its clients, which include payroll services and so Barrett is not the entity that is providing the work opportunity for disadvantaged individuals or in distressed economic areas. Thus, the court concluded, a statutory employer who pays wages for services provided to another person was not Congress's intended beneficiary of these credits.

For a discussion of wages that qualify for the WOTC, see Parker Tax ¶104,515. For a discussion of wages that qualify for the EZEC, see Parker Tax ¶105,610.

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