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Payments for Accounting Services Were Wages, Not Self-Employment Income

(Parker Tax Publishing June 2020)

The Tax Court held that bi-weekly payments received by a CPA, who went into a partnership with another CPA and then subsequently sold his interest in the business to his partner while continuing to provide accounting services to the firm, were appropriately characterized as wages and not self-employment income. Additionally, the court concluded that, because the taxpayer was an employee, his business-related expenses were only deductible as employee business expenses subject to the 2-percent of adjusted gross income limitation. Thoma v. Comm'r, T.C. Memo. 2020-67.


Roland Thoma is a CPA who purchased a partial ownership in an accounting firm in 1976. At some point after 1976 but before August 2005, Thoma became the sole owner of the accounting firm and operated the firm as a sole proprietorship. In 2006, Thoma went into business with another accountant, Eric Hjerpe. They executed two contracts relating to the business, one being a partnership agreement executed in 2005, with a stated effective date of January 1, 2006, and the second contract "restated" the 2005 agreement. From 2006 until 2011, Thoma provided accounting services solely through Thoma & Hjerpe (T&H). Thoma worked solely for his clients which he brought to the firm, and Hjerpe likewise brought his own clients to the firm and continued working solely for them. In 2010, Thoma agreed to sell his interest in T&H to Hjerpe. The 2010 agreement stated that as long as Hjerpe was not in default, Thoma, the "Seller/Employee," retained no management or supervisory role with respect to the operation of the business.

In 2010 and 2011, T&H made biweekly payments to Thoma for accounting services rendered to T&H. T&H issued Schedules K-1 reporting the payments as guaranteed payments to a limited partner. No amounts were withheld from the payments to Thoma. Thoma did not receive any paid sick leave or paid vacations. T&H had professional liability insurance during 2010 and 2011, and Thoma was included on the policy.

In 2011, the U.S. Department of Justice (DOJ) sent a letter to T&H, which Thoma described as a civil investigative demand issued personally to him requesting the records of one of his clients. Thoma responded to the letter but never informed Hjerpe about it. Hjerpe eventually learned about the letter. A few weeks later, Thoma arrived at the offices of T&H and found that the locks had been changed and he no longer had access to the network, client files, and email accounts. The same day, Thoma received a letter from Hjerpe informing him that he was being placed on administrative leave for his "gross mishandling" of the DOJ letter. Thoma did not provide any accounting services to his clients at T&H after receiving Hjerpe's letter. His association with T&H ended on November 20, 2011, the day Hjerpe placed him on administrative leave.

Thoma's individual tax returns for 2010 and 2011 reported his income from T&H as self-employment income, and Thoma claimed deductions for the amounts he directly deposited into his SIMPLE IRA and for his health insurance premiums. He also claimed a deduction for one-half of his self-employment tax liability. In 2015, the IRS sent Thoma a notice of deficiency for 2010 and 2011. The notice determined that Thoma was an employee of T&H and recharacterized his income as wages. As a result, Thoma's expenses of working for T&H were treated as unreimbursed employee expenses that were deductible only as miscellaneous itemized expenses subject to the 2-percent of adjusted gross income (AGI) floor. In addition, the notice determined that as an employee, Thoma's health insurance expenses were deductible only as deductions for medical expenses and his SIMPLE IRA contributions were not deductible. The notice also determined that Thoma was liable for accuracy related penalties.

Thoma took his case to the Tax Court. He claimed that T&H had consistently been operated as a partnership. He also argued that, by moving for the admission of the Schedules K-1 into evidence, the IRS was estopped from challenging T&H's reporting of Thoma's income on the K-1s. Thoma said that the 2010 agreement reflected the existence of a partnership because it provided that on a default by Hjerpe, Thoma would immediately become the managing partner, and Thoma contended that a non-partner could not suddenly become the managing partner. The 2010 agreement also contained an expense-reimbursement provision which, according to Thoma, showed that he could "have a tax deductible loss," meaning that he was at a risk of a loss by working at T&H. Thoma argued in the alternative that, if the court held that he was not a partner, he was an independent contractor because Hjerpe did not control the way Thoma performed his accounting services and Thoma did not receive benefits of the type that support employee status.

Tax Court's Analysis

The Tax Court rejected Thoma's arguments and upheld the determinations in the notice of deficiency after finding that Thoma was an employee of T&H in 2010 and 2011. In the court's view, Thoma and Hjerpe did not intend to join together for the purpose of carrying on a business or sharing in the profits or losses, and therefore, T&H was not a partnership. The court noted that the 2010 agreement unambiguously provided that Thoma was an at-will employee of Hjerpe. The court found that by 2010, Thoma had no management authority and Hjerpe controlled the affairs of T&H. The court further noted that because Thoma characterized his position as that of a limited partner who was not entitled to the profits of T&H, Hjerpe was the 100 percent owner of T&H. The court found that the Schedules K-1 were not controlling merely because the IRS introduced them as evidence, but rather were just one factor in determining the existence of a partnership agreement.

The court further held that Thoma was not an independent contractor. In the court's view, the relationship between Thoma and Hjerpe was more permanent than that of an independent contractor because Thoma had worked for T&H for many years. The court found that Hjerpe, on behalf of T&H, had the right to discharge Thoma, which he exercised in 2011. The court noted that T&H provided Thoma with professional liability insurance, office space, and tax preparation software, and Thoma did not have any investment in T&H. The court concluded that T&H was in the business of accounting, and the work Thoma performed for his clients was within the scope of T&H's regular business. In addition, the court said that other factors, including the absence of an opportunity for profit or loss and the control over the details of Thoma's work, weighed in favor of employee status.

The court also upheld the imposition of penalties after finding that Thoma failed to show he acted with reasonable cause and good faith. According to the court, Thoma did not rely on the Schedules K-1 in preparing his returns and even if he had, his reliance would not be reasonable. The court said that as an experienced accountant, Thoma had reason to know that it was inconsistent to treat himself as a partner in an entity in which he had no ownership interest, no liability for debts, and no right to profits. The court also found that, with respect to Thoma's claimed business expenses, he did not take reasonable steps to comply with recordkeeping requirements.

For a discussion of determining the existence of a partnership, see Parker Tax ¶20,105. For a discussion of the difference between employees and independent contractors, see Parker Tax ¶13,105. For discussion of accuracy-related penalties, see Parker Tax ¶262,120.

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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