News & Articles


11 / 08 / 2010

Cheryl A. Mayfield Therapy Center v. IRS, T.C. Memo 2010-239
In a Section 7436 proceeding, the United States Tax Court has held that a spa properly classified certain massage therapists, anail technicians, and cosmetologists as other than employees, when each service provider paid weekly "booth rent" equal to the greater of approximately $80 base rent or 25% of the service provider's gross revenues.  The taxpayer contended that they had a valid landlord/tenant relationship with the service providers, but the IRS claimed that the service providers were, in fact, employees.
The taxpayer operated a spa out of a building that had about 12 message rooms, with a reception area and workstations for cosmetologists and nail technicians.  The taxpayer spa eventually conceded that the receptionist and message instructor were, in fact, employees (i.e., improperly classified as not being employees).
The message therapists and cosmetologists had to have a license (hereafter, they will be referred to as "service providers").  They received no set salary or wages and no fringe benefits, and set their own hours, with some working "full time" and others "part-time" and one worker only when he had scheduled appointments.  Other service providers spent time at the spa even when they did not have appointments.  The spa was open 6 days a week and later expanded to stay open for 7 days a week.  The spa hours depended a bit on whether the owner or some other service provider were there.  Most of the service providers had keys to the spa and could come into the spa for appointments outside of the spa's normal business hours.  Clients made appointments for spa services at the receptionist's desk.  Either the owner or the receiptionist answerd the phone, or if they were unavailable, one of the service providers would answer the phone.  The service providers rotated scheduling, unless a client requested a particular service provider.  A service provider could decline servicing any particular customer.  Service providers were not required to charge posted prices, and often charged less and occasionally provided free services for repeat customers, family and friends.  The spa offered discounted prices for clients who prepaid for packages, and participation in these "spa parties" was voluntary.  The spa accepted payment by cash, check, gift certificate, or credit card. Service providers received a weekly check.  Each cosmetologist and message therapist provided her own supplies.  While each massage therapist had an assigned room, some sharing existed.  Service providers collectively decided to wear shirts with the spa logo and it, but each service provider purchased his or her own clothing. 
Each week, the spa would prepare payout sheets for the service providers, and these sheets listed each service providers clients and the total amount that each client paid for services rendered, and from these amounts, the spa would deduct booth rent, expenses for items purchased from the spa, and any amount the service provider might have taken from the "basket" money that sat in the reception area.  Each week, the spa wrote the service providers checks for the net amounts due them.  No W-2s were filed.
The Tax Court was of the view that the taxpayer had the burden of proof, based on Ewens & Miller v. IRS, 117 T.C. 263 (2001), and that for purposes of employment taxes, the term "employee" is to be determined under the "usual common law rules" per IRC Sec. 3121(d)(2).  The Tax Court also cited to Nationwide Mut. Ins. Co. v. Darden, 503 U.S. 318, 323 (1992), Marvel v. United States, 719 F.2d 1507 (10th Cir. 1983) and Leavell v. IRS, 104 T.C. 140 (1995).  The Tax Court went on to note that the IRS "has identified 20 factors", per IRS Rev. Ruling 87-41, 1987-1 C.B. 296, 298-299, and further noted its view that the Court of Appeals for the 10th Circuit endorses the use of the 20 factors, per the E Inv. Corp v. United States, 49 F.3d 651, 653-654 (10th Cir. 1995).
The taxpayer spa contended that the relationship with the service providers was not that of employer-employee but rather, landlord-tenant.  When the spa wrote each service provider a weekly check for the balance of the customer fees that it had collected, the argument was that this was merely as a financial intermediary for the service provider, but the Court found this argument "unpersuasive."  As they viewed it, the clients paid the spa, not the service providers, and thus, these fund were within the control and disposition of the spa, until it paid the service providers by writing them checks, citing to 1.6041-1(h)(definition of "payment").  But, the Tax Court concluded that this did not answer the question as to whether the payments were made to the service providers in their capacities as employees or independent contractors.  Noting that the IRS' own rulings go back and forth, and further how a fixed rent arrangement evidences self-employment status, supported a finding of independent contractor status, akin to a "straight commission basis" approach, with no minimum guaranteed level of payment.  So, too was the fact that the service providers received no employee benefits such as vacation or sick leave, nor cover their business or travel expenses.  The fact that service providers made significant investments in outfitting and decorating their massage rooms further evidenced independent contractor status.  The Court observed how the service providers bore the risk of suffering net losses from operations as the spa, and yet had opportunities for profit by working longer hours, outside of regular business hours.  The Court noted that the service providers believed that they had a nonemployee relationship with the spa, as well. 
Going further, the Court found taht the spa did not tell the service providers how to provide their services to clients, and only required compliance with a small number of instructions relating to operations.  The service providers were licensed professionals, and set their own hours.  The could change their schedules as they pleased.  The service providers retained the right to refuse any client. 
[TLF NOTE:  The Tax Court does not mention the fact that the 20-factor test itself, does not provide, as a factor, the intent of the parties.  Nor does the Court address the fact that the IRS themselves, in light of the Darden decision, appear to have retreated from this test, in favor of a categories of evidence approach, in its worker classification internal manuals and in some cases outside of the 10th Circuit.]. 
The Court did find some aspects of the relationship that suggested employment status.  For example, the Court found that the services were "intergrated into" the spa's operations, and there was no showing that the service providers made their services available to the general public regularly and consistently, and also, that the clients paid the spa, rather than the service providers directly.  The work relationship appared to be one that had alot of turnover, something the Court felt was indicative of employment status.
In the end, the Court found that it was a close case, but weighing all of the evidence, it concluded that the service providers' autonomy predominated over factors indicating control of the spa over the workers.