T.C. Memo. 1995-555
UNITED STATES TAX COURT
ERTAN AND SUSAN EREN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 866-94. Filed November 21, 1995.
James Daniel McCarthy, for petitioners.
Aretha Jones, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
JACOBS, Judge: Respondent determined a $15,459 deficiency in
petitioners' 1989 Federal income tax. The sole issue for decision
is whether petitioner Ertan Eren's 1989 income from the U.S.
Department of State, Office of Foreign Buildings Operations (FBO),
qualifies for the section 911 foreign earned income exclusion.
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Petitioners' entitlement to such exclusion depends upon the
classification (independent contractor vis-a-vis employee) of
Ertan Eren's employment relationship with FBO during the year under
consideration. For the reasons set forth herein, we hold that such
relationship was that of an employee with the consequence that
petitioners are not entitled to the claimed section 911 foreign
earned income exclusion.
All section references are to the Internal Revenue Code for
the year under consideration, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The
stipulation of facts and the attached exhibits are incorporated
herein by this reference.
Background
Petitioners Ertan and Susan Eren, husband and wife, resided in
Rockville, Maryland, at the time they filed their petition. They
filed a joint Federal income tax return for 1989.
Ertan Eren is an architect1. He resided in Bogota, Colombia,
from July 1988 through June 1990. At that time, he worked for FBO
as project director for the construction of an annex to the U.S.
Embassy in Bogota.
1
All references to petitioner in the singular will be to
Ertan Eren.
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Petitioner's Contracts with FBO
During the late 1970's and early 1980's, petitioner rendered
architectural services to FBO on an "as needed" basis under a labor
hour contract for various FBO projects in Brazil. He signed his
first personal service contract (PSC) with FBO in 1983, and has
been performing services solely for FBO since that time. His
subsequent contracts with FBO have been renewed, modified, or
renegotiated on an annual basis.
On March 6, 1984, petitioner and FBO signed a contract
designating petitioner as the project manager2 with respect to the
improvements and repairs at the U.S. Embassy in Ankara, Turkey, and
other U.S. foreign service posts. Petitioner worked in Turkey for
a number of years under modified versions of this PSC. In July
1988, he was transferred from Turkey to Bogota.
Petitioner's contract with FBO, as in effect during 1989,
states in part: "The Project Manager will inspect construction,
improvements and/or repairs at project sites and will be directly
responsible to FBO in the performance of his duties under this
contract." The contract provides that petitioner will "Perform
appropriate functions and obligations in accordance with procedures
or other directives issued by the Contracting Officer or his
designee."
2
The term "project manager" and "project director" are
used interchangeably herein.
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Petitioner's Duties in Bogota
As project director for the Bogota annex, petitioner was
responsible for the inspection and supervision of the construction
of such annex. He was not subject to daily supervision by FBO.
FBO provided petitioner with a "Project Director's Handbook",
which he was to use as a guide in performing his duties.
Petitioner was required to personally perform his duties to FBO on
a full-time basis. He was required to work a minimum of 40 hours
a week; however, he typically worked longer hours. Petitioner was
not paid for the extra hours he worked.
FBO provided petitioner with all requisite contract documents,
specifications, and drawings for the annex construction.
Petitioner did not have authority to change the documents.
Petitioner was appointed a contracting officer's technical
representative (COTR) pursuant to a memorandum dated November 10,
1988. The memorandum outlined 11 specific duties and activities
that petitioner had to perform as COTR. Primarily, petitioner was
required to insure that all materials furnished, and the work
performed, on the Bogota annex project were in accordance with the
contract specifications and that the work progressed on schedule.3
3
Petitioner had substantial control over the contractor
hired to build the annex. He was able to order work redone or
stopped because of the contractor's failure to follow accepted
safety procedures or project specifications without prior FBO
approval. Before authorizing FBO to pay the contractor,
(continued...)
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Petitioner was required to maintain a daily log describing the work
progress on the construction site.
Pursuant to a February 21, 1989, memorandum that supplemented
the November 10, 1988, memorandum, petitioner was given authority
to substitute materials, equipment, and/or products for the
construction of the Bogota annex so long as they were equal to or
better than those specified in the contract, and the substitution
did not entail an additional cost to the government.
During the year under consideration, petitioner was required
to submit two types of monthly reports regarding the progress of
the construction of the Bogota annex to the FBO area branch chief
for construction management. One was a telegraphic report that
had to be sent before the 10th of each month; the other was a
written report kept in book form. The reports included statements
of progress and problems incurred or anticipated in the
construction of the annex. FBO had the right to terminate
petitioner's contract if he failed to submit these monthly reports.
The Bogota Project Budget
When petitioner was assigned to a project post, he was
required to prepare a budget proposal and submitted it to FBO for
approval. With regard to the Bogota annex project, FBO approved
3
(...continued)
petitioner inspected the job site to ensure that the contractor
was performing satisfactory work.
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petitioner's request for $250,000 for 1989. Although petitioner
did not have authority to exceed the approved budget, he could
allocate approved budget funds as necessary.
The $250,000 budget for 1989 did not include petitioner's
$74,000 salary. His biweekly salary was based on a Government
schedule (the Foreign Service Schedule). Petitioner did not
receive any per diem in 1989.
Petitioner had the authority to hire and fire his staff
without FBO approval. He hired several workers who entered into
contracts with FBO and were paid by FBO.
PSC Provisions
Petitioner did not receive standard Government employee
benefits such as life insurance and retirement benefits under the
terms of his 1989 PSC. Rather, 5 percent of his compensation was
allocated for purchasing health insurance. Petitioner received home
leave,4 sick leave, and annual leave.
Department of State Directives and Memorandum
Two FBO directives required that personal service contractors
be treated as employees. The first directive, issued July 7, 1987,
refers to the Foreign Affairs Manual, which states that "a personal
service contractor is not eligible for the 'foreign earned income
exclusion'". The second, issued July 7, 1987 (and revised on
4
Home leave is a mandatory Department of State leave for
foreign service workers.
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December 4, 1987, and December 20, 1988), provides that overseas
PSC's treat a contractor as an FBO government employee for all
purposes except retirement.
Petitioner was notified by a December 12, 1989, FBO memorandum
that as a result of an Internal Revenue Service review of FBO
personnel policies, it was determined that PSC's signed by FBO
contractors created an employee-employer relationship between the
parties and that petitioner should designate himself as an FBO
employee (rather than as an independent contractor) on his 1989
Federal income tax return.
Subsequent to the issuance of this memorandum, FBO issued
petitioner a Form W-2 for "wages, tips and other compensation" in
the amount of $74,183.04. FBO withheld Social Security tax from
petitioner's income in the amount of $3,604.80.
Petitioners' 1989 Federal Income Tax Return
On petitioners' 1989 Form 1040, petitioners reported $74,183
as "business income" on line 12 and then subtracted $70,0005 on
line 22 ("other income") with the notation "Exclusion from Form
2555."6 Thus, petitioner claimed a section 911 exclusion for a
5
The maximum amount permitted for the earned income
exclusion was $70,000.
6
Form 2555, Foreign Earned Income, attached to
petitioners' 1989 return, reported foreign earned income of
$74,183, and listed "name of employer" as "self".
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substantial portion of the compensation he received from FBO.
Respondent disallowed the claimed exclusion.
Petitioner also calculated self-employment tax on Form SE in
the amount of $6,250. Respondent concedes that petitioner is not
liable for self-employment tax if we hold that he was an employee
of FBO in 1989.
ULTIMATE FINDING OF FACT
Petitioner was an FBO employee in 1989.
OPINION
At issue is the characterization for tax purposes of
petitioner's relationship with FBO during 1989. Petitioner argues
that his relationship with FBO in 1989 was that of an independent
contractor and therefore petitioners are entitled to exclude
$70,000 of his 1989 income from FBO as "foreign earned income"
within the purview of section 911(b)(1)(B)(ii). Respondent
contends that petitioner's relationship with FBO in 1989 was that
of an employee and therefore petitioners are not entitled to the
exclusion.
Section 911 provides in relevant part:
(a) Exclusion from Gross Income.--At the election
of a qualified individual (made separately with
respect to paragraphs (1) and (2)), there shall be
excluded from the gross income of such individual,
and exempt from taxation under this subtitle, for
any taxable year--
(1) the foreign earned income of
such individual, and
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(2) the housing cost amount of such
individual.
(b) Foreign Earned Income.--
(1) Definition.--For purposes of this section--
(A) In General.--The term "foreign
earned income" with respect to any
individual means the amount received by
such individual from sources within a
foreign country or countries which
constitute earned income attributable to
services performed by such individual
during the period described in
subparagraph (A) or (B) of subsection
(d)(1), whichever is applicable.
(B) Certain Amounts Not Included In
Foreign Earned Income.--The foreign
earned income for an individual shall not
include amounts--
* * * * * * *
(ii) paid by the United
States or an agency thereof
to an employee of the United
States or an agency thereof *
* *
The term "employee" is not defined in the Code; therefore,
common law rules must be applied to determine whether an individual
is an employee. Nationwide Mut. Ins. Co. v. Darden, 503 U.S. 318,
322 (1992); Matthews v. Commissioner, 92 T.C. at 351, 360 (1989),
affd. 907 F.2d 1173 (D.C. Cir. 1990); Simpson v. Commissioner, 64
T.C. 974, 984 (1975). Whether an employer-employee relationship7
7
Sec. 31.3401(c)-1(b), Employment Tax Regs., defines an
(continued...)
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exists is a question of fact. Air Terminal Cab, Inc. v. United
States, 478 F.2d 575, 578 (8th Cir. 1973); Professional & Executive
Leasing, Inc. v. Commissioner, 89 T.C. 225, 232 (1987), affd. 862
F.2d 751 (9th Cir. 1988). If an employer-employee relationship
exists, its characterization by the parties as some other
relationship, such as independent contractor, is of no consequence.
Sec. 31.3121(d)-1(a)(3), Employment Tax Regs.
7
(...continued)
employer-employee relationship as follows:
(b) Generally the relationship of employer
and employee exists when the person for whom
services are performed has the right to
control and direct the individual who
performs the services, not only as to the
result to be accomplished by the work but
also as to the details and means by which
that result is accomplished. That is, an
employee is subject to the will and control
of the employer not only as to what shall be
done but how it shall be done. In this
connection, it is not necessary that the
employer actually direct or control the
manner in which the services are performed;
it is sufficient if he [or she] has the right
to do so. The right to discharge is also an
important factor indicating that the person
possessing that right is an employer. Other
factors characteristic of an employer, but
not necessarily present in every case, are
the furnishing of tools and the furnishing of
a place to work to the individual who
performs the services. In general, if an
individual is subject to the control or
direction of another merely as to the result
to be accomplished by the work and not as to
the means and methods for accomplishing the
result, he [or she] is not an employee.
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This Court has enumerated the following factors8 in
determining whether an employee-employer relationship exists: (1)
The degree of control exercised by the principal over the details
of the work; (2) which party invests in the facilities used in the
work; (3) the opportunity of the individual for profit or loss; (4)
whether the principal has the right to discharge the individual;
(5) whether the work is part of the principal's regular business;
(6) the permanency of the relationship; and (7) the relationship
the parties believe they are creating. Weber v. Commissioner, 103
T.C. 378, 387 (1994), affd. per curiam 60 F.3d 1104 (4th Cir.
1995); Professional & Executive Leasing, Inc. v. Commissioner, 89
T.C. at 232; Simpson v. Commissioner, supra at 984-985; see also
United States v. Silk, 331 U.S. 704, 716 (1947). No single factor
is dispositive. Simpson v. Commissioner, supra at 985. All of the
facts and circumstances must be studied. Professional & Executive
Leasing, Inc. v. Commissioner, supra at 232.
While all of the above factors are important, the "right-to-
control" is the "master test" in determining the nature of a
working relationship. Matthews v. Commissioner, 92 T.C. at 361.
Both the control exercised by the alleged employer and the degree
to which the alleged employer may intervene to impose control must
8
The parties cite Rev. Rul. 87-41, 1987-1 C.B. 296,
which lists 20 factors to consider in determining whether a
common law employer-employee relationship exists. Many of these
factors are incorporated into this Court's seven factors.
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be examined. Radio City Music Hall Corp. v. United States, 135
F.2d 715, 717 (2d Cir. 1943); deTorres v. Commissioner, T.C. Memo.
1993-161. "[N]o actual control need be exercised, as long as the
employer has the right to control." Professional & Executive
Leasing, Inc. v. Commissioner, 862 F.2d at 753. In order for an
employer to retain the requisite control over the details of an
employee's work, the employer need not direct each step taken by
the employee. Professional & Executive Leasing, Inc. v.
Commissioner, 89 T.C. at 234; Gierek v. Commissioner, T.C. Memo.
1993-642. The exact amount of control required to find an
employer-employee relationship varies with different occupations.
United States v. W. M. Webb, Inc., 397 U.S. 179, 192-193 (1970).
In fact, the threshold level of control necessary to find employee
status is in most circumstances lower when applied to professional
services than when applied to nonprofessional services. Azad v.
United States, 388 F.2d 74, 77 (8th Cir. 1968); Professional and
Executive Leasing, Inc. v. Commissioner, supra at 234. "From the
very nature of the services rendered by * * * professionals, it
would be wholly unrealistic to suggest that an employer should
undertake the task of controlling the manner in which the
professional conducts his activities." Azad v. United States,
supra; Weber v. Commissioner, 103 T.C. at 388. An alleged
employer's control "must necessarily be more tenuous and general
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than the control over nonprofessional employees". James v.
Commissioner, 25 T.C. 1296, 1301 (1956).
We begin our analysis of the seven factors enumerated above
with the control factor. The record contains numerous
illustrations of FBO's right to control petitioner and its actual
control over him. Petitioner's contract with FBO during the year
under consideration stated that petitioner "will be directly
responsible to FBO in the performance of his duties under this
contract." While petitioner was permitted to hire and fire his
staff, and order substitutions of materials, FBO did not permit him
to deviate from the construction documents or exceed the budget.
Further, he was required to follow a Project Director's Handbook.
FBO also controlled petitioner by dictating his hours, pay,
and leave. FBO required petitioner to work full time, a minimum of
40 hours a week. Petitioner's biweekly FBO salary was based on
the Foreign Service Schedule. In addition to his salary, FBO
permitted petitioner to earn and accrue home leave, annual leave,
and sick leave.9
Petitioner also was required to maintain a daily log of the
progress of the construction project, and submit both oral and
written reports to FBO. These monthly reports were not optional;
9
While petitioner had to pay for his own health
insurance and did not accrue retirement benefits, we do not
believe such facts preclude a holding that petitioner was an FBO
employee.
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if petitioner failed to submit such reports, FBO had the right to
terminate his contract.
We are satisfied that petitioner was subject to substantial
control by FBO. Although petitioner worked for FBO in a
professional capacity, which would limit the amount of control FBO
had over petitioner's day-to-day activities,10 FBO dictated the
contract documents and drawings, budget, hours, and monthly reports
with which petitioner was required to comply. We therefore
conclude that FBO had the right to exercise control over petitioner
and in fact exerted a substantial amount of control over him. See
James v. Commissioner, supra.
We now turn to the other factors. With respect to the second
factor, petitioner had no investment in the work facilities;
rather, FBO provided petitioner with office space and staff
assistance. See Professional & Executive Leasing v. Commissioner,
89 T.C. at 234. FBO entered into contracts with petitioner's staff
and paid their salaries.
As to the third factor, petitioner had no opportunity for
profit or loss. The pay he received depended only upon the number
10
Petitioner argues that he was not an employee because
he scheduled his own daily activities. We believe that
petitioner's ability to schedule his activities only demonstrates
that in connection with professionals less supervision is
necessary. See Azad v. United States, 388 F.2d 74, 77 (8th Cir.
1968).
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of days he worked. The amount FBO paid petitioner was not
dependent upon completion of the project.
As to the fourth factor, while FBO had the right to discharge
petitioner without cause with a 30-day notice, petitioner also
could terminate the contract.
As to the fifth factor, FBO was in charge of constructing U.S.
Government buildings overseas. Petitioner's assignment in Bogota
during the year under consideration was to oversee the construction
of an annex to the U.S. Embassy. This type of work was clearly
within the scope of FBO's regular business.
As to the sixth factor, we believe that the relationship
between petitioner and FBO was intended to be somewhat permanent as
opposed to transitory. Petitioner had been working solely for FBO
since 1983. He was required to personally perform the services of
project director designated in his contract with FBO. He did not
offer his services to the public and did not perform services for
any individual or entity other than FBO, as would an independent
contractor. See Jacobs v. Commissioner, T.C. Memo. 1993-570;
Casety v. Commissioner, T.C. Memo. 1993-410; Gamal-Eldin v.
Commissioner, T.C. Memo. 1988-150, affd. without published opinion
876 F.2d 896 (9th Cir. 1989).
Finally, as to the seventh factor, the type of relationship
the parties intended to create when they signed various
modifications to petitioner's contract is not clear. However, in
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December 1989, FBO provided petitioner with a Form W-2 and withheld
Social Security tax from petitioner's income. This, in our
opinion, indicates that FBO intended to create an employer-employee
relationship. See, e.g., Juliard v. Commissioner, T.C. Memo. 1991-
230. Further, FBO Policy and Procedures Directives in effect
during the year under consideration provided that a personal
services contractor is not eligible for the foreign earned income
exclusion, and that overseas PSC's treat the contractor as an FBO
government employee for all purposes except retirement. And,
petitioner was advised by the December 12, 1989, FBO memorandum
that he should designate himself as an FBO employee on his 1989
return.
After considering all the facts and circumstances present in
this case, we conclude that petitioner was an FBO employee in 1989.
Therefore, petitioners are not entitled to the foreign earned
income exclusion under section 911(a) for such year.
To reflect the foregoing and respondent's concession,
Decision will be entered
under Rule 155.