T.C. Memo. 2000-176
UNITED STATES TAX COURT
MARCOS ELISEO AND TEODORA C. ESCOBAR DE PAZ, ET AL.,1
Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 19401-98, 2358-99, Filed May 26, 2000.
2743-99.
Marcos Eliseo Escobar de Paz, pro se in docket No. 19401-98.
Jose A. Batres, pro se in docket No. 2358-99.
Agustin Perez, pro se in docket No. 2743-99.
Ric Hulshoff, Gary Slavett, and Jean Song, for respondent.
1
Cases of the following petitioners are consolidated
herewith: Jose A. and Dina Batres, docket No. 2358-99; and
Agustin Perez and Isabel Sanchez, docket No. 2743-99.
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MEMORANDUM OPINION
NAMEROFF, Special Trial Judge: Respondent determined that
petitioners in these consolidated cases are liable for
deficiencies in Federal income tax as follows:
Docket No. Year Amount
19401-98 1996 $22,389
2358-99 1995 2,679
2743-99 1996 3,659
Respondent also determined that petitioners in docket Nos.
19401-98 and 2743-99 were liable for the accuracy-related penalty
under section 6662(a)2 but has now conceded that issue. After
other concessions which will be detailed hereinafter, the issue
to be resolved in these consolidated cases is whether part of the
income earned by petitioner husbands from their trucking activity
can be allocated to a leasing activity. If we hold for
petitioners on this issue, we must then decide whether
petitioners’ method of allocation or some other method is
correct.
Some of the facts have been stipulated and are so found.
The several stipulations of fact and attached exhibits are
incorporated herein by reference. At the time of the filing of
the petitions herein, all petitioners resided in the State of
California.
2
Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the years at issue.
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Marcos Eliseo Escobar de Paz (Mr. Escobar) and Teodora C.
Escobar de Paz filed a joint Federal income tax return for 1996
on which they reported wages of $25,851. The Escobars’ 1996
return did not include a Schedule C, Profit or Loss from
Business, or Schedule E, Supplemental Income or Loss, nor did it
contain any schedule listing expenses. In the notice of
deficiency, respondent determined that the Escobars had received
unreported self-employment income of $64,481 resulting in the
aforesaid deficiency of $22,389. Included therein was self-
employment tax of $9,111, one-half of which was allowed as a
deduction.
During 1996, Mr. Escobar received compensation of $64,481
from Shipper’s Transport Express (Shipper’s Transport) for
transporting shipping containers with his own truck. The amount
of wages reported on line 7 of the 1996 Escobar return reflects a
reduction of the income from Shipper’s Transport of $38,630.
The parties have agreed that Mr. Escobar incurred business
expenses of $28,947 in 1996 for the operation of his truck.
Respondent is no longer contesting the identification of the
income from Shipper’s Transport as wage income and agrees that
the imposition of the self-employment tax (and corresponding
deduction) is erroneous. However, respondent contends that the
entire amount of compensation received from Shipper’s Transport
is reportable as gross wages, and that the Escobars are entitled
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to a deduction on Schedule A, Itemized Deductions, for
unreimbursed employee business expenses of $28,947, subject to
the limitations set forth in section 67(a).
Jose A. Batres (Mr. Batres) and Dina Batres filed their 1995
joint Federal income tax return and reported wage income of
$18,327. Included in the return is a Schedule E for a
“commercial tractor”, on which the Batreses reported rents of
$22,374 and expenses totaling $22,374, resulting in zero income
or loss. In the notice of deficiency, respondent determined that
the Batreses had unreported Schedule C income of $41,5473 and
allowable Schedule C expenses of $22,590. Wage income was
reduced by $18,327. Respondent further determined that
petitioners were liable for self-employment tax of $2,679, and
$1,340 was allowed as a deduction for self-employment taxes. Mr.
and Mrs. Batres have not contested the amount of income
determined by respondent to have been received by Mr. Batres from
his trucking operation. Respondent now does not contest that Mr.
Batres’ income was received as an employee, subject to the
resolution of the lease activity issue, and the Batreses are
entitled to a deduction on Schedule A for unreimbursed business
3
This amount includes additional unreported income that
was not reported as either wages or Schedule E rents on the 1995
return.
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expenses of $22,590, subject to the limitations set forth in
section 67(a).
Agustin Perez (Mr. Perez) and Isabel Sanchez (Ms. Sanchez)
filed their 1996 Federal income tax return and reported wage
income of $29,365. The Perez-Sanchez return includes a Schedule
E which reports rents received (“lease value”) of $42,238, offset
by an equivalent amount of expenses. In the notice of
deficiency, respondent determined that they had gross receipts
for Schedule C of $71,603, allowed Schedule C business expenses
of $42,895, determined further that Mr. Perez was liable for
self-employment tax of $4,056, and allowed a self-employment tax
deduction of $2,028. Again, respondent no longer contests the
classification of employee, concedes the self-employment tax
issues, and agrees that a deduction of $42,895 is allowable on
Schedule A as a miscellaneous itemized deduction, subject to the
section 67(a) limitation.
Each of petitioner husbands herein entered into an agreement
with a trucking company regarding his working relationship. Mr.
Escobar and Shipper’s Transport entered into an agreement
entitled “Owner-Operator Equipment Agreement” on February 10,
1995. In 1995, Mr. Batres entered into a contract with Calko
Transport Co., Inc. (Calko). Mr. Perez, on October 23, 1995,
entered into an agreement entitled “Lease and Subhaul Agreement
with Independent Contractor” with Interstate Consolidation, Inc.,
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(Interstate) as carrier. Shipper’s Transport, Calko, and
Interstate are hereinafter referred to collectively as the
carriers. Messrs. Escobar, Batres, and Perez are collectively
referred to as the owner-operators.
While the specific terms of the three documents vary, the
general tenor is the same. Their purpose is to enable the
carriers to obtain transportation services through the lease of
tractor equipment owned by an independent contractor, said
tractor to be furnished with a qualified driver. Each owner-
operator purports to lease his tractor-truck to the carrier
company. Each owner-operator warrants that the equipment will be
in good condition, that he will place placards on the vehicle
showing that it is operated by the carrier, that he agrees to
operate the vehicle as an independent contractor, and that he
will be responsible for all expenses necessary for the operation
of the equipment. Compensation for the agreements will be paid
by carriers in accordance with a schedule, not included in the
record, but apparently reflecting an industrywide schedule of
tariffs. (The Court understands that the compensation for
transporting the cargo is generally divided 60-40 between the
carrier and the owner-operator for standard size and distance
hauls.) Under these agreements, the carrier assumes liability
for bodily injuries to or the death of any person resulting from
negligent operation, maintenance, or use of the equipment, but
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the cost of this insurance is to be deducted from the
compensation due to the owner-operator. Moreover, the owner-
operator agrees to furnish insurance known as “bob-tail”
insurance, pertaining to the operation of the tractor without a
trailer. The terms of the agreements may be terminated by either
party upon short notice.
Interstate is a trucking company or a freight forwarding
company which transports goods from one point of origin to
another point of origin. The company owns no trucks and
contracts with independent contractors to perform the services.
The operations of Shipper’s Transport are similar.
An owner-operator is a service provider who either owns and
drives his own truck or owns more than one truck and hires other
drivers to drive one or more of them. In order to provide
services to a carrier, an owner-operator must enter into a
written agreement and qualify under various safety provisions
dictated by the carrier, its insurance carrier, and government
regulations. For example, Interstate offers insurance coverage
to owner-operators that it uses. The insurance coverage offered
by Interstate is effective only while the owner-operator is
driving for the company. If an owner-operator is driving his
tractor providing services to another company without the
authorization of Interstate, the insurance provided by the
carrier will not be effective. The trucks belonging to the
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owner-operators are represented to Interstate’s insurance carrier
as leased trucks.
Petitioners contend that the owner-operators were engaged in
two separate activities: (1) Leasing of their trucks to the
carrier companies for a rental which is the equivalent of their
expenses; and (2) providing the service of driving the trucks for
wages. Respondent contends that petitioners engaged in a single
activity; namely, providing transportation of cargo for the
carriers by use of their own vehicle. In this context, we must
determine whether the leases had independent significance so as
to give rise to a separate business activity.
Labels used in formal written documents do not necessarily
control the tax consequences of a given transaction. See Frank
Lyon Co. v. United States, 435 U.S. 561, 573 (1978). This Court
may look to the substance of the transaction in order to
determine the correct tax consequences. It is well established
that the economic substance of a transaction, rather than its
form, controls for Federal tax purposes. See Gregory v.
Helvering, 293 U.S. 465 (1935). Thus the fact that the documents
state that the transactions are leases does not govern, and this
Court must consider the substance of the transactions between the
owner-operators and the carriers. After a careful review of this
record, we conclude that petitioners did not engage in two
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separate activities and that the lease activity had no
independent significance for tax purposes.
A lease is defined as a “contract by which the rightful
possessor of personal property conveys the right to use that
property in exchange for consideration.” Black’s Law Dictionary
898 (7th ed. 1999). In the instant cases, the carriers did not
contract solely to use the owner-operators’ trucks for a
stipulated period of time for consideration. The carriers and
owner-operators agreed to enter into a business relationship for
the purpose of transferring cargo from one point to another using
the latter’s vehicles. The payments for the services provided
were to be based upon published schedules relating to the weight
of the cargo and the distance transferred. Petitioners were not
paid for the use of their vehicles if they did not drive, and
petitioners did not receive wages for driving if they did provide
their own vehicles. As a practical matter, petitioners retained
control of the use of their vehicles at all times and were
responsible for all operating expenses. The carriers never
acquired possession of the vehicles. It is true that each owner-
operator was required to display the carrier’s placard on the
side of his truck while it was being used for that carrier, but
the placard could be removed if the truck was to be used for
other purposes. Moreover, there was no definite lease term.
Petitioners were always free to use their trucks how and for whom
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they wished, provided they removed the placards of any other
company. They could accept or reject loads as they wished. They
could earn as much or as little as wanted because they were free
to use the equipment as much or as little as they wanted.
It is clear from this record that the leases only served the
carriers’ needs to comply with governmental regulations. This
regulatory scheme was put into place to protect the public by
preventing common carriers from evading liability for accidents
caused by the independent drivers. See Zamalloa v. Hart, 31 F.3d
911, 913-914 (9th Cir. 1994); Empire Fire & Marine Ins. Co. v.
Guaranteed Natl. Ins. Co., 868 F.2d 357, 362 (10th Cir. 1989);
see also Prestige Cas. Co. v. Michigan Mut. Ins. Co., 99 F.3d
1340, 1342-1343 (6th Cir. 1996) (I.C.C. regulations that require
every lease entered into by an I.C.C. licensed carrier contain a
clause stating that the authorized carrier maintains “exclusive
possession, control, and use of the equipment for the duration of
the lease” promulgated to curb the abuse of carriers using leased
vehicles to avoid safety regulations and to address public
confusion as to who was financially responsible for the
vehicles); 49 C.F.R. secs. 376.11 and 376.12 (1997).
It is also understandable that the leases served the
practical purpose of ensuring adequate insurance coverage. A
carrier which engages the services of many owner-operators would
have an administrative headache monitoring the adequacy (and
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current existence) of the various insurance policies of the
owner-operators. Therefore, it makes sense to try to cover as
many as possible by blanket policies, under which insurance
companies require that the insured have an ownership interest in
the vehicle, which in turn is satisfied by the lease arrangement.
However, in most if not all cases, the owner-operators pay for
this insurance by having its cost deducted from their hauling
proceeds.
Accordingly, we conclude that for income tax purposes the
lease arrangements with the carriers had no independent economic
significance, all the income the owner-operators received from
the carriers was wage income, and the expenses pertaining to the
operation of the trucks are deductible as itemized deductions on
Schedule A, subject to the limitations of section 67(a).
To reflect the foregoing,
Decisions will be entered
under Rule 155.