Staffing company tax problem

No FUTA exemption for staffing company that was considered the employer for state UI purposes Chief Counsel Advice 200827007

Mike Habib, EA

The IRS has denied a federal unemployment tax (FUTA) exemption to a staffing company because it did not consider the company to be the common law employer of the workers in question

Facts. According to the IRS, the taxpayer conducted its operations in a manner similar to businesses commonly called employee leasing companies or professional employer organizations. The taxpayer offered client businesses multiple employee benefit and payroll services, including withholding, depositing, and reporting of all applicable federal and state employment-related taxes. The taxpayer filed Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, and Form 941, Employer’s Quarterly Federal Tax Return, for all of its clients on an aggregate basis, using its own name and employer identification number.

Law. The FUTA tax under IRC §3301 is imposed on every employer equal to a certain percentage of the wages that it pays with respect to employment. IRC §3306(b) provides that for FUTA purposes, the term “wages” means all remuneration for employment, with certain specified exceptions. IRC §3306(c) defines employment, in relevant part, as any service of whatever nature performed by an employee for the person employing him. Therefore, unless amounts paid are excepted from “wages,” or the services performed are excepted from “employment,” FUTA tax will apply.

In Rev Rul 54-471, 1954-2 CB 348, the IRS stated that the common law relationship of the parties determined whether an employment tax liability exists, even when a third party is involved in the payment of wages. A common law employer/employee relationship exists between an entity and individuals when the entity has the right to direct and control the performance of services by the individuals. Factors considered in determining whether an entity has an employer/employee relationship with workers include the nature and degree of financial and behavioral control that the entity has, and the relationship of the parties, including the relationship the parties believe they are creating.

The taxpayer filed a claim for refund of FUTA taxes, based on its belief that it was eligible for the FUTA exemption under IRC §3306(c). The taxpayer contended that it was the employer of its clients’ workers because it was considered to be the employer for state unemployment tax purposes. The taxpayer’s representative also asserted that the taxpayer was the employer of the workers in question because the taxpayer was the statutory employer of those workers under IRC §3401(d)(1).

Ruling. The IRS denied the taxpayer’s refund claim because there was no evidence that the taxpayer was the common law employer of the workers in question. The IRS said that the facts provided with respect to how the taxpayer initiated its relationship with its clients, the range of businesses conducted by the clients, and the geographic dispersion of the clients, weighed against viewing the taxpayer as the common law employer. The IRS noted that: (1) the client company continued to control the daily performance of its workers’ duties, and (2) the taxpayer did not provide employees with any specific instructions as to when, where, or how the work would be performed.

The IRS said that the fact that the taxpayer was considered the employer of the workers for state unemployment tax purposes had no effect on the determination of who was the employer of the workers for FUTA purposes. Similarly, the IRS ruling would not change even if the taxpayer was considered the statutory employer of the workers in question. FUTA liability, including the exception from FUTA provided under IRC §3306(c), is determined based on who is the common law employer.