Division III: Improper Association Agreement Leads to Back Employment Tax Payment
A doctor had been operating as a sole proprietorship. He associated with two other doctors, but neither one joined as a partner. Rather, they were paid out of 1099s, billed through the office, and were otherwise treated as employees. The Employment Security Department held that the evidence supported the finding the doctors were employee and not partners:
Ms. Hughes' review revealed (1) the dental practice was registered as a sole proprietorship with both the Department and the Washington Department of Revenue, (2) Dr. Armand listed the dental practice on his tax returns as a sole proprietorship, and (3) payments made to Drs. Loretta and Louise were reported as miscellaneous income on Internal I Revenue Service (IRS) Form 1099s. She concluded Drs. Loretta and Louise were employees of the dental practice and unemployment insurance taxes should have been 1 paid. The Department issued Dr. Armand an order and notice of assessment requiring him to pay $1,896.37 in back taxes, penalties, and interest. Dr. Armand first administratively appealed.
The Court of Appeals agreed with the auditor (and the administrative law judge who adopted the auditor's findings. The doctor believed that because the associated doctors were paid a portion of the profits, that meant they weren't employees. However, employees can be paid a portion of profits and still not be partners. Rather, you need an agreement to share not just in the good years, but in the bad years, absorbing any losses. It didn't help the doctor's case that his association agreement with the two other doctors explicitly stated they were not partners. As such, they were employees receiving a portion of the profit, and employment security taxes should have been paid.
When forming a business, or bringing new people into a business, it is important to divide responsibilities and ensure that the partnership is structured to maximum tax advantage, to ensure not only the best outcomes for all involved, but to also avoid pitfalls associates with mistakes. Allow Issaquah Law Group to help you with any formation or expansion of your business.