                                                                        FILED
                                                            United States Court of Appeals
                                                                    Tenth Circuit
                   UNITED STATES COURT OF APPEALS August 24, 2011

                                TENTH CIRCUIT                   Elisabeth A. Shumaker
                                                                    Clerk of Court


 MILO L. SHELLITO; SHARLYN K.
 SHELLITO,

              Petitioners - Appellants,                  No. 10-9002
                                                   (United States Tax Court)
 v.                                                  (T.C. No. 102223-06)

 COMMISSIONER OF INTERNAL
 REVENUE,

              Respondent - Appellee.


                           ORDER AND JUDGMENT *


Before PORFILIO, ANDERSON, and O’BRIEN, Circuit Judges.




      After examining the briefs and appellate record, this panel has determined

unanimously that oral argument would not materially assist in the determination

of this appeal. See Fed. R. App. P. 34(a)(2); 10th Cir. R. 34.1(G). The case is

therefore ordered submitted without oral argument.




      *
        This order and judgment is not binding precedent except under the
doctrines of law of the case, res judicata, and collateral estoppel. It may be cited,
however, for its persuasive value consistent with Fed. R. App. P. 32.1 and 10th
Cir. R. 32.1.
      Milo and Sharlyn Shellito, husband and wife, appeal a decision by the

United States Tax Court upholding income tax deficiencies of $3,995 and $6,947,

respectively, for the years 2001 and 2002. During those years the Shellitos fully

deducted their family medical expenses not covered by insurance, plus insurance

premiums, by claiming such amounts on Schedule F (Profit or Loss from

Farming) of their joint Form 1040 Income Tax return as an ordinary business

expense for an employee benefit program. The business expense was justified by

designating Mrs. Shellito as her husband’s employee for the work she did on their

farm, then, pursuant to a medical reimbursement plan for employees, reimbursing

her for the payment of out-of-pocket medical expenses and premiums for the

entire family, including her employer-husband.

      The question for business expense deduction purposes is whether Mrs.

Shellito was a bona fide employee receiving compensation for her services. The

Tax Court held she was not a bona fide employee because, among other things,

her purported compensation as an employee was illusory. For the reasons stated

below, we vacate the decision of the Tax Court and remand the case for further

consideration.



                                BACKGROUND

      Mr. and Mrs. Shellito reside on a farm in Kansas. The farming operation

conducted there consists of approximately 2300 acres of leased and 47 acres of

                                        -2-
deeded land used to raise around 200 head of cattle and grow wheat, milo, corn

and soybeans. Mr. Shellito commenced farming in 1978, and was joined by Mrs.

Shellito in 1982. Mr. Shellito testified at trial that the farm was always his and

was so regarded by other farmers in the area. In other words, he did not regard

Mrs. Shellito as having a proprietary interest in the farm.

      In that connection Mr. Shellito testified that he owned all the numerous

pieces of equipment used in the farm operation, including the combines and

tractors, as evidenced by bills of sale in his name, and his leased land was solely

in his name. For example, in 1990 he leased, in his own name, approximately

1400 acres of land, plus 80 head of cattle, and numerous pieces of farm

equipment (five tractors, one combine, two discs, two hoe drills with trailer, one

cultivator, one planter, one plow, two V-blades, one grinder, one auger, two

swathers, one baler, two trucks and two trailers) from his father, and that lease

was renewed through and including the years in question in this case, 2001 and

2002. Stip. of Facts, ¶ 7; Ex. 13-J. He also testified that he made all the

decisions regarding the farm operation, including expansion and equipment

acquisition, and that he directed his wife in the work she did on the farm. The

Shellitos filed joint form 1040 income tax returns for 2001 and 2002, together

with Schedule F “Profit and Loss From Farming” forms reporting all farm income

and expenses and listing Mr. Shellito as the sole proprietor.




                                         -3-
      Mrs. Shellito has worked on the farm continuously since approximately

1982, putting in about 40 hours per week on average. Among her other duties she

has assisted with planting and harvesting crops, including the operation of tractors

and equipment, feeding and caring for the large cattle herd, building and repairing

fences, maintaining and performing basic repairs of equipment, running necessary

farm errands, handling the farm records and books, and performing all the other

tasks relating to the farm. She testified that this work was done for her husband,

that he made all the business and operating decisions and did so without her input

or consent, that he directed her in her work including means, methods and what

was to be accomplished, that the equipment she used belonged to him, and that

she did not regard herself as a business partner. On their joint income tax returns

for 2001 and 2002 she listed her occupation as housewife.

      Prior to and during 2001-02, the Shellitos handled their business and

personal income and expenses through a single, joint checking account on which

both of them wrote checks. They also financed the farming operations with

multiple loans from the Smith County State Bank and Trust Company on

promissory notes signed by both Mr. and Mrs. Shellito (one was signed by Mrs.

Shellito alone). Mr. Shellito acknowledged that the loans would not have been

granted without Mrs. Shellito’s signature, and that the farming business would

have been impossible without the loans. The only real property owned by the

Shellitos, 47 acres, is, according to Mr. Shellito, held in joint tenancy, Aplt. App.

                                          -4-
at 263, and Mrs. Shellito has an ownership interest in three pick-up trucks used in

the farming operations. Additionally, the Shellitos were both named on insurance

policies covering the farm and its equipment.

      In 2001, the Shellitos, on the advice of their accountant, recast their

business structure to take advantage of the tax deduction businesses could take by

having a medical reimbursement plan for employees. 1 For this purpose they

purchased a commercially marketed package for family farmers, the

AgriPlan/BizPlan 2, which provided a preprinted medical reimbursement plan,

application, year-end administrative services relative to amounts allowed as a

deduction under the plan, and advice for implementation.

      To implement this arrangement the Shellitos signed a brief employment

agreement prepared by their accountant, dated May 29, 2001. The agreement



      1
       During 2001, a taxpayer who was self-employed was permitted to deduct
only 60% of the cost of health insurance premiums paid for himself, his spouse,
and his family. I.R.C. § 162(l)(1). That percentage increased to 70% in 2002,
and 100% for years 2003 and after. Id. Also in 2001 and 2002 (and continuing to
the present), any unreimbursed medical expenses that a taxpayer paid out of
pocket could only be deducted to the extent that they exceeded 7.5% of the
taxpayer’s adjusted gross income. Id. § 213(a). Amounts paid to an employee
pursuant to a healthcare reimbursement plan, however, were fully deductible as a
business expense. Id. § 162(a)(1); Treas. Reg. § 1.162-10(a).
      2
       For the years in issue AgriPlan (for small farms) and BizPlan (for small
businesses) were divisions of Total Administrative Services Corporation. Aplt.
App. at 54. Although it would seem on the surface that only the AgriPlan was
adopted here, the combined references, AgriPlan/BizPlan or AgriPlan/BIZPLAN,
are commonly used, and no information contained in the record sheds further light
on the subject.

                                         -5-
declared that Mr. Shellito was employing his wife as a hired hand to do farm

work he directed her to do; but it did not specify either hours or compensation.

Aplt. App. at 318. Mrs. Shellito concurrently opened an individual checking

account from which she commenced thereafter to pay the family’s (including her

employer-husband’s) medical bills not covered by insurance, as well as insurance

premiums. 3 Mr. Shellito paid her $100 per month as wages as well as reimbursing

her for the payment of medical bills and expenses out of her account. He made

these payments to her by checks signed by him, on their joint checking account,

for deposit into her individual account.

      Mrs. Shellito kept a daily log of her hours spent in farm work, although not

specifying what work was done. The log totals showed 1,169 hours worked after

May 29, in 2001, and 2,226 hours in 2002. In addition, the couple kept accurate

tax records reflecting this arrangement, deducting and reporting payroll taxes on

the $100/monthly wages and issuing W-2's. Thus, they reported wages ($700 plus

$54 in employment taxes in 2001, and $1200 plus $92 in employment taxes in

2002) as income on their joint income tax returns—offset by like amounts ($700

and $1200) taken as expenses for labor hired on Schedule F. Finally, the couple

transmitted annually to AgriPlan/BizPlan detailed year-end accountings of



      3
       Some out-of-pocket medical bills and some insurance premiums continued
to be paid out of the couple’s joint checking account, but, as with other
discrepancies throughout this case, we do not pursue the point because our
decision is not affected by those facts.

                                           -6-
amounts claimed for medical expense and insurance premium reimbursements,

and they received back a year-end report indicating the total allowable benefit

amount which they then reported as a business expense deduction for “Employee

benefit programs” on Schedule F attached to their Form 1040 for each year. The

amount of that deduction for 2001 was $15,593; for 2002, it was $20,897.

      The Commissioner issued a notice of deficiency to the Shellitos with

respect to their 2001 and 2002 tax liabilities disallowing the foregoing amounts as

business expense deductions. After various adjustments, the resulting deficiency

in taxes amounted to $3,995 for 2001 and $6,947 for 2002. 4 The Commissioner

also imposed an accuracy-related penalty under I.R.C. § 6662(a) in the amount of

$1,389 for 2002. Following a trial, the Tax Court upheld the Commissioner’s

determination as to the employee benefit plan deductions, but found for the

taxpayers on the proposed penalty. The Commissioner does not appeal that

ruling.




      4
       The Shellitos agreed to $7,847 in adjustments for 2001, leaving $7,057 in
issue before the Tax Court for that year. The Commissioner, contrary to his
position on other amounts, allowed a deduction of $689 in both 2001 and 2002 for
insurance premiums paid for a health insurance policy in Mrs. Shellito’s name,
and allowed the deductions for wages. And the Commissioner allowed $2,898
and $3,646, respectively, as deductions for health insurance pursuant to I.R.C.
§ 162(l). There are various discrepancies in the figures throughout the case.
They are not material to our decision.

                                        -7-
                                   DISCUSSION

      The Tax Court held that Mrs. Shellito was not her husband’s employee

because she was not compensated. The court reasoned that Mrs. Shellito obtained

no economic benefit from funds paid into her individual account from the

couple’s joint checking account due to the fact that she is presumed to be an equal

owner in the funds in that account. And, further, that her payment of medical

expenses from her individual checking account was simply an assumption of her

husband’s liability under state law for the family’s medical expenses.

Accordingly, the court concluded that the form of the transactions in question did

not reflect their substance and did not give rise to a true employment relationship.

As additional support for its conclusion, the court pointed to the fact that

Mrs. Shellito had done the same farm work for nineteen years without

compensation. The Shellitos argue on appeal that the Tax Court failed to

undertake a common law agency analysis to determine whether an employer-

employee relationship existed, and erred in its “no compensation” reasoning.



                                         A.

      “We review the Tax Court’s factual findings under the clearly erroneous

standard and review its legal conclusions de novo.” Wheeler v. Comm’r., 521

F.3d 1289, 1291 (10th Cir. 2008) (further quotation omitted). Whether a person

is an employee is a question of fact which we review for clear error. See Marvel


                                         -8-
v. United States, 719 F.2d 1507, 1515 (10th Cir. 1983); Hockett v. Sun Co., Inc.

(R&M), 109 F.3d 1515, 1525-26 (10th Cir. 1997); Weber v. Comm’r., 60 F.3d

1104, 1110 (4th Cir. 1995). But, we review de novo the standards and tests

governing the factual analysis, and the application of the law to the facts.

Whether the form over substance, economic substance, or similar doctrines apply,

is a mixed question of fact and law; but the ultimate determination that such a

doctrine applies is a matter of law which we review de novo. Sala v. United

States, 613 F.3d 1249, 1252 (10th Cir. 2010). See Frank Lyon Co. v. United

States, 435 U.S. 561, 581 n.16 (1978) (“The general characterization of a

transaction for tax purposes is a question of law . . . .”); Keeler v. Comm’r., 243

F.3d 1212, 1217 (10th Cir. 2001) (noting that the ultimate determination of

whether a transaction lacks economic substance is a question of law.); James v.

Comm’r., 899 F.2d 905, 909 (10th Cir. 1990) (“[W]e review de novo the ultimate

characterization of the transactions as shams.”) 5




      5
        But see Nicole Rose Corp. v. Comm’r., 320 F.3d 282, 284 (2d Cir. 2003)
(treating the ultimate determination of whether a transaction lacks economic
substance as a question of fact); and Yosha v. Comm’r., 861 F.2d 494, 499 (7th
Cir. 1988) (“The question whether a particular transaction has economic
substance, like other questions concerning the application of a legal standard to
transactions or events, is governed by the clearly erroneous standard.”).

                                          -9-
                                          B.

      Business expense deductions for medical reimbursement payments to an

employee are governed by § 162(a) and (a)(1) of the Internal Revenue Code and

accompanying treasury regulations. They provide as follows:

      162. Trade or business expenses

      (a) In general. — There shall be allowed as a deduction all the
      ordinary and necessary expenses paid or incurred during the taxable
      year in carrying on any trade or business, including —
             (1) a reasonable allowance for salaries or other
             compensation for personal services actually rendered;

I.R.C. § 162(a)(1). As the language of the statute indicates, “[t]he test of

deductibility in the case of compensation payments is whether they are reasonable

and are in fact payments purely for services.” Treas. Reg. § 1.162-7 (emphasis

added).

      The regulations provide that “[a]mounts paid or accrued within the taxable

year for. . . a sickness, accident, hospitalization, medical expense . . . or similar

benefit plan, are deductible under section 162(a) if they are ordinary and

necessary expenses of the trade or business.” Treas. Reg. § 1.162-10(a). 6



      6
        In addition to the employer being able to deduct such benefit plan
payments, they are not includable in the taxable income of the employee.
Specifically, employer provided insurance coverage is not included pursuant to
I.R.C. § 106(a), and amounts paid directly or indirectly to the employee as
reimbursement for expenses incurred by the employee for his or her care or the
care of the employee’s spouse or dependents, are not includable pursuant to
I.R.C. § 105(b). The exclusion from income of the amounts here in question is
not in issue.

                                          -10-
      The application of those provisions to farming and other small business

sole proprietorships where one spouse is employed by the other in a bona fide

employment relationship has long been acknowledged by the Internal Revenue

Service. Thus, Rev. Rul. 71-588, 1971-2 C.B. 91 (1971) provides as follows: 7

      Amounts reimbursed under an accident and health plan covering all
      bona fide employees, including the owner’s wife, and their families
      are not includable in the employee’s gross income and are deductible
      by the owner as business expenses.

      The taxpayer operated a business as a sole proprietorship with
      several bona fide fulltime employees including his wife. The
      taxpayer had an accident and health plan covering all employees and
      their families. During 1970 two employees, including the wife,
      incurred expenses for medical care for themselves, their spouses, and
      their children, and were reimbursed pursuant to the plan. The
      reimbursed amounts qualified both as amounts received under an
      accident or health plan for employees within the meaning of section
      105(e) of the Internal Revenue Code of 1954 and as amounts
      described in section 105(b) of the Code.

      Held, the reimbursed amounts received by the employees are not
      includable in their gross income pursuant to section 105(b) of the
      Code and these amounts are deductible by the taxpayer as a business
      expense under section 162(a) of the Code.

Id. (emphasis added). 8


      7
        While revenue rulings are not binding on either the Tax Court or this
court, we are entitled to give them consideration and “the public generally has the
right to rely on positions taken by the Commissioner in revenue rulings,” Alumax
Inc. v. Comm’r., 109 T.C. 133, 163 n.12 (1997), aff’d, 165 F.3d 822 (11th Cir.
1999); Pub. Emps. Ret. Bd. v. Shalala, 153 F.3d 1160, 1163 (10th Cir. 1998).
      8
       Some have attempted to distinguish Rev. Rul. 71-588 from cases like the
one before us on the ground that two employees in addition to the employee-
spouse were included in the benefit plan. See, e.g., Eyler v. Comm’r., T.C.M.
                                                                    (continued...)

                                       -11-
      Pursuant to the Commissioner’s ruling, arrangements such as the one before

us have been widely marketed by tax professionals and organizations providing

business management, forms, tips and related matters, leading, inevitably, to

challenges by the Commissioner and cases in the Tax Court. There are six

decisions out of the Tax Court directly relevant to this case. All involve spouse

employees and medical benefit plans, and business expense deductions on either

Schedule F or Schedule C. Indeed, four of the decisions involve

AgriPlan/BizPlan tax benefit packages identical to the one before us. And, three

of the decisions involve sole proprietor farming operations. While such cases are,

admittedly, governed by the “facts and circumstances” principle, and are

Memorandum Opinions, the positions taken by the Commissioner in those cases

are enlightening. The point here is that not one of those cases materially assists

the Commissioner’s position, adopted by the Tax Court, in this case.

      Frahm v. Comm’r., T.C.M. 2007-351, 2007 WL 4179352 (Nov. 27, 2007),

is directly on point. That case involved a sole proprietorship farming business in

which the husband employed his wife using an AgriPlan/BizPlan tax package, and

reimbursed her for amounts paid for the cost of health insurance premiums,



      8
       (...continued)
2007-350, 2007 WL 4179355, at *3 n.14 (Nov. 27, 2007). We do not see the
ruling as being dependent on the number of employees included in the benefit
plan, and no pronouncement from the Internal Revenue Service has indicated
otherwise. To the contrary, the ruling has been widely applied to single
employee-spouse situations.

                                        -12-
deducting those amounts on Schedule F as payments pursuant to a benefit plan.

Mrs. Frahm, the only employee, did farm work similar to that performed by Mrs.

Shellito, and had apparently done so for years prior to the years in which she was

designated as an employee. The funds in question were drawn on the couple’s

joint checking account by way of checks issued by Mr. Frahm to Mrs. Frahm.

The health insurance premiums were largely paid by Mrs. Frahm from her

individual checking account. Some were paid from the joint checking account.

      Significantly, the Commissioner conceded that Mrs. Frahm was

Mr. Frahm’s employee for purposes of the health plan reimbursement deduction,

did not dispute the bona fides of payments originating from the couple’s joint

checking account, or funds flowing thereafter from that account into Mrs.

Frahm’s individual checking account, and did not even attempt to dispute the

deductibility of the noninsurance medical expenses paid by Mrs. Frahm. Id. at

*7-8, n.25. He did dispute payments made indirectly by Mr. Frahm. The Tax

Court ruled in favor of the Frahms. The Commissioner’s concessions in Frahm,

and the Tax Court’s ruling, are irreconcilable with the case before us.

      Speltz v. Comm’r., T.C. Summ. Op. 2006-25, 2006 WL 334296 (Feb. 14,

2006), upheld the deductibility of healthcare reimbursement payments to a

husband-employee who worked part time in his wife’s day care business

conducted in their home. In reaching its decision in that case, the Tax Court

applied a common law agency test to determine whether an employer-employee


                                        -13-
relationship existed, and it placed the burden on the Commissioner to prove that

the husband was not a bona fide employee. Significantly, the court emphasized

that the taxpayers had substantiated the services provided, including keeping

records with respect to the hours spent in performing those services. Speltz is

significant also for the fact that the only compensation paid to Mr. Speltz was the

medical reimbursement benefit. There was no dispute that such a benefit

constituted compensation, and the court found it to be a reasonable amount.

      In the case before us, there is evidence of similarly careful recordkeeping.

And, Mrs. Shellito was paid in two ways: a wage of $100 per month plus (as in

Speltz) substantial medical reimbursement benefits amounting to more than

$20,000 in 2002. The Commissioner does not seriously dispute Mrs. Shellito’s

total claimed compensation package as being adequate in the farm work market

for the work performed.

      Francis v. Comm’r., T.C.M. 2007-33, 2007 WL 424601 (Feb. 8, 2007),

likewise involved a sole proprietorship farm, with an employee spouse, and the

adoption of an AgriPlan/BizPlan package. In Francis, the Commissioner did

question the spouse’s status as an employee, referring to her uncompensated

services for many years prior to executing an employment agreement. But the

Commissioner did not invoke the sham transaction, substance over form,

economic substance or compensation theories. Rather, the Commissioner’s

primary argument was that no evidence existed showing that Mrs. Francis actually


                                        -14-
did the work claimed. For instance, she failed to document the number of hours

worked. The Tax Court agreed with that argument and found it unnecessary to

decide whether Mrs. Francis was a bona fide employee. Such an approach is

inconsistent with the Commissioner’s central approach in this case and

inconsistent with the facts, since in the case before us, Mrs. Shellito, in fact,

documented her hours and testified without any serious challenge with respect to

her services.

      Albers v. Comm’r., T.C.M. 2007-144, 2007 WL 1649090 (June 7, 2007),

likewise involved a sole proprietorship farm, wife-employee, AgriPlan/BizPlan

package, and claimed medical expense reimbursement deductions on Schedule F.

The Commissioner did not challenge the bona fides of the employment agreement,

benefit plan, or other matters adopted pursuant to the AgriPlan/BizPlan; nor did

he seek to pursue a substance over form or economic substance theory, or any

position with respect to the fact that a joint checking account was involved.

Rather, the Commissioner’s position was a straightforward challenge to the

payment or reimbursement of anything by or on behalf of Mrs. Albers with

respect to healthcare expenses. The Tax Court held that there was no credible

evidence that Mr. Albers paid anything at all, directly or indirectly, to Mrs.

Albers pursuant to the medical reimbursement plan. The arguments advanced by

the Commissioner in the case before us were not advanced in Albers, and the

evidence clearly establishes the payment by Mrs. Shellito in the case before us of


                                          -15-
the health-related expenses in question, and her reimbursement for those

payments.

      Snorek v. Comm’r., T.C.M. 2007-34, 2007 WL 424536 (Feb. 8, 2007),

likewise involved an AgriPlan/BizPlan health insurance and unreimbursed health

expense deduction package; but the business involved was a sole proprietorship

upholstery business, and the claimed medical expense reimbursements were listed

on Schedule C (Profit or Loss from Business). As in Albers, and other cases, the

Commissioner did not attack the claimed spousal employment arrangement (there

involving a husband-employee) on substance over form or sham transaction, or

similar grounds, nor did the Commissioner attempt to trace funds back to a joint

checking account, or trace the history of the claimed spousal involvement in the

business. Rather, the claim was simply that the taxpayers did not produce

evidence that Mr. Snorek paid anything or was reimbursed for anything. The Tax

Court noted: “Petitioners did not, for example, introduce receipts or canceled

checks showing that Mr. Snorek paid the health insurance premiums for Mrs.

Snorek. Petitioners also did not introduce the premium statement or policy itself,

which may have identified the party responsible for making the premium

payments for the insured.” Id. at *2. Unlike Snorek, the record before us

abounds with documentary evidence and proof of billing and payments which,

according to the implication arising from the reasoning in Snorek, would lead to a

decision for the taxpayers in the instant case.


                                         -16-
      Finally, in Haeder v. Comm’r, T.C.M. 2001-7, 2001 WL 40100 (Jan. 17,

2001), the Tax Court upheld a disallowance of business expense deductions for

medical benefit reimbursements from the taxpayer to his wife on the ground that

she not only did not perform any work in the taxpayer’s business, but that the

taxpayer did not have any business. Furthermore, the Tax Court relied on the fact

that no W-2 was issued, no payments were made directly to the purported

employee-wife and there was no documentation of either the work purportedly

performed or the time spent performing services, implying, apparently, a

favorable outcome for the taxpayer where there is proof of such matters. Such is

the case before us.

      We have discussed the relevant cases in some detail because it is important

to show the inconsistencies in the Commissioner’s overall position in these cases,

as well as the fact that the Shellitos’ case, on its face, is benefitted by the decided

cases, and is not harmed by the Commissioner’s position taken in any of them. 9

Furthermore, the cases highlight the fact that in tax law form often merges with

      9
       The government contends that our case of Folsom v. O’Neal, 250 F.2d 946
(10th Cir. 1957), supports their position. Aple’s Br. at 31. We disagree. Folsom
involved an attempt by an individual to qualify for Social Security payments. The
Bureau of Old-Age and Survivors Insurance, Social Security Administration
determined that the claim was not well founded because the applicant had not
demonstrated that he had been employed. After further proceedings, the case
made its way to this court, where we emphasized that “[t]he nature and extent of
judicial review in a proceeding of this kind is limited in scope,” id. at 947, and
under that standard, upheld the agency’s decision. Furthermore, our decision was
both brief and lacking in any developed reasoning with respect to the issue
presented. Under these circumstances, Folsom is of little benefit here.

                                          -17-
substance by way of requirements for documentation and proof of a specific

structure (e.g., employment agreement, documentation of hours worked, a written

plan with a third-party administrator, testimony as to work performed, canceled

checks showing payment by the husband to the wife, separate bank accounts,

documented payments by the wife out of her account for medical expense

purposes, and so on).



                                         C.

      Faced in the case before us with the fact that the Shellitos crossed all of the

T’s and dotted all of the I’s with respect to an employment relationship, the

Commissioner has retrenched, arguing, really for the first time in these cases, that

Mrs. Shellito’s claimed compensation was illusory because (1) her payment of

medical expenses simply relieved Mr. Shellito of his obligation under Kansas law

to pay for her medical expenses (the doctrine of necessaries); (2) she obtained no

economic benefit from checks written to her by her husband out of their joint

checking account in which she was presumed to have an equal ownership interest;

and, in effect, that medical expenses were still being paid out of the Shellitos’

joint checking account even though the funds passed through Mrs. Shellito’s

individual account; and reasoning from these propositions that, as the Tax Court

stated: “We conclude that Mrs. Shellito received no remuneration under the

purported employment arrangement and consequently during the years at issue, as


                                        -18-
in the preceding years, there was no bona fide employment relationship.” Shellito

v. Comm’r., T.C.M. 2010-41, 2010 WL 727985, at *6 (Mar. 3, 2010). Then,

leveraging that conclusion, the court stated that there being no bona fide

employment relationship, the Shellitos’ employment agreement failed for lack of

economic substance. Id. (“the purported employment agreement was a mere

formality.”)



                                         1.

      It was error for the district court to rely on the Kansas doctrine of

necessaries. The Kansas doctrine of necessaries applies equally to husbands and

wives and imposes upon each a duty to provide for the other’s necessities,

including medical services. See St. Francis Reg’l Med. Ctr., Inc. v. Bowles, 836

P.2d 1123, 1125-28 (Kan. 1992). Thus, the duty only comes into force to the

extent that one of the spouses is unable to provide for themselves. Here,

Mrs. Shellito’s argument is that, by way of compensation received from her

alleged employment by her husband’s farming business, Mrs. Shellito was able to

provide for her own medical services.

      It is puzzling that the Commissioner would even attempt to advance the

argument that Mrs. Shellito’s payments should be disregarded because they

convert a legal support obligation into a deductible expense. That position has

not been adopted by the Commissioner since it would punish a taxpayer for


                                        -19-
employing a spouse or family member. Revenue Ruling 71-588, 1971-2 C.B. 91,

1971 WL 26635 (1971), and Rev. Rul. 59-110, 1959-1 C.B. 45, 1959 WL 12187

(1959) (Employee-Dependent), were both based on determinations that an

obligation to support does not preclude favored tax treatment in their respective

situations. And, although Rev. Rul. 59-110 was superseded by Rev. Rul. 73-393,

1973-2 C.B. 33, 1973 WL 33072, the general conclusion has remained the same:

“[F]or wages paid to the child for services actually performed, the fact that there

may be a legal obligation to support the child is not determinative of the

deductibility of such wages as a business expense.” Id. The same reasoning

applies to a spouse.

      The proposition that the deductibility of medical reimbursement payments

depends on whether or not medical expenses might be paid from another source,

even if that source has an obligation to pay, is also not supported by any case law,

and it would result in inconsistent treatment of benefit plans and a disincentive to

employers to provide benefits. Based on the Service’s own prior

pronouncements, it would be surprising if the Commissioner now endorses the

“support obligation” argument as a litigating position in these types of cases.

Accordingly, in analyzing whether Mrs. Shellito received compensation, any

obligation arising from the Kansas common law doctrine of necessaries must be

excluded.




                                         -20-
                                         2.

      Likewise, the Tax Court’s disqualification of any amounts received by

Mrs. Shellito as compensation because they originated from the couple’s joint

checking account, is flawed. If the use of a single joint account disqualifies

spousal employment, it is strange that this threshold bar has not been used in the

decided cases. Significantly, none of the cases referred to above relied on the

existence and use of joint checking accounts, as such, as a disqualifying factor.

Whether the joint account-compensation disqualifier appears in the I.R.S. audit

guides, internal memoranda or other materials is at least problematic if for no

other reason than its omission from Rev. Rul. 71-588, as well as the case law.

Furthermore, a separate account requirement would simply invite another

structural layer: here, a separate account for the business of the farm, from which

funds would simply be transferred to the general joint account and/or to Mrs.

Shellito’s separate account (plus, the business account would probably be in joint

tenancy anyway because the business relied on Mrs. Shellito to do the

bookkeeping).

      Finally, the argument that Mrs. Shellito owned half of the funds in the joint

checking account does not withstand scrutiny in any event. First, it does not

address the purported other half of payments she would have received (hard to do

since the funds are fungible). More to the point, this argument is based on an

improper implicit finding that there was no proof presented to suggest that the


                                        -21-
Shellitos did not equally own the funds in their joint checking account. As the

Shellitos point out, the Kansas Supreme Court has held that "the presumption of

equal ownership can be rebutted with evidence regarding the owner's relative

contribution to the asset and donative intent." Brewer v. Schalansky, 102 P.3d

1145, 1150 (Kan. 2004). There is evidence in the record to rebut the presumption

of equal ownership. Mr. Shellito testified that the joint account was the account

that was his business account, used for all the business income and expenses, and

that it was a joint account because the bank required Mrs. Shellito's name to be on

it as well. Aplt. App. at 265. The inequality of contributions to the account is

readily apparent from the fact that the family's income came from the sole-

proprietorship farming business.

      In addition, the argument that Mrs. Shellito received no economic benefit

because her financial position with a separate account was the same as without it

ignores the reality of spousal employment. Combined gross income would

obviously not change. Employment of a spouse in a small business is done to

avoid decreasing the couple’s income, which would result from paying an

unrelated hired hand. And, to narrow these kinds of cases to situations where the

employed spouse is setting up a completely separate asset portfolio with her

separate account does not find a supporting requirement in the reported cases.




                                        -22-
                                         3.

      The Tax Court also invoked the substance over form doctrine, citing True

v. United States, 190 F.3d 1165 (10th Cir. 1999). However, the court’s reliance

on that doctrine was based largely on its finding that Mrs. Shellito did not receive

any compensation—a subject we have addressed above. While the court’s

reasoning also included the fact that Mrs. Shellito worked for no compensation

prior to 2001-2002, the substance over form principle cannot support the Tax

Court’s conclusion as its decision now stands. On remand, the Tax Court is not

required to refrain from the use of doctrines such as substance over form,

economic substance, and so forth, to decide this case, provided the doctrine

selected is appropriate for the purpose, and supported by the record. See Rogers

v. United States, 281 F.3d 1108, 1113-19 (10th Cir. 2002) (discussing these

various doctrines). In this regard, however, it is important to note that the

Commissioner did not invoke such a doctrine in any of the cases discussed above.

Why such an approach should be adopted now is problematic.



                                         D.

      For the reasons we have stated, we are compelled to remand this case to the

Tax Court for further consideration. On remand, the Tax Court should begin its

analysis of whether or not Mrs. Shellito was a bona fide employee by applying the

common law agency doctrine. See generally Zinn v. McKune, 143 F.3d 1353,


                                        -23-
1357 (10th Cir. 1998) (the definition of employee “should be fleshed out by

applying common-law agency principles to the facts and circumstances

surrounding the working relationship of the parties” (Title VII case)); Nationwide

Mut. Ins. Co. v. Darden, 503 U.S. 318, 322-27 (1992) (differentiating between

employee and independent contractor); Clackamas Gastroenterology Assoc., P.C.

v. Wells, 538 U.S. 440, 452 (distinguishing between employee and partner,

shareholder, and director); Marvel, 719 F.2d at 1514 (determining whether an

individual is an employee for federal employment tax purposes); Hockett, 109

F.3d at 1526; Speltz, 2006 WL 334296, at*5-6 (determination of spouse as

employee); Herr v. Heiman, 75 F.3d 1509 (10th Cir. 1996); Carter v. Central

States, Southeast and Southwest Areas Pension Plan, 656 F.2d 575 (10 th Cir.

1981) (pension plan); Rev. Rul. 87-41, 1987-1 D.B. 296, 1987 WL 419174

(1987); Treas. Reg. §§ 31.3121(d)-1, 31.3306(i)-1, and 31-3401(c)-1; Restatement

(Second) of Agency, §§ 220(1) and (2). 10




      10
         The Commissioner argues, and the Tax Court found, that the common-law
tests relating to employment do not apply because Mrs. Shellito was not
compensated and therefore she was not employed at all, citing O’Connor v. Davis,
126 F.3d 112 (2d Cir. 1997), Graves v. Women’s Professional Rodeo Ass’n, Inc.,
907 F.2d 71 (8th Cir. 1990), and McGuinness v. Univ. of N.M. Sch. of Med., 170
F.3d 974 (10th Cir. 1998). Those cases hold that the receipt of compensation by
the putative employee is an essential condition to the existence of an employer-
employee relationship. However, that proposition begs the question here. In the
three cases cited, it was a given that no compensation was paid. Here, the
question of compensation is a central issue. The resolution of that question in
favor of the Shellitos renders the three cited cases irrelevant.

                                       -24-
      The touchstone is whether the person for whom the services are performed

has the right to direct and control the means and manner in which the work shall

be done and the result to be accomplished. However, the common law test for

describing the conventional master-servant relationship contains no shorthand

formula or magic phrase that can be applied to find the answer. All of the

incidents of the relationship must be assessed and weighed with no one factor

being decisive. See Nationwide, 503 U.S. at 324.

      The relevant factors to consider in a case like this would not, of course,

replicate those used to analyze an employee-independent contractor relationship,

for instance. Instead, the factors should concentrate on such things as the right of

control, ownership or investment in the business and its assets, risk and reward,

financial control, the parties’ intent, including the existence of a written

employment agreement, 11 work history, nature, extent and documentation of work

performed, tax and other formalities relating to worker status, and similar factors.

      The common-law test for determining whether Mrs. Shellito qualifies as an

employee is not conclusive. Rather, it is highly relevant to, and provides context

for, the determination of the overarching statutory requirement governing this

case: whether or not the amounts paid to Mrs. Shellito were “compensation for

personal services actually rendered.” I.R.C. § 162(a)(1). (See Treas. Reg.

      11
       Of course “the mere existence of a document styled ‘employment
agreement’ [does not] lead inexorably to the conclusion that either party is an
employee.” Clackamas, 538 U.S. at 450.

                                          -25-
§ 1.162-7: “[t]he test of deductibility in the case of compensation payments is

whether they are reasonable and are in fact payments purely for services.”) The

controlling nature of this requirement is highlighted by the fact that the Shellitos

claim the health care reimbursements at issue constituted compensation. The

determination in question necessarily ties into deductibility as a business expense

under § 162(a). 12


                                  CONCLUSION

       Because of the determination set forth above, it is necessary to remand this

case to the Tax Court for further consideration, which will entail findings of fact

that we cannot make here. We do so reluctantly, in view of the fact that this case

has been pending either administratively or before the courts for an inordinate

period of time, burdening the taxpayers with uncertainty with respect to their

affairs.

       For the reasons stated above, the decision of the Tax Court is VACATED

and the case is REMANDED for reconsideration in accordance with this opinion.




       12
       The Tax Court is entitled to view the arrangement in question with a
heightened level of skepticism in determining whether payments were made on
account of the employer-employee relationship. See True, 190 F.3d at 1174, n.6.
However, at a certain level of skepticism the Tax Court may very well be required
to make credibility findings with respect to the testimony in the record.

                                         -26-
On remand we urge the Tax Court to reconsider assigning the burden of proof in

this case in accordance with I.R.C. § 7491(a)(2).

                                               ENTERED FOR THE COURT

                                               Stephen H. Anderson
                                               Circuit Judge




                                        -27-
