                   T.C. Summary Opinion 2005-159



                      UNITED STATES TAX COURT



         MATTHEW HUDACK AND KRISTEN HUDACK, Petitioners v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 3432-04S.             Filed November 2, 2005.


     Matthew Hudack, pro se.

     Michael S. Hensley, for respondent.



     PANUTHOS, Chief Special Trial Judge:   This case was heard

pursuant to the provisions of section 7463 of the Internal

Revenue Code in effect at the time that the petition was filed.1




     1
        Unless otherwise indicated, all subsequent section
references are to the Internal Revenue Code (Code) in effect at
relevant times, and all Rule references are to the Tax Court
Rules of Practice and Procedure. All monetary amounts are
rounded to the nearest dollar.
                                        - 2 -

The decision to be entered is not reviewable by any other court,

and this opinion should not be cited as authority.

       Respondent determined deficiencies in petitioners’ Federal

income taxes as well as accuracy-related penalties as follows:

                                                  Penalty
                 Year      Deficiency           Sec. 6662(a)

                 1999       $17,096                $3,419
                 2000        16,469                 3,294

       After petitioners’ concessions,2 the issues for decision

are:       (1)    Whether Matthew Hudack (petitioner) was a statutory

employee for 1999 and 2000 (years in issue); and (2) whether

petitioners are liable under section 6662(a) for accuracy-related

penalties for the years in issue.

       Adjustments to the amounts of petitioners’ itemized

deductions and the alternative minimum tax are purely

computational matters, the resolution of which depends on our

disposition of the first disputed issue.

                                  Background

       Some of the facts have been stipulated, and they are so

found.       We incorporate by reference the parties’ stipulation of

facts and the accompanying exhibits.

       At the time that the petition was filed, petitioners resided

in Santa Ana, California.



       2
        For 1999, petitioners concede that they are not entitled
to claimed “business promotion” expenses of $974 and “client
costs” expenses of $402.
                               - 3 -

     In 1986, petitioner received his license to sell life

insurance products in the State of California.     From 1986 to June

1990 and from June 1993 to at least the date of trial, petitioner

worked for the Manufacturers Life Insurance Co. (USA) (Manulife)

selling life insurance products.     Manulife is a Toronto-based

insurance company that sells annuities, group pensions, insurance

policies, and college savings plans and provides investment

account management services.

     On January 1, 1999, petitioner executed a “Regional Director

Employment Agreement” (agreement) with Manulife, which was in

effect during the years in issue.3     The agreement required

petitioner to serve Manulife full time as a primary

representative and an integral part of Manulife’s sales service

for an indefinite period.   The agreement also required petitioner

to “agree not to sell, solicit, market or otherwise promote

financial products for any company other than” Manulife and its

subsidiaries without Manulife’s written consent and to adhere to

all policies, procedures, and written rules and regulations of

Manulife including Manulife’s codes of conduct.

     Under the agreement, petitioner was an at-will employee.

The agreement provided that petitioner was “attached” to

Manulife’s Orange County Sales Office in Irvine, California

(Irvine office), and assigned him the southern California sales



     3
         Manulife has 29 regional directors nationwide.
                               - 4 -

territory.   The agreement set petitioner’s compensation on a

commission schedule based on the business category for the

products that he sold.4   In addition, Manulife provided

petitioner with an annual reimbursement allocation, which

petitioner could use for any business-related expense.5

Petitioner, however, was responsible for business expenses

exceeding his reimbursement allocation.   Manulife did not pay

petitioner for vacation days, but Manulife provided that

petitioner was eligible to enroll in its benefit and retirement

plans.

     Petitioner’s responsibilities were to identify sales

opportunities for insurance agents, brokers, financial planners,

and stockbrokers and to provide financial plans for their

clients.   As the regional director, petitioner reported his goals

and objectives to the western regional manager.   In his sales

presentations, petitioner used financial planning information

packets that were preapproved by Manulife.6   Petitioner’s only

office location was the Irvine office.    Petitioner purchased his



     4
        Although not further explained in the record, it appears
that petitioner received an annual base salary of $60,000 for old
sales commissions as evidenced in his 1999 monthly compensation
statements.
     5
        The record does not disclose the amount of petitioner’s
reimbursement allocation, nor does it explain Manulife’s
reimbursement procedures.
     6
        For 1999, petitioner led the company in sales for life
insurance products.
                                - 5 -

own computer, fax machine, and cellular phone for use in his

sales activities, but he paid no rent or other business expenses

(e.g., utilities, office supplies and equipment, furniture, and

copier) in connection with the Irvine office.    Those expenses

were paid by Manulife.   In the Irvine office, Manulife employed

two support staff employees to assist petitioner.

     Manulife issued Forms W-2, Wage and Tax Statement, to

petitioner reporting wages or other compensation of $496,053 and

$436,891 for 1999 and 2000, respectively.    The Forms W-2 also

reported that Manulife withheld the applicable payroll taxes.

The Forms W-2 further indicated that petitioner participated in

Manulife’s health insurance program, pension plan, and deferred

compensation plan.    Manulife did not check box 15 for statutory

employee.7

     Petitioners timely filed a Form 1040, U.S. Individual Income

Tax Return, for each of the years in issue.    Petitioners attached

to each return, inter alia, a Schedule C, Profit or Loss From

Business.    On each Schedule C, petitioner identified his

principal business or profession as life insurance sales and his

business address as the Irvine office.    Petitioner reported the

following on the Schedules C:




     7
        We note that the 2000 Form W-2 box 15 for statutory
employee contained a handwritten “X”.
                                - 6 -

     Year     Gross Receipts1   Total Expenses    Net Profit
                2
     1999        $526,773          $98,890         $427,883
     2000        441,898            76,540          365,358
     1
        Gross receipts included the amounts reflected on the
respective Forms W-2 issued by Manulife as well as self-
employment income from other sources.
     2
        In 1999, petitioner received self-employment income of
$3,400 from Manulife, which was reported on a Form 1099-MISC,
Miscellaneous Income.

Expenses consisted of advertising, automobile expenses,

commissions and fees, depreciation, insurance, legal and

professional services, office expenses, rent or lease of

equipment, supplies, travel, meals and entertainment, utilities,

and other expenses.8

     Petitioner consulted with his return preparer, W.R. Frey

(Mr. Frey), and discussed the nature of his work.    Following the

consultation, Mr. Frey advised petitioner to file as a statutory

employee.

     In the notice of deficiency, respondent determined that

petitioner was a common law employee and, therefore, not

permitted to report income and expenses on Schedule C.

Respondent further determined that petitioners are liable for the

accuracy-related penalty under section 6662(a).




     8
        We note that petitioner did not report on his return any
reimbursement income or its associated expense because he
considered it a “wash”.
                                - 7 -

                              Discussion

A.   Petitioner’s Employment Status9

     Generally, adjusted gross income means gross income less

trade or business expenses, except in the case of the performance

of services by an employee.    Sec. 62(a)(1).   As relevant herein,

an individual performing services as an employee may deduct

expenses incurred in the performance of services as an employee

only as miscellaneous itemized deductions on Schedule A, Itemized

Deductions, and then only to the extent such expenses exceed 2

percent of the individual’s adjusted gross income.     Secs.

62(a)(2); 63(a), (d); 67(a) and (b); 162(a).    In contrast, an

individual who qualifies as a statutory employee as defined under

section 3121(d)(3) is not subject to the section 67(a) 2-percent

limitation for expenses incurred in the performance of services

as an employee.   Rev. Rul. 90-93, 1990-2 C.B. 33.10   Thus, a

statutory employee under section 3121(d)(3) is allowed to deduct

expenses from gross income on Schedule C that otherwise would be




     9
        We render a decision on the merits based on the
preponderance of the evidence, without regard to the burden of
proof under sec. 7491(a).
     10
        Rev. Rul. 90-93, 1990-2 C.B. 33, provides that an
individual treated as a statutory employee under sec. 3121(d)(3)
for employment tax purposes who would otherwise be characterized
as an independent contractor is not considered an employee for
purposes of secs. 62 and 67, and, therefore, may deduct business
expenses on Schedule C.
                                 - 8 -

subject to the 2-percent limitation of section 67(a).      See sec.

62(a)(1).

     Petitioner contends that he was a statutory employee under

section 3121(d)(3)(B) and, therefore, that he may report his

business-related income and expenses on Schedule C.

     Section 3121(d) defines “employee” for employment tax

purposes as follows:

          SEC. 3121(d). Employee.--For purposes of this
     chapter, the term “employee” means--

                 (1) any officer of a corporation; or

                 (2) any individual who, under the usual
            common law rules applicable in determining
            the employer-employee relationship, has the
            status of an employee; or

                 (3) any individual (other than an
            individual who is an employee under paragraph
            (1) or (2)) who performs services for
            remuneration for any person--

                   *    *    *    *      *   *   *

                      (B) as a full-time life
                 insurance salesman;

Under section 3121(d)(3), however, the provisions of section

3121(d)(3)(B) apply only if a full-time life insurance salesman

does not have the status of an employee under the usual common

law rules applicable in determining the employer-employee

relationship.    Lickiss v. Commissioner, T.C. Memo. 1994-103.
                               - 9 -

Therefore, we must first determine whether petitioner was a

common law employee during the years in issue.11

     For purposes of section 62(a), subtitle A of the Code does

not define “employee”.   Under these circumstances, we apply

common law rules to determine whether an individual is an

employee.   Nationwide Mut. Ins. Co. v. Darden, 503 U.S. 318, 323-

325 (1992); Weber v. Commissioner, 103 T.C. 378, 386 (1994),

affd. 60 F.3d 1104 (4th Cir. 1995).    Whether an individual is a

common law employee is a question of fact.    Profl. & Executive

Leasing, Inc. v. Commissioner, 862 F.2d 751, 753 (9th Cir. 1988),

affg. 89 T.C. 225 (1987); Simpson v. Commissioner, 64 T.C. 974,

984 (1975).   Among the relevant factors in determining the nature

of an employment relationship are the following:   (1) The degree

of control exercised by the principal over the details of the

work; (2) the taxpayer’s investment in the facilities used in the

work; (3) the taxpayer’s opportunity for profit or loss; (4) the

permanency of the relationship between the parties; (5) the

principal’s right of discharge; (6) whether the work performed is

an integral part of the principal’s business; (7) what

relationship the parties believe they are creating; and (8) the

provision of employee benefits.   NLRB v. United Ins. Co., 390

U.S. 254, 258 (1968); Profl. & Executive Leasing, Inc. v.


     11
        The parties agree that petitioner otherwise qualifies as
a full-time life insurance salesman pursuant to sec.
3121(d)(3)(B).
                                - 10 -

Commissioner, supra; Simpson v. Commissioner, supra.     No one

factor is determinative; rather, all the incidents of the

relationship must be assessed and weighed.     NLRB v. United Ins.

Co., supra.

       1.   Degree of Control

       The crucial test to determine the nature of a working

relationship is the employer’s right to control the manner in

which the taxpayer’s work is performed.     Weber v. Commissioner,

supra at 387.    It is not necessary for the employer to exercise

control over the details of the taxpayer’s work; rather, all that

is necessary is that the employer have the right to control the

details of the taxpayer’s work.     Profl. & Executive Leasing, Inc.

v. Commissioner, supra at 754; McGuire v. United States, 349 F.2d

644, 646 (9th Cir. 1965); Weber v. Commissioner, supra at 388.

To retain the requisite control over the details of an

individual’s work, the employer need not stand over the

individual and direct every move made; it is sufficient that the

employer has the right to do so.     Weber v. Commissioner, supra at

388.    Similarly, the employer need not set the individuals’s

hours or supervise every detail of the work environment to

control the individual.     Gen. Inv. Corp. v. United States, 823

F.2d 337, 342 (9th Cir. 1987).

       While petitioner had control over his own sales performance,

Manulife had the right to control the manner in which he
                               - 11 -

performed his work.   Manulife set petitioner’s sales commission

schedule, his sales territory, and his annual reimbursement

allocation.   Moreover, Manulife restricted petitioner’s ability

to sell or promote other company’s financial products without

Manulife’s consent and required petitioner to use preapproved

financial information packets to market Manulife’s life insurance

products.   In addition, Manulife required petitioner to use the

Irvine office to conduct business and to use Manulife’s support

staff to assist him in his sales activities.   These facts suggest

that Manulife generally retained the right to regulate and direct

petitioner’s business activities.

     We give little or no weight to the fact that the agreement

merely required petitioner to adhere to Manulife’s policies,

procedures, written rules, and codes of conduct and that Manulife

required petitioner to report his goals and objectives to the

western regional manager because the record does not identify the

procedures for enforcement of the rules and for reporting

requirements.

     The totality of the evidence on this factor supports a

finding that Manulife had the right to control the manner in

which petitioner performed his work and that petitioner therefore

was an employee of Manulife.
                              - 12 -

     2.   Investment in Facilities

     During the years in issue, petitioner worked out of

Manulife’s Irvine office, which was his only work location.

Indeed, petitioner’s business contact information listed the

Irvine office as his business address.

     Moreover, Manulife employed at its Irvine office two support

employees to assist petitioner in his sales activities.     Manulife

was responsible for hiring, supervising, and paying these

employees.   Although petitioner provided his own computer and fax

machine, he was not otherwise responsible for any business

expenses associated with this office, including rent, office

supplies, equipment, and furniture.

     This factor strongly suggests that petitioner was an

employee of Manulife.

     3.   Opportunity for Profit or Loss

     Petitioner received commissions based on his sales

performance.   Manulife also reimbursed petitioner for his

business expenses up to an annual limit.

     Compensation on a commission basis is entirely consistent

with an employer-employee relationship.    Tex. Carbonate Co. v.

Phinney, 307 F.2d 289, 292 (5th Cir. 1962); Capital Life & Health

Ins. Co. v. Bowers, 186 F.2d 943 (4th Cir. 1951).   While

petitioner conceivably could have suffered some loss as a result

of his sales activities, he may still be an employee under the
                              - 13 -

common law test if his risk of loss was negligible.   Lewis v.

Commissioner, T.C. Memo. 1993-635; Radovich v. Commissioner, T.C.

Memo. 1954-220.   Moreover, the risk that he would not receive any

commissions because of low sales performance is common to both

employees and statutory employees.

     Other than his computer, fax machine, cellular phone, and

business expenses that exceeded his annual reimbursement

allocation, petitioner did not have any capital investments or

bona fide liability for expenses (such as salary payments to

unrelated employees) in his sales activities such that he would

be subject to a real risk of economic loss.

     This factor supports a finding that petitioner was an

employee of Manulife.

     4.   Permanency of Relationship

     Since becoming a licensed life insurance salesman in 1986,

petitioner has worked for Manulife from 1986 to June 1990 and

again from June 1993 to at least the date of trial.   Moreover,

under the agreement, petitioner was hired to work for an

indefinite period of time.

     This factor supports a finding that petitioner was an

employee of Manulife.

     5.   Principal’s Right To Discharge

     The relationship between petitioner and Manulife was

terminable at the will of either party without any further
                              - 14 -

compensation.   With respect to a statutory employee, the parties

would likely have this same right.     Therefore, we accord this

factor little or no weight.

     6.   Integral Part of Business

     Manulife is in the business of selling its products.       Sales

representatives, such as petitioner, are Manulife’s key

connection with its customers.   This factor supports a finding

that petitioner was an employee of Manulife.     See Lewis v.

Commissioner, supra.

     7.   Relationship Parties Believe They Created

     Petitioner contends that he was a statutory employee.      On

the Forms W-2, however, Manulife did not mark the statutory

employee box.   Further, Manulife paid the applicable payroll

taxes and did not issue a Form 1099.     The withholding of such

taxes by Manulife is consistent with a finding that petitioner

was an employee.   See Azad v. United States, 388 F.2d 74, 78 (8th

Cir. 1968); Weber v. Commissioner, 103 T.C. at 392.

     This factor would support a finding that petitioner was an

employee.

     8.   Employee Benefits

     Petitioner participated in Manulife’s pension plan and

deferred compensation plan.   Moreover, petitioner received health

benefits through Manulife’s group health insurance plan.
                                - 15 -

       Typically, statutory employees are not entitled to

participate in employee benefit plans.     There is an exception,

however, for full-time life insurance salespeople who are treated

as employees for purposes of certain employee benefit programs

maintained by a business.     Sec. 7701(a)(20).   We find this factor

is neutral.

       9.   Conclusion as to Employment Status

       On balance, considering the record and weighing all of the

factors, we conclude that during the years in issue petitioner

was a common law employee, rather than a statutory employee under

section 3121(d)(3)(B).     Therefore, petitioner is not entitled to

report gross income and expenses on Schedule C.     Accordingly, we

sustain respondent’s determination on this issue.

B.   Section 6662(a) Accuracy-Related Penalty

       The final issue for decision is whether petitioners are

liable for accuracy-related penalties under section 6662(a) for

the years in issue.

       Section 6662(a) imposes a penalty equal to 20 percent of any

underpayment of tax that is attributable to either negligence or

disregard of rules or regulations, or a substantial

understatement of income tax.     See sec. 6662(a) and (b)(1) and

(2).

       The term “negligence” includes any failure to make a

reasonable attempt to comply with the provisions of the internal
                                - 16 -

revenue laws.    Sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax

Regs.   The term “disregard” includes any careless, reckless, or

intentional disregard.    Sec. 6662(c); sec. 1.6662-3(b)(2), Income

Tax Regs.

     An understatement of income tax is “substantial” if it

exceeds the greater of 10 percent of the tax required to be shown

on the return, or $5,000.    Sec. 6662(d)(1)(A).   An

“understatement” is defined as the excess of the tax required to

be shown on the return over the tax actually shown on the return.

Sec. 6662(d)(2)(A).

     Whether the accuracy-related penalty is applied because of

negligence or disregard of rules or regulations, or a substantial

understatement of tax, section 6664 provides an exception to

imposition of the accuracy-related penalty if the taxpayer

establishes that there was reasonable cause for the

understatement and that the taxpayer acted in good faith with

respect to that portion.    Sec. 6664(c)(1); sec. 1.6664-4(b),

Income Tax Regs.; see United States v. Boyle, 469 U.S. 241, 242

(1985).     Although not defined in the Code, “reasonable cause” is

viewed in the applicable regulations as the “exercise of ordinary

business care and prudence”.    Sec. 301.6651-1(c)(1), Proced. &

Admin. Regs.; see United States v. Boyle, supra at 246.     The

determination of whether a taxpayer acted with reasonable cause

and in good faith is made on a case-by-case basis, taking into
                                 - 17 -

account all the pertinent facts and circumstances.     Sec. 1.6664-

4(b)(1), Income Tax Regs.     Generally, the most important factor

is the extent of the taxpayer’s effort to assess the proper tax

liability, including reliance on the advice of a tax return

preparer.    Id.

     By virtue of section 7491(c), respondent has the burden of

production with respect to the accuracy-related penalty.     To meet

this burden, respondent must produce sufficient evidence

indicating that it is appropriate to impose the penalty.     See

Higbee v. Commissioner, 116 T.C. 438, 446 (2001).     Once

respondent meets this burden of production, petitioner must come

forward with persuasive evidence that respondent’s determination

is incorrect.      Rule 142(a); see Higbee v. Commissioner, supra.

As a defense to the penalty, petitioner bears the burden of

proving that he or she acted with reasonable cause and in good

faith.    See sec. 6664(c)(1); see also Higbee v. Commissioner,

supra; sec. 1.6664-4(b)(1), Income Tax Regs.

     Respondent satisfied his burden of production under section

7491(a)(1) because the record shows that petitioners

substantially understated their income tax for the years in

issue.    See sec. 6662(d)(1)(A)(ii); Higbee v. Commissioner, supra

at 442.     Accordingly, petitioners bear the burden of proving that

the accuracy-related penalty should not be imposed with respect

to any portion of the understatement for which they acted with
                               - 18 -

reasonable cause and in good faith.     See sec. 6664(c)(1); Higbee

v. Commissioner, supra at 446.     The mere fact that we held

against petitioners with respect to petitioner’s employment

status does not, in and of itself, require holding for respondent

on the accuracy-related penalty.    See Hitchins v. Commissioner,

103 T.C. 711, 719 (1994).

     Petitioners contend that they are not liable for accuracy-

related penalties because they reasonably relied on their tax

return preparer.   On the basis of the entire record in this case

and in light of the nature of petitioner’s occupation as a life

insurance salesperson, we find that petitioners’ reliance on

their tax return preparer that petitioner was a statutory

employee was reasonable.    Therefore, petitioners are not liable

for the accuracy-related penalties for the years in issue.

Accordingly, respondent’s determination on this issue is not

sustained.

     We have considered all of the other arguments made by the

parties, and, to the extent that we have not specifically

addressed them, we conclude that they are without merit.

     Reviewed and adopted as the report of the Small Tax Case

Division.
                               - 19 -

     To reflect our disposition of the disputed issues, as well

as petitioners’ concessions,



                                    Decision will be entered

                               for respondent as to the

                               deficiencies in taxes and for

                               petitioners as to the penalties.
