                       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.
                              - 2 -


                        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.
                               - 3 -


     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
                               - 4 -


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.
                               - 5 -


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.,
                                - 6 -


(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
                                 - 7 -


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
                               - 8 -


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
                               - 9 -


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
                              - 10 -


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
                              - 11 -


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.
