303 W. 42nd St. Enter. v. Internal Revenue

• Decision Date: 01 August 1997
• Docket Number: Docket No. 97-6066
• Citation: 181 F.3d 272
• Parties: (2nd Cir. 1999) 303 WEST 42ND ST. ENTERPRISES, INC., Plaintiff-Counter-Defendant-Appellant, v. INTERNAL REVENUE SERVICE and UNITED STATES OF AMERICA, Defendants-Counter-Claimants-Appellees
• Court: U.S. Court of Appeals — Second Circuit

Page 272

181 F.3d 272 (2nd Cir. 1999)

303 WEST 42ND ST. ENTERPRISES, INC., Plaintiff-Counter-Defendant-Appellant, v. INTERNAL REVENUE SERVICE and UNITED STATES OF AMERICA, Defendants-Counter-Claimants-Appellees.

Docket No. 97-6066

August Term, 1997

UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

Argued: April 28, 1998

Decided: June 18, 1999

Plaintiff, the operator of an adult entertainment facility, appeals from the March 1, 1996 judgment (as amended May 22, 1996) of the United States District Court for the Southern District of New York (Leonard B. Sand, Judge) dismissing plaintiff's claim for refund of employment taxes assessed against it for fantasy booth performers working at the facility and granting defendant's counterclaim seeking payment of employment taxes for all payroll periods during 1989 and 1990.

Reversed and remanded with instructions.

KEVIN M. FLYNN, New York, N.Y. (Kostelanetz & Fink, LLP, New York, N.Y., Of Counsel), for Plaintiff-Counter-Defendant-Appellant.

MARY JO WHITE, New York, N.Y., United States District Attorney for the Southern District of New York (Glenn C. Colton, Assistant United States Attorney, Edward A. Smith, Assistant United States Attorney, On the Brief), for Defendants-Counter-Claimants-Appellees.

Before: NEWMAN and LEVAL, Circuit Judges, and WEXLER, District Judge.^*

WEXLER, District Judge:

The Internal Revenue Service ("IRS") assessed a deficiency against plaintiff, operator of an adult entertainment facility known as Show World ("Show World"), for employment taxes relating to performers working in plaintiff's One-on-One fantasy booths ("performers" or "booth performers"). Plaintiff paid part of the tax assessment and instituted this action for refund. The District Court denied plaintiff's motion for summary judgment on the refund claim and granted the cross-motion for summary judgment of defendant United States (the "Government") seeking payment of the balance of the deficiency assessment.

Plaintiff contends the deficiency was not properly assessed (1) because the booth performers were not employees, and (2) because, even if they were, plaintiff is shielded from liability for past employment taxes by the "safe harbor" provision of section 530 of the Revenue Act of 1978 ("section 530").¹ In general, and subject to certain qualifications, section 530 shields a taxpayer who pays others for services from employment tax liability if the taxpayer has consistently treated them as other-than-employees unless the taxpayer had no reasonable basis for doing so. Such a basis may arise where the industry's practice is to treat such workers as, for example, independent contractors and the employer relies on that practice in so misclassifying its workers. The District Court construed section 530 protection to require reliance on a uniform industry classification and, because the adult entertainment industry does not uniformly place workers like booth performers in a specific category of non-employee, the District Court found section 530 protection unavailable to plaintiff. We reverse and remand for further proceedings.

BACKGROUND

The facts in this case are essentially undisputed. Plaintiff operates an adult entertainment business located at 303 West 42nd Street in New York City under the name "Show World." Although Show World offers a variety of adult entertainments on its premises, the subject of this appeal concerns what Show World describes as "One-on-One fantasy booths." Within the booths, a single performer (usually a woman) performs a private erotic show requested by a Show World patron.

Each booth is constructed in two parts with a glass partition in the center that separates the performer from the patron and bars physical contact between them. The booth is equipped with a movable privacy shade that covers the glass, telephones on either side of the partition, and a timing device operated by tokens (the "token box") which the patron purchases from Show World. When the patron deposits a token, the shade opens to permit the patron to view the performer and the telephones are activated on both sides of the partition. To keep the shade up and the telephones active, a patron must regularly deposit tokens. The amount of viewing time that a token buys is set by Show World.

Through the telephones, the performer and patron negotiate the content of and the price for the performance, as well as communicate during it. The patron pays the performer for the requested act by passing money through a slot in the booth.

Although the performer retains all of the directly-paid performance fee, the same is not true of the token box receipts. Under written agreements for use of the booths, executed daily by the performers and Show World, the token box receipts are split in a 60%-40% share with the performer receiving the smaller share. These agreements are drafted in the form of a lease with Show World as the landlord and the performer as a renter of the booth. Show World retains the performer's share of the token box receipts from her first day of work as a "security deposit," though the security deposit is returned to the performer if she works through all of the days she books for use of a booth. Thus, two distinct financial transactions take place in the booth: (1) the patron transfers cash directly to the performer who retains it as a performance fee and (2) the patron transfers tokens to Show World, which, in turn, passes a share to the performer.

The IRS conducted an on-site examination of Show World's fantasy booth operation and concluded that the performers were Show World's employees. On or about November 26, 1991, the IRS sent a letter and examination report ("the Report") to Show World proposing deficiencies for unpaid social security, unemployment taxes, and federal income tax (collectively, "employment taxes"). These deficiencies totaled $268,313.36, plus interest.² The liability for employment taxes asserted in the Report covered quarterly and annual tax periods for the years 1989 and 1990. Show World administratively appealed the proposed assessment without success.

On conclusion of the administrative appeals, the IRS sent Show World a notice of employment taxes due for the quarterly tax period October 1, 1989 through December 31, 1989 (the "Notice"), one of the tax periods covered by the Report. The Notice demanded payment of employment taxes and interest in the amounts of $18,539.57 and $5,757.17, respectively, which totaled $24,296.74.

On or about November 4, 1992, Show World paid the sum of $24,296.74 to the IRS and then filed a timely claim for refund. The IRS failed to act on Show World's refund claim within the six-month period set forth in section 6532(a) of the Internal Revenue Code. As a result, on July 1, 1993, plaintiff commenced this action seeking a refund of the employment taxes paid for the October-December 1989 quarter. The Government filed an answer and counterclaim. The counterclaim sought payment of $249,773.49, representing the balance of the proposed tax assessment set forth in the Report (including accrued interest), plus additional penalties and interest. The parties' claims in this matter are limited to the tax years 1989 and 1990.

In the District Court, Show World moved for summary judgment on its claim for refund of the $24,296.74 it paid the IRS for the October-December 1989 quarter, arguing that it is entitled to the refund because the performers are not employees, but tenants who pay rent pursuant to a lease and because, in any event, it is entitled to section 530's "safe harbor" protection. The Government cross-moved for summary judgment on its counterclaim, contending that the performers are Show World's employees and that Show World was not entitled to safe harbor protection. The District Court applied the common law rules for determining employment status as set forth in the IRS's "twenty factors" test. See Rev. Rul. 87-41, 1987-1 C.B. 296. The District Court found that the performers were Show World's employees and that Show World was not entitled to safe harbor protection. Accordingly, the court denied Show World's motion for summary judgment on the refund claim and entered judgment on the Government's cross-motion for summary judgment on the balance of the deficiency.

DISCUSSION

I. Standard of Review and Show World's Arguments on Appeal

We review a grant of summary judgment by applying the same standard as the District Court applied, determining de novo whether or not summary judgment is warranted. Repp v. Webber, 132 F.3d 882, 889 (2d Cir. 1997), cert. denied, 119 S. Ct. 52 (1998). On appeal, Show World again contends that the performers are not its employees but its tenants who run their own independent businesses. Show World argues that the District Court's application of the common law test was inappropriate because the performers fall into neither of that test's possible classifications -- employee or independent contractor -- being tenants who operate their booths under lease.³ Show World further contends that even if the common law test could be applied to the booth performers, the performers are not employees.

We agree with the District Court's rejection of the notion that the booth performers were tenants of Show World. Further, we find no error in the lower court's conclusion that the booth performers were employees of Show World during the relevant time period. We discuss only the question of whether Show World is shielded from tax liability by section 530's safe harbor.

II. The Safe Harbor of Section 530 of the Revenue Act of 1978

A. General

Section 530 provides a "safe harbor" that permits a taxpayer to avoid liability for employment tax for past periods, regardless whether the individuals working for the taxpayer would be properly considered employees. The statute provides, inter alia, that "If . . . (A) the taxpayer did not treat an individual as en employee for any period, and (B) . . . all...