Charlotte's Office Boutique, Inc. v. C.I.R.

• Decision Date: 07 October 2005
• Docket Number: No. 04-71325.,04-71325.
• Citation: 425 F.3d 1203
• Parties: CHARLOTTE'S OFFICE BOUTIQUE, INC., Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

425 F.3d 1203

CHARLOTTE'S OFFICE BOUTIQUE, INC., Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 04-71325.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted July 11, 2005.

Filed October 7, 2005.

Petitioner-appellant was represented by Robert E. Kovacevich of Spokane, WA.

Respondent-appellee was represented by Eileen J. O'Connor, Assistant Attorney General, Thomas J. Clark, and Regina S. Moriarty of Washington, D.C.

Appeal from a Decision of the United States Tax Court. Tax Ct. No. 5077-01.

Before: HUG, PAEZ, and CALLAHAN, Circuit Judges.

CALLAHAN, Circuit Judge:

On its face, this is an appeal by Charlotte's Office Boutique, Inc., from the Tax Court's determination that its royalty payments to Charlotte Odell, one of its two shareholders, were actually wages and that appellant was liable for employment taxes on those wages and penalties. This appeal, however, also raises a challenge to the Tax Court's jurisdiction, which was first raised before the Tax Court by the Commissioner of Internal Revenue ("Commissioner") and is asserted by both parties on appeal, with the Commissioner taking the laboring oar.

Following the trial in the Tax Court, the Commissioner filed a motion to dismiss alleging that the Tax Court lacked jurisdiction over three of the four tax years in question. Appellant joined in the motion. The Tax Court, however, denied the motion and rendered judgment in favor of the Commissioner on all the issues framed by appellant's petition for review.

Appellant filed a notice of appeal objecting to both the Tax Court's determination of jurisdiction and its rejection of appellant's challenges to the determination of taxes and penalties. In response, the Commissioner first asserts that the Tax Court lacked jurisdiction for three of the four tax years in question, and then contends that to the extent that the Tax Court retained jurisdiction, it properly determined that appellant owes taxes and penalties.

In affirming the Tax Court's opinions, we first consider the jurisdiction issue asserted by both parties, and determine that the Tax Court's jurisdiction under 26 U.S.C. § 7436(a) was not limited by the Commissioner's admission that appellant treated Mrs. Odell as an employee in years 1996 through 1998. We then address appellant's challenges to the Tax Court's determinations of liability, taxes and penalties, and conclude that none are persuasive.

I

Prior to 1976, Mrs. Odell and her then-husband did business with various United States Post Offices, selling items such as calculators, chairs and office supplies. When she divorced in 1976, her ex-husband gave her the list of their customers. Mrs. Odell explained that certain agencies had "Buy Indian Programs" and that she is a Native American. Starting in 1989, Mrs. Odell ran the business as a sole proprietorship.

In January 1995, Mrs. Odell incorporated her business as Charlotte's Office Boutique, Inc. The stock was owned equally by Mrs. Odell and her second husband, Theodore, whom she married in 1988. Mrs. Odell is appellant's president, and she and Theodore are the only directors.

In connection with the incorporation, the sole proprietorship conveyed to appellant an ownership interest in certain assets, such as bank accounts and inventory, but did not convey the customer list used by the proprietorship. In August 1996, appellant and Mrs. Odell entered into three agreements effective January 1, 1995. The Tax Court explained the arrangements as follows:

These agreements were an employment agreement, a rental agreement, and a licensing and sale agreement. Pursuant to the employment agreement, [appellant] agreed to pay $400 per month to Ms. Odell in return for her services, and Ms. Odell agreed that she would receive no employment compensation from January 1, 1995, through July 31, 1996. Pursuant to the rental agreement, [appellant] agreed to pay to Ms. Odell $600 per month to rent certain of her property. Pursuant to the licensing and sale agreement, [appellant] agreed to pay to Ms. Odell a monthly royalty fee of the larger of $200 or 5 percent of the gross receipts for all office supplies sold under the agreement. [Appellant] had resolved on February 15, 1996, to pay Ms. Odell for 1995 a royalty payment equal to 5 percent of gross receipts for the use of her existing Government contracts and her experience in obtaining Government contracts. [Appellant] also had resolved to pay Ms. Odell a salary of $400 per month. Charlotte's Office Boutique, Inc. v. Comm'r, 121 T.C. 89, 93-94, 2003 WL 21783383 (2003).

Appellant's business required minimal labor. Mrs. Odell primarily handled the day-to-day administration, such as dealing with and paying suppliers, processing customer orders and bookkeeping. She estimated that this took her a couple of hours a day. Theodore also worked for appellant a couple of hours a day, handling the shipping and the computer work, and helping to facilitate sales. He was not paid by appellant.

In all, appellant reported the following payments to Mrs. Odell:

                Year Salary Royalties
                   1995          0     $42,048
                   1996     $2,000     $34,200
                   1997     $4,800     $51,611
                   1998     $4,800     $46,690
                

The Commissioner commenced his audit of appellant's and the Odells' tax returns in December 1997, and later expanded the audit to cover 1995 through 1998. In January 2001, the Commissioner issued a Notice of Determination Concerning Worker Classification against appellant. The first four sentences of the Notice read:

As a result of an employment tax audit, we are sending you this NOTICE OF DETERMINATION CONCERNING WORKER CLASSIFICATION UNDER SECTION 7436. We have determined that the individual(s) listed or described on the attached schedule are to be legally classified as employees for purposes of federal employment taxes under subtitle C of the Internal Revenue Code and that you are not entitled to relief from this classification pursuant to section 530 of the Revenue Act of 1978 with respect to such individual(s). This determination could result in employment taxes being assessed against you.

If you want to contest this determination in court, you may file a petition with the United States Tax Court for a redetermination of the above-referenced issues.

The Notice alleged that Mrs. Odell was appellant's employee for purposes of federal employment taxes, that the royalty payments were actually wages, and that appellant was liable for unreported employment taxes for 1995 through 1998, as well as statutory additions to taxes because appellant had not withheld employment taxes on the wages.¹ The Notice also alleged that appellant had "other workers."

Appellant filed a petition in the Tax Court for a redetermination of its employment tax liabilities. Trial was held in June 2002. Following the trial, the Commissioner filed a motion to dismiss with regard to tax years 1996 through 1998. The Commissioner argued that because appellant paid Mrs. Odell a salary during this period of time, there was no actual controversy as to whether she was an employee, and accordingly, the Tax Court lacked jurisdiction under 26 U.S.C. § 7436(a).²

The Tax Court ruled that it had jurisdiction, that the royalty payments were wages, and affirmed the tax assessments and the additions thereto. Charlotte's Office Boutique, 121 T.C. at 91. The Tax Court subsequently issued an opinion holding that it had jurisdiction to redetermine additions to taxes attributable to nonpayment of employment taxes. Charlotte's Office Boutique, Inc. v. Comm'r, 87 T.C.M. (CCH) 998 (2004).

II

We first consider the Commissioner's assertion that the Tax Court lacked jurisdiction for three of the four tax years involved. Such a challenge to subject-matter jurisdiction is reviewed de novo. Estate of Branson v. Comm'r, 264 F.3d 904, 908 (9th Cir.2001); I & O Publ'g. Co., Inc. v. Comm'r, 131 F.3d 1314, 1315 (9th Cir.1997).

The Commissioner argues that the Tax Court lost jurisdiction over tax years 1996 through 1998 when he conceded that appellant did not have any other workers for those years and that appellant had treated Mrs. Odell as an employee in those years. In other words, the Commissioner maintains that because he and appellant agreed that Mrs. Odell was an employee for tax years 1996 through 1998, there is no controversy between the Commissioner and appellant as to Mrs. Odell's classification under 26 U.S.C. § 7436. The Commissioner argues that this lack of controversy as to Mrs. Odell's classification for 1996 through 1998 deprives the Tax Court of jurisdiction to review his determination of taxes and penalties for those years, even though appellant continues to contest those taxes and penalties.

In evaluating the Commissioner's position, we turn first to the statute at issue. Subsection (a) of § 7436 reads:

Creation of remedy.—If, in connection with an audit of any person, there is an actual controversy involving a determination by the Secretary as part of an examination that—

(1) one or more individuals performing services for such person are employees of such person for purposes of subtitle C, or

(2) such person is not entitled to the treatment under subsection (a) of section 530 of the Revenue Act of 1978 with respect to such an individual,

upon the filing of an appropriate pleading, the Tax Court may determine whether such a determination by the Secretary is correct and the proper amount of employment tax under such determination. Any such redetermination by the Tax Court shall have the force and effect of a decision of the Tax Court and shall be reviewable as such.

Section 7436 was added to the Internal Revenue Code through the Taxpayer Relief Act of 1997, Pub.L. No. 105-34, 111 Stat. 788, 1055 (1997). Before its enactment, "judicial review of IRS assessment of employment taxes or related penalties was available only if a taxpayer paid a divisible part of the assessment, filed a claim for refund,...