Hornaday v. Comm'r of Internal Revenue

• Decision Date: 07 November 1983
• Docket Number: Docket No. 26419–81.
• Citation: 81 T.C. 830,81 T.C. No. 51
• Parties: JAMES M. HORNADAY and VIRGINIA A. HORNADAY, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

81 T.C. 830

81 T.C. No. 51

JAMES M. HORNADAY and VIRGINIA A. HORNADAY, Petitioners

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 26419–81.

United States Tax Court

Filed November 7, 1983.

In 1977, 1978 and 1979, P received $40,000 under a contract (the “consulting contract”) entered into between Guilford Mills, Inc. and P pursuant to the terms of which P promised to perform consulting services to Guilford Mills, Inc. whenever that company requested. P did not at any time offer consulting services to any individual or entity other than Guilford Mills, Inc.

Held, under all of the facts and circumstances of this case, P was engaged in the trade or business of consulting during the years in issue and the fact that P offered consulting services to only Guilford Mills, Inc. is not determinative of this issue. Ditunno v. Commissioner, 80 T.C. 362 (1983), appeal dismissed (6th Cir. 9/13/83); Steffens v. Commissioner, 707 F.2d 478 (11th Cir. 1983); Grosswald v. Schweiker, 653 F.2d 58 (2d Cir. 1981), followed.

Held further, the amounts received by P under the consulting contract were self-employment income subject to tax under sec. 1401, I.R.C. 1954. Howard L. Williams and G. Garner Prillaman, Jr., for the petitioners.

Frank D. Armstrong, for the respondent.

KORNER, Judge:

Respondent determined deficiencies in petitioners' Federal self-employment taxes as follows:

+--------------------+
                ¦Year  ¦Deficiency   ¦
                +------+-------------¦
                ¦      ¦             ¦
                +------+-------------¦
                ¦1977  ¦$1,304       ¦
                +------+-------------¦
                ¦1978  ¦1,434        ¦
                +------+-------------¦
                ¦1979  ¦1,855        ¦
                +--------------------+
                

The sole issue for decision is whether money received by petitioner, James M. Hornaday, under a contract between him and Guilford Mills, Inc., is self-employment income subject to tax under section 1401.¹

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The stipulations of fact, together with the exhibits attached thereto, are incorporated herein by this reference.

James M. (hereinafter “petitioner”) and Virginia A. Hornaday, husband and wife, (hereinafter collectively referred to as “petitioners”), resided at Greensboro, North Carolina, at the time the petition was filed in this case. Petitioners filed joint Federal income tax returns for the years 1977, 1978 and 1979 with the Internal Revenue Service Center at Memphis, Tennessee.

Guilford Mills, Inc. (hereinafter “Guilford Mills”) is a United States corporation which was founded by petitioner in 1946, and since that time has been engaged in the manufacture and sale of textiles. Petitioner, who was 85 years old at the time of trial herein, was the chief executive officer of Guilford Mills until 1968 when he became chairman of the board of that company. Petitioner continued to preside as chairman of the board of Guilford Mills until March, 1971, when he terminated his active employment with that company through retirement.

On March 15, 1971, petitioner entered into a written contract (hereinafter “the consulting contract”) with Guilford Mills, pursuant to the terms of which he agreed to provide consulting services to Guilford Mills for the rest of his life as Guilford Mills deemed necessary. Petitioner's prior employment contract was terminated. As compensation, the consulting contract provided that Guilford Mills was to pay petitioner $40,000 per year and provide petitioner with the use of a new automobile every two years and an office at Guilford Mills' headquarters. The consulting contract also provided that should petitioner be unable to perform consulting services by reason of physical or mental disability. he would nonetheless continue to receive payments under the contract. Moreover, the consulting contract further provided that if petitioner should die within five years after March 1971, $20,000 per year would be payable to petitioner's wife, Virginia A. Hornaday, for the remainder of the five-year period. The consulting contract did not preclude petitioner from rendering consulting services to competitors of Guilford Mills or any other person or entity.

Paragraph 10 of the consulting contract provides:

10. (a) Consultant [petitioner] will not divulge, furnish or make accessible to anyone (otherwise than in the regular course of business of Corporation [Guilford Mills]) any knowledge or information with respect to confidential or secret methods, processes, plans or materials of the Corporation, or with respect to any other confidential or secret aspects of the business of the Corporation.

(b) Consultant agrees to communicate and make known to the Corporation all knowledge possessed by him relating to any methods, developments, inventions and/or improvements, whether patented, patentable or unpatentable which concerns in any way the business of the Corporation or the industry generally, from the time of entering upon employment until the termination thereof, and whether acquired by Consultant before or during the term of employment; provided, however, that nothing herein shall be construed as requiring any such communication where the method, development, invention and/or improvement is lawfully protected from disclosure as the trade secret of a third party or by any other lawful bar to such communication.

Any methods, developments, inventions and/or improvements, whether patentable or unpatentable which Consultant may conceive of or make along the lines of the Corporation's business while in its employ, shall be and remain the property of the Corporation. Consultant agrees promptly to communicate and disclose all such methods, developments, inventions and/or improvements to the Corporation and to execute and deliver to it any instruments deemed necessary by the Corporation to effect disclosure and assignment thereof to it. Consultant further agrees on request to execute patent applications based on such methods, developments, inventions and/or improvements, including any other instruments deemed necessary by the Corporation for the prosecution of such patent applications or the acquisition of Letters Patent in this and any foreign countries.

(c) The provisions of this paragraph shall survive the termination of this Agreement, irrespective of the reason therefor.

(d) Consultant acknowledges that the services to be rendered by him are of a special, unique and extra-ordinary character and that it would be very difficult or impossible to replace such services and by reason thereof consents and agrees that if he violates any of the provisions of this Agreement, the Corporation shall be entitled to an injunction to be issued by any court of competent jurisdiction restraining him from committing or continuing any violation of this Agreement.

During the early years of the consulting contract (i.e., 1971 through 1975), petitioner's advisory services were sought by Guilford Mills regarding his expertise in the areas of real estate and plant expansion. Petitioner provided consulting services to Guilford Mills with respect to such matters through 1975.

Although petitioner stood ready and able to provide consulting services to Guilford Mills during years in issue herein (i.e., 1977, 1978 and 1979), that company found no occasion to call upon petitioner for these purposes during said years. Moreover, although the consulting agreement did not restrict petitioner's consulting activities, he did not offer or provide such services to any individual or entity other than Guilford Mills at any time.

Petitioner was paid $40,000 in each of the years 1977, 1978 and 1979 in accordance with the terms of the consulting agreement. These $40,000 payments were reported by petitioners on their 1977, 1978 and 1979 income tax returns as consultation fees. Guilford Mills did not withhold any part of the $40,000 annual payments for income or Social Security taxes and did not issue a Form W-2 to petitioners for these years. Petitioners paid no self-employment taxes with respect to these amounts.

OPINION

The issue presented in this case is whether the payments petitioner received under his consulting contract with Guilford Mills are subject to the self-employment tax. The parties agree that such payments are subject to the self-employment tax only if they derived from a “trade or business” carried on by petitioner. An overview of the relevant statutory provisions will serve to place the disputed issue in its proper perspective.

The self-employment tax was enacted by the Social Security Act Amendments of 1950, ch. 809, 64 Stat. 477. It functions to finance the extension of Social Security benefits to self-employed individuals. S. Rept. 1669, 81st Cong., 2d Sess. (1950), 1950–2 C.B. 302, 306, 352–353. For self-employed individuals, it is the counterpart of the taxes imposed upon the wages of employees by the Federal Insurance Contributions Act (FICA) and the Federal Unemployment Tax Act (FUTA). See sections 3121(a) and 3306(b).

With respect to employees, FICA and FUTA taxes are imposed only on wages. Sections 3101(a), 3301. Income received by employees which does not constitute “wage” income is not subject to these taxes.²

The statutory structure of the self-employment tax follows a similar pattern. This tax is imposed on each individual's “self-employment income.” Section 1401. “Self-employment income” is defined as “net earnings from self-employment,” with certain exceptions not here pertinent. Section 1402(b). “Net earnings from self-employment” in turn is defined as gross income, less certain deductions, derived by an individual from any “trade or business carried on” by such individual. Section 1402(a). Thus, just as non-wage income is not subject to FICA and FUTA taxes in the employee context, income which is not derived from a “trade or business” of a non-employee, is not subject to the self-employment tax. However, the above provisions are to be broadly construed to favor coverage for social security purposes, Rasmussen v....