Vanderbilt Law Review


Mary LaFrance

First Page



When professionals and other persons who offer their goods and/or services to the public conduct their businesses through corporations, the Treasury has acknowledged that for federal income tax purposes it must treat those corporations as separate and distinct from their controlling shareholder- employees, even where there is only a single shareholder-employee, provided that the corporation has a business purpose and the taxpayer consistently respects the corporate form. However, the Treasury has refused to accord equal dignity to incorporated workers who offer their services not to the public at large but to a single recipient or a small number of recipients. The rationale for denying the separate taxpayer status of these "loan-out" corporations is that the party "borrowing" the services of the corporation's employee is the true employer under common law rules designed to distinguish between independent contractors and employees.

This Article examines the tax benefits of incorporating a service business and the principles which have evolved to prevent taxpayer abuse of those benefits, and evaluates the Treasury's rationale for using worker reclassification to deny loan-outs the tax benefits available to other closely-held corporations. The examination reveals that the common law worker classification standards are not an appropriate test of whether a corporation or its employee is the principal in a transaction. Although paternalism and administrative convenience arguments may favor classifying workers as employees under some circumstances, these arguments deserve little weight where the worker makes the affirmative decision to form a loan-out, thus acknowledging employee status and disputing only the identity of the employer. In effect, the government's position in the loan-out cases denies the taxpayer the opportunity to select the employment contract that will provide the greatest after-tax returns.

Taken to its logical consequence, the government's worker reclassification approach to disregarding loan-outs would treat any controlled corporation as the agent of its controlling shareholder, a position inconsistent with settled principles of tax law. It is also unnecessary, in light of the anti-abuse rules which are already available to distinguish fraudulent transactions. The Article concludes that the Treasury's effort to disregard properly formed loan- outs through worker reclassification lacks a sound basis in policy and that it increases, rather than decreases, the inequities of the tax system.