In Morello v. Commissioner, No. C314603 (Sept. 8, 2014), the Massachusetts Appellate Tax Board (MATB) determined that the Commissioner of Revenue (Commissioner) had correctly concluded that an individual working as a loan originator was not an independent contractor and did not qualify as an outside salesperson. Therefore, she could not deduct business expenses or unreimbursed employee-business expenses (from her state income tax return).
Wendy J. Morello (Ms. Morello) worked as a loan originator for Heritage Mortgage Company, Inc. (Heritage). When she filed her Massachusetts income tax returns, she deducted certain expenses on Schedule Y as unreimbursed business expenses. The expenses deducted consisted of:
- Mileage, for commuting between her home and Heritage’s office and travel between Heritage’s office and business appointments;
- Meal and entertainment expenses;
- Client gifts;
- Dry cleaning and cell phone bills; and
- Marketing and bank fees.
The Commissioner disallowed these deductions and assessed Ms. Morello $2,902.43 in tax and accrued interest for 2005, 2006, and 2007. Ms. Morello appealed such determination to the MATB.
The issue raised to the MATB is whether Ms. Morello worked as an independent contractor for Heritage, allowing her to deduct ordinary and necessary business expenses. If Ms. Morello was not an independent contractor and worked as an employee of Heritage, then the MATB had to determine whether she qualified as an “outside salesperson” for Massachusetts tax purposes, entitling her to deduct unreimbursed employee business expenses associated with her employment at Heritage.
The MATB findings and opinion
In evaluating whether Ms. Morello worked as an employee of Heritage or as an independent contractor, the MATB found that Ms. Morello was not an independent contractor and was instead an employee of Heritage. In reaching this conclusion, the MATB relied on the following facts:
- Ms. Morello’s state tax returns were consistent with being an employee. All income from Heritage was reported on Form W-2, she reported expenses on Schedule Y (the Massachusetts form for employee business expense deductions), not on Schedule C (as profit or loss from a business), and Heritage withheld taxes from her wages.
- Heritage provided training, sponsorship (including a bond for liability), and the use of office equipment, such as a computer and fax machine, to Ms. Morello.
- Heritage described Ms. Morello as an employee who worked full-time and was entitled to, but waived her right to, receive medical benefits.
- Ms. Morello sought to establish her own “book of business” consisting of realtors and attorneys who would refer business to her, but failed to establish that she engaged in these activities on a sufficiently regular, consistent, and continuous basis as required to meet the standard of a trade or business. Ms. Morello claimed no income from building a personal book of business referrals.
- Ms. Morello’s travel logs and other records displayed many internal inconsistencies and the Commissioner was often unable to determine whether meetings had a specific business purpose.
- The MATB was unpersuaded by Ms. Morello’s statement that, while she was a licensed loan officer required to be sponsored by a company, she was free to disassociate herself from her sponsor and choose another sponsor at any time.
Having determined that Ms. Morello was an employee of Heritage, the MATB considered whether she qualified as an “outside salesperson” enabling her to deduct unreimbursed employee-business expenses. An analysis conducted by the Commissioner of Ms. Morello’s travel logs revealed that she spent only about 13 to 15 percent of her time working on outside sales activities for Heritage, which included client meetings and real estate closings. The MATB determined that the amount of time she spent visiting realtors and attorneys to build her own personal book of business, which activities were not at the request of Heritage, did not qualify as outside sales activities. The MATB determined that the amount of time Ms. Morello spent on qualifying outside sales activities was insufficient for her to be treated as an outside salesperson who regularly “solicited business for the employer away from the employer’s place of business.” Thus, deductions of unreimbursed employee expenses were denied by the MATB.
Lastly, the MATB determined that as an employee of Heritage, Ms. Morello was only able to deduct transportation expenses between her regular place of employment, Heritage, and her outside meetings specifically related to the performance of her job with Heritage.
There is often a fine line between being an independent contractor or employee. Therefore, if you intend to qualify as an independent contractor, it is important that any company you are working for treats you as an independent contractor. For example, in this case, it was very detrimental to Ms. Morello’s argument that she received a Form W-2 and was offered medical benefits, which are consistent with status as an employee of the company, not as an independent contractor.
Furthermore, the Morello case demonstrates the importance of being able to properly substantiate any business expenses. A reading of this case indicates that even if the MATB had determined that Ms. Morello was an independent contractor, it is likely that many of her claimed business expenses would have been denied for lack of proper substantiation.