T.C. Memo. 1995-555

UNITED STATES TAX COURT

ERTAN AND SUSAN EREN, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

 Docket No. 866-94. Filed November 21, 1995.

 James Daniel McCarthy, for petitioners.

 Aretha Jones, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

JACOBS, Judge: Respondent determined a $15,459 deficiency in

petitioners' 1989 Federal income tax. The sole issue for decision

is whether petitioner Ertan Eren's 1989 income from the U.S.

Department of State, Office of Foreign Buildings Operations (FBO),

qualifies for the section 911 foreign earned income exclusion.
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1 All references to petitioner in the singular will be to

Ertan Eren.

Petitioners' entitlement to such exclusion depends upon the

classification (independent contractor vis-a-vis employee) of

Ertan Eren's employment relationship with FBO during the year under

consideration. For the reasons set forth herein, we hold that such

relationship was that of an employee with the consequence that

petitioners are not entitled to the claimed section 911 foreign

earned income exclusion. 

All section references are to the Internal Revenue Code for

the year under consideration, and all Rule references are to the

Tax Court Rules of Practice and Procedure.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The

stipulation of facts and the attached exhibits are incorporated

herein by this reference.

Background

Petitioners Ertan and Susan Eren, husband and wife, resided in

Rockville, Maryland, at the time they filed their petition. They

filed a joint Federal income tax return for 1989. 

Ertan Eren is an architect1. He resided in Bogota, Colombia,

from July 1988 through June 1990. At that time, he worked for FBO

as project director for the construction of an annex to the U.S.

Embassy in Bogota. 
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2 The term "project manager" and "project director" are

used interchangeably herein.

Petitioner's Contracts with FBO

During the late 1970's and early 1980's, petitioner rendered

architectural services to FBO on an "as needed" basis under a labor

hour contract for various FBO projects in Brazil. He signed his

first personal service contract (PSC) with FBO in 1983, and has

been performing services solely for FBO since that time. His

subsequent contracts with FBO have been renewed, modified, or

renegotiated on an annual basis. 

On March 6, 1984, petitioner and FBO signed a contract

designating petitioner as the project manager2 with respect to the

improvements and repairs at the U.S. Embassy in Ankara, Turkey, and

other U.S. foreign service posts. Petitioner worked in Turkey for

a number of years under modified versions of this PSC. In July

1988, he was transferred from Turkey to Bogota. 

Petitioner's contract with FBO, as in effect during 1989,

states in part: "The Project Manager will inspect construction,

improvements and/or repairs at project sites and will be directly

responsible to FBO in the performance of his duties under this

contract." The contract provides that petitioner will "Perform

appropriate functions and obligations in accordance with procedures

or other directives issued by the Contracting Officer or his

designee." 
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3 Petitioner had substantial control over the contractor

hired to build the annex. He was able to order work redone or

stopped because of the contractor's failure to follow accepted

safety procedures or project specifications without prior FBO

approval. Before authorizing FBO to pay the contractor,

(continued...)

Petitioner's Duties in Bogota

As project director for the Bogota annex, petitioner was

responsible for the inspection and supervision of the construction

of such annex. He was not subject to daily supervision by FBO.

FBO provided petitioner with a "Project Director's Handbook",

which he was to use as a guide in performing his duties.

Petitioner was required to personally perform his duties to FBO on

a full-time basis. He was required to work a minimum of 40 hours

a week; however, he typically worked longer hours. Petitioner was

not paid for the extra hours he worked.

FBO provided petitioner with all requisite contract documents,

specifications, and drawings for the annex construction.

Petitioner did not have authority to change the documents. 

Petitioner was appointed a contracting officer's technical

representative (COTR) pursuant to a memorandum dated November 10,

1988. The memorandum outlined 11 specific duties and activities

that petitioner had to perform as COTR. Primarily, petitioner was

required to insure that all materials furnished, and the work

performed, on the Bogota annex project were in accordance with the

contract specifications and that the work progressed on schedule.3
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3(...continued)

petitioner inspected the job site to ensure that the contractor

was performing satisfactory work. 

Petitioner was required to maintain a daily log describing the work

progress on the construction site. 

Pursuant to a February 21, 1989, memorandum that supplemented

the November 10, 1988, memorandum, petitioner was given authority

to substitute materials, equipment, and/or products for the

construction of the Bogota annex so long as they were equal to or

better than those specified in the contract, and the substitution

did not entail an additional cost to the government.

 During the year under consideration, petitioner was required

to submit two types of monthly reports regarding the progress of

the construction of the Bogota annex to the FBO area branch chief

for construction management. One was a telegraphic report that

had to be sent before the 10th of each month; the other was a

written report kept in book form. The reports included statements

of progress and problems incurred or anticipated in the

construction of the annex. FBO had the right to terminate

petitioner's contract if he failed to submit these monthly reports.

The Bogota Project Budget

When petitioner was assigned to a project post, he was

required to prepare a budget proposal and submitted it to FBO for

approval. With regard to the Bogota annex project, FBO approved
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4 Home leave is a mandatory Department of State leave for

foreign service workers. 

petitioner's request for $250,000 for 1989. Although petitioner

did not have authority to exceed the approved budget, he could

allocate approved budget funds as necessary. 

The $250,000 budget for 1989 did not include petitioner's

$74,000 salary. His biweekly salary was based on a Government

schedule (the Foreign Service Schedule). Petitioner did not

receive any per diem in 1989.

Petitioner had the authority to hire and fire his staff

without FBO approval. He hired several workers who entered into

contracts with FBO and were paid by FBO. 

PSC Provisions

Petitioner did not receive standard Government employee

benefits such as life insurance and retirement benefits under the

terms of his 1989 PSC. Rather, 5 percent of his compensation was

allocated for purchasing health insurance. Petitioner received home

leave,4 sick leave, and annual leave. 

Department of State Directives and Memorandum 

Two FBO directives required that personal service contractors

be treated as employees. The first directive, issued July 7, 1987,

refers to the Foreign Affairs Manual, which states that "a personal

service contractor is not eligible for the 'foreign earned income

exclusion'". The second, issued July 7, 1987 (and revised on
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5 The maximum amount permitted for the earned income

exclusion was $70,000. 

 

6 Form 2555, Foreign Earned Income, attached to

petitioners' 1989 return, reported foreign earned income of

$74,183, and listed "name of employer" as "self". 

December 4, 1987, and December 20, 1988), provides that overseas

PSC's treat a contractor as an FBO government employee for all

purposes except retirement. 

Petitioner was notified by a December 12, 1989, FBO memorandum

that as a result of an Internal Revenue Service review of FBO

personnel policies, it was determined that PSC's signed by FBO

contractors created an employee-employer relationship between the

parties and that petitioner should designate himself as an FBO

employee (rather than as an independent contractor) on his 1989

Federal income tax return. 

Subsequent to the issuance of this memorandum, FBO issued

petitioner a Form W-2 for "wages, tips and other compensation" in

the amount of $74,183.04. FBO withheld Social Security tax from

petitioner's income in the amount of $3,604.80. 

Petitioners' 1989 Federal Income Tax Return

On petitioners' 1989 Form 1040, petitioners reported $74,183

as "business income" on line 12 and then subtracted $70,0005 on

line 22 ("other income") with the notation "Exclusion from Form

2555."6 Thus, petitioner claimed a section 911 exclusion for a
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substantial portion of the compensation he received from FBO.

Respondent disallowed the claimed exclusion.

Petitioner also calculated self-employment tax on Form SE in

the amount of $6,250. Respondent concedes that petitioner is not

liable for self-employment tax if we hold that he was an employee

of FBO in 1989. 

ULTIMATE FINDING OF FACT

Petitioner was an FBO employee in 1989. 

OPINION

At issue is the characterization for tax purposes of

petitioner's relationship with FBO during 1989. Petitioner argues

that his relationship with FBO in 1989 was that of an independent

contractor and therefore petitioners are entitled to exclude

$70,000 of his 1989 income from FBO as "foreign earned income"

within the purview of section 911(b)(1)(B)(ii). Respondent

contends that petitioner's relationship with FBO in 1989 was that

of an employee and therefore petitioners are not entitled to the

exclusion. 

Section 911 provides in relevant part: 

(a) Exclusion from Gross Income.--At the election

of a qualified individual (made separately with

respect to paragraphs (1) and (2)), there shall be

excluded from the gross income of such individual,

and exempt from taxation under this subtitle, for

any taxable year--

(1) the foreign earned income of 

such individual, and 
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7 Sec. 31.3401(c)-1(b), Employment Tax Regs., defines an

(continued...)

(2) the housing cost amount of such

individual. 

(b) Foreign Earned Income.--

(1) Definition.--For purposes of this section--

(A) In General.--The term "foreign

earned income" with respect to any

individual means the amount received by

such individual from sources within a

foreign country or countries which

constitute earned income attributable to

services performed by such individual

during the period described in

subparagraph (A) or (B) of subsection

(d)(1), whichever is applicable.

(B) Certain Amounts Not Included In

Foreign Earned Income.--The foreign

earned income for an individual shall not

include amounts--

* * * * * * * 

(ii) paid by the United

States or an agency thereof

to an employee of the United

States or an agency thereof *

* *

The term "employee" is not defined in the Code; therefore,

common law rules must be applied to determine whether an individual

is an employee. Nationwide Mut. Ins. Co. v. Darden, 503 U.S. 318,

322 (1992); Matthews v. Commissioner, 92 T.C. at 351, 360 (1989),

affd. 907 F.2d 1173 (D.C. Cir. 1990); Simpson v. Commissioner, 64

T.C. 974, 984 (1975). Whether an employer-employee relationship7
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7(...continued)

employer-employee relationship as follows:

(b) Generally the relationship of employer

and employee exists when the person for whom

services are performed has the right to

control and direct the individual who

performs the services, not only as to the

result to be accomplished by the work but

also as to the details and means by which

that result is accomplished. That is, an

employee is subject to the will and control

of the employer not only as to what shall be

done but how it shall be done. In this

connection, it is not necessary that the

employer actually direct or control the

manner in which the services are performed;

it is sufficient if he [or she] has the right

to do so. The right to discharge is also an

important factor indicating that the person

possessing that right is an employer. Other

factors characteristic of an employer, but

not necessarily present in every case, are

the furnishing of tools and the furnishing of

a place to work to the individual who

performs the services. In general, if an

individual is subject to the control or

direction of another merely as to the result

to be accomplished by the work and not as to

the means and methods for accomplishing the

result, he [or she] is not an employee.

exists is a question of fact. Air Terminal Cab, Inc. v. United

States, 478 F.2d 575, 578 (8th Cir. 1973); Professional & Executive

Leasing, Inc. v. Commissioner, 89 T.C. 225, 232 (1987), affd. 862

F.2d 751 (9th Cir. 1988). If an employer-employee relationship

exists, its characterization by the parties as some other

relationship, such as independent contractor, is of no consequence.

Sec. 31.3121(d)-1(a)(3), Employment Tax Regs. 
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8 The parties cite Rev. Rul. 87-41, 1987-1 C.B. 296,

which lists 20 factors to consider in determining whether a

common law employer-employee relationship exists. Many of these

factors are incorporated into this Court's seven factors. 

This Court has enumerated the following factors8 in

determining whether an employee-employer relationship exists: (1)

The degree of control exercised by the principal over the details

of the work; (2) which party invests in the facilities used in the

work; (3) the opportunity of the individual for profit or loss; (4)

whether the principal has the right to discharge the individual;

(5) whether the work is part of the principal's regular business;

(6) the permanency of the relationship; and (7) the relationship

the parties believe they are creating. Weber v. Commissioner, 103

T.C. 378, 387 (1994), affd. per curiam 60 F.3d 1104 (4th Cir.

1995); Professional & Executive Leasing, Inc. v. Commissioner, 89

T.C. at 232; Simpson v. Commissioner, supra at 984-985; see also

United States v. Silk, 331 U.S. 704, 716 (1947). No single factor

is dispositive. Simpson v. Commissioner, supra at 985. All of the

facts and circumstances must be studied. Professional & Executive

Leasing, Inc. v. Commissioner, supra at 232. 

While all of the above factors are important, the "right-tocontrol" is the "master test" in determining the nature of a

working relationship. Matthews v. Commissioner, 92 T.C. at 361.

Both the control exercised by the alleged employer and the degree

to which the alleged employer may intervene to impose control must
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be examined. Radio City Music Hall Corp. v. United States, 135

F.2d 715, 717 (2d Cir. 1943); deTorres v. Commissioner, T.C. Memo.

1993-161. "[N]o actual control need be exercised, as long as the

employer has the right to control." Professional & Executive

Leasing, Inc. v. Commissioner, 862 F.2d at 753. In order for an

employer to retain the requisite control over the details of an

employee's work, the employer need not direct each step taken by

the employee. Professional & Executive Leasing, Inc. v.

Commissioner, 89 T.C. at 234; Gierek v. Commissioner, T.C. Memo.

1993-642. The exact amount of control required to find an

employer-employee relationship varies with different occupations.

United States v. W. M. Webb, Inc., 397 U.S. 179, 192-193 (1970).

In fact, the threshold level of control necessary to find employee

status is in most circumstances lower when applied to professional

services than when applied to nonprofessional services. Azad v.

United States, 388 F.2d 74, 77 (8th Cir. 1968); Professional and

Executive Leasing, Inc. v. Commissioner, supra at 234. "From the

very nature of the services rendered by * * * professionals, it

would be wholly unrealistic to suggest that an employer should

undertake the task of controlling the manner in which the

professional conducts his activities." Azad v. United States,

supra; Weber v. Commissioner, 103 T.C. at 388. An alleged

employer's control "must necessarily be more tenuous and general
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9 While petitioner had to pay for his own health

insurance and did not accrue retirement benefits, we do not

believe such facts preclude a holding that petitioner was an FBO

employee. 

than the control over nonprofessional employees". James v.

Commissioner, 25 T.C. 1296, 1301 (1956). 

We begin our analysis of the seven factors enumerated above

with the control factor. The record contains numerous

illustrations of FBO's right to control petitioner and its actual

control over him. Petitioner's contract with FBO during the year

under consideration stated that petitioner "will be directly

responsible to FBO in the performance of his duties under this

contract." While petitioner was permitted to hire and fire his

staff, and order substitutions of materials, FBO did not permit him

to deviate from the construction documents or exceed the budget.

Further, he was required to follow a Project Director's Handbook.

FBO also controlled petitioner by dictating his hours, pay,

and leave. FBO required petitioner to work full time, a minimum of

40 hours a week. Petitioner's biweekly FBO salary was based on

the Foreign Service Schedule. In addition to his salary, FBO

permitted petitioner to earn and accrue home leave, annual leave,

and sick leave.9

Petitioner also was required to maintain a daily log of the

progress of the construction project, and submit both oral and

written reports to FBO. These monthly reports were not optional;
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10 Petitioner argues that he was not an employee because

he scheduled his own daily activities. We believe that

petitioner's ability to schedule his activities only demonstrates

that in connection with professionals less supervision is

necessary. See Azad v. United States, 388 F.2d 74, 77 (8th Cir.

1968).

if petitioner failed to submit such reports, FBO had the right to

terminate his contract. 

We are satisfied that petitioner was subject to substantial

control by FBO. Although petitioner worked for FBO in a

professional capacity, which would limit the amount of control FBO

had over petitioner's day-to-day activities,10 FBO dictated the

contract documents and drawings, budget, hours, and monthly reports

with which petitioner was required to comply. We therefore

conclude that FBO had the right to exercise control over petitioner

and in fact exerted a substantial amount of control over him. See

James v. Commissioner, supra. 

We now turn to the other factors. With respect to the second

factor, petitioner had no investment in the work facilities;

rather, FBO provided petitioner with office space and staff

assistance. See Professional & Executive Leasing v. Commissioner,

89 T.C. at 234. FBO entered into contracts with petitioner's staff

and paid their salaries. 

As to the third factor, petitioner had no opportunity for

profit or loss. The pay he received depended only upon the number
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of days he worked. The amount FBO paid petitioner was not

dependent upon completion of the project. 

As to the fourth factor, while FBO had the right to discharge

petitioner without cause with a 30-day notice, petitioner also

could terminate the contract.

As to the fifth factor, FBO was in charge of constructing U.S.

Government buildings overseas. Petitioner's assignment in Bogota

during the year under consideration was to oversee the construction

of an annex to the U.S. Embassy. This type of work was clearly

within the scope of FBO's regular business. 

As to the sixth factor, we believe that the relationship

between petitioner and FBO was intended to be somewhat permanent as

opposed to transitory. Petitioner had been working solely for FBO

since 1983. He was required to personally perform the services of

project director designated in his contract with FBO. He did not

offer his services to the public and did not perform services for

any individual or entity other than FBO, as would an independent

contractor. See Jacobs v. Commissioner, T.C. Memo. 1993-570;

Casety v. Commissioner, T.C. Memo. 1993-410; Gamal-Eldin v.

Commissioner, T.C. Memo. 1988-150, affd. without published opinion

876 F.2d 896 (9th Cir. 1989). 

Finally, as to the seventh factor, the type of relationship

the parties intended to create when they signed various

modifications to petitioner's contract is not clear. However, in
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December 1989, FBO provided petitioner with a Form W-2 and withheld

Social Security tax from petitioner's income. This, in our

opinion, indicates that FBO intended to create an employer-employee

relationship. See, e.g., Juliard v. Commissioner, T.C. Memo. 1991-

230. Further, FBO Policy and Procedures Directives in effect

during the year under consideration provided that a personal

services contractor is not eligible for the foreign earned income

exclusion, and that overseas PSC's treat the contractor as an FBO

government employee for all purposes except retirement. And,

petitioner was advised by the December 12, 1989, FBO memorandum

that he should designate himself as an FBO employee on his 1989

return. 

After considering all the facts and circumstances present in

this case, we conclude that petitioner was an FBO employee in 1989.

Therefore, petitioners are not entitled to the foreign earned

income exclusion under section 911(a) for such year.

To reflect the foregoing and respondent's concession,

 Decision will be entered

 under Rule 155.