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February 28, 1996


The opinion of the court was delivered by: SAND


 Plaintiff corporation, 303 West 42nd St. Enterprises, operates an "adult entertainment" center known as Show World. The Internal Revenue Service assessed a deficiency against Show World for employment taxes on dancers working in Show World's one-on-one fantasy booths. Plaintiff paid part of the assessment and has instituted this action for refund. Plaintiff moves for summary judgment on its refund claim. The Government cross-moves for summary judgment on its counterclaim for employment taxes for all payroll periods during 1989 and 1990. We deny plaintiff's motion for summary judgment and grant the Government's motion for summary judgment.


 According to Show World's chief financial officer, the one-on-one booths account for 15-30% of the company's gross revenue. Deposition of Scott Wexler ("Wexler Dep".), June 29, 1994, at 18. The booths consist of two parts, with a glass partition separating the booth performer from the customer. As soon as the customer deposits a coin, the performer becomes visible, and the telephones become operational. What happens inside the booth is private, determined by the number of coins the customer deposits and conversation with the performer. During the time when the performer is visible to the customer the performer engages in a sexually provacative routine. See Footnote 5 infra, Notice of Motion, Exhibit 6, August 16, 1995.

 Many of these routines have set prices. Id. Patrons negotiate with the performers for the amount to be paid for the selected performance. The patron pays the performer directly by inserting money into a slot provided for this purpose. The performer keeps all of the monies so paid. In addition to these monies, the customer inserts coins into the deposit box in order to keep the window clear and the telephone operative. Show World sets the price of the tokens, sells them to its patrons, and sets the amount of time that each coin will allow the customer to communicate with the performer. Deposition of Audrey Metzger, June 21, 1994, 12-14. At the end of the day (or night), when the performer has finished her shift, the tokens are collected and the visual telephonic communicator is paid 40% of the coins deposited; Show World keeps the additional 60%. Wexler Dep. at 24. The performers are then asked to sign a purported lease agreement, which specifies that Show World may withhold the performer's 40% as a security deposit for the reservation of the booth for the rest of the week. Id. at 25.

 Show World argues that as a result of this lease, the visual telephonic communicators are tenants. In support of its contention that it enters into a landlord-tenant relationship, rather than an employer-employee relationship, Show World argues that its twenty-one booths are all similar. The performers rent the booths by paying a fee equal to 60% of the coins deposited in their booth boxes during their shifts. A lease agreement is signed by the performer after her first shift is completed. At that time, she is able to lease the booth for future shifts, although the record indicates that booths are never leased for more than a couple of days.

 Believing booth performers to be employees rather than tenants, on November 26, 1991, the Internal Revenue Service ("IRS") issued Show World a Notice of Deficiency in the amount of $ 268,313.26 for additional employment taxes and interest for all periods encompassing the 1989 and 1990 calendar years. Show World paid $ 24,296.74 in assessed deficiencies for the quarter ending December 31, 1989. Several weeks later, the adult entertainment company filed an administrative claim for a refund of the amount paid. Show World's claim for refund was denied by the IRS.

 By complaint dated June 24, 1993, Show World commenced the instant action seeking reimbursement of the $ 24,296.74 under the theory that a safe harbor provision, § 530 of the Revenue Act of 1978, prevents the government from treating Show World's booth performers as employees for the purpose of assessing employment taxes. In reply, the Government asserted that the safe harbor provision is inapplicable to Show World. The Government then filed a counterclaim against Show World for employment taxes in the amount of $ 249,773.79 plus interest for the quarters ending March 31, 1989, June 30, 1989, September 30, 1989, March 31, 1990, June 30, 1990, September 30, 1990 and December 31, 1990. Thereafter, plaintiff Show World moved for summary judgment on its refund claim and the Government cross-moved for summary judgment on its deficiency assessment.


 This case is before us on uncontested facts. The parties debate only whether, on the facts presented, the safe-harbor provision applies and whether visual telephonic communicators are employees under the tax code. As both motions thus turn wholly on questions of law, summary judgment is the appropriate vehicle for their resolution.

 A. The Employment Tax and Section 530

 The classification of workers as either employees or non-employees under the Internal Revenue Code determines both the nature and quantity of taxes imposed. If an employer-employee relationship exists, the employer is subject to social security taxes under the Federal Insurance Contributions Act (FICA) ( § 3101) and unemployment taxes under the Federal Unemployment Tax Act (FUTA) ( § 3301). If there is no employer-employee relationship, the employer is not subject to FICA and FUTA, rather, the worker pays self-employment taxes under the Self-Employment Contributions Act (SECA) ( § 1401-1403). *fn1"

 In addition to FICA and FUTA, the Internal Revenue Code requires employers to withhold Federal income taxes from employee paychecks in accordance with procedures proscribed by the Internal Revenue Service. Using the employee's Withholding Allowance Certificate and a table issued by the IRS, the employer computes the correct amount of Federal income withholding tax. The computation is based on the number of withholding allowances claimed, the employee's wages, and the frequency of payroll payments. Joint Committee Print, JCX-27-92, Present Law and Issues Relating to Misclassification of Employees and Independent Contractors for Federal Tax Purposes. If there is no employer-employee relationship, however, no income tax withholding is required.

 Historically, whether an employer-employee relationship existed was determined under a common law test. If the person contracting for the work had the "right to control not only the result of the service, but also the means by which that result is accomplished," the worker was an employee. Treas. Reg. 31.3401(c)(1)(b), cited in Committee Print; Rept. No 100-76, 100th Cong., 1st Session. At present, the term "employee" is defined by Section 3121(d) of the Code to include, "any individual who, under the usual common law rules applicable in determining the employer-employee relationship, has the status of an employee."

 In response to controversies over employment status between taxpayers and the IRS, Congress enacted section 530 of the Revenue Act of 1978 (P.L. 95-600). *fn2" Section 530 allows a taxpayer to treat a worker as a non-employee, regardless of the individual's actual status under the common law test discussed supra, as long as the taxpayer's treatment of the worker for tax purposes has been consistent and a reasonable basis exists for such treatment. A reasonable basis is considered to exist if the taxpayer reasonably relies on 1) judicial precedent; 2) a past failure of the IRS to raise such an employment tax issue on audit; and 3) "long-standing recognized practice of a significant segment of the industry in which such individual was engaged." 26 U.S.C. § 3401. In relevant part, section 530 states:

 If for purposes of employment taxes, the taxpayer did not treat an individual as an employee for any period, and in the case of periods after December 31, 1978, all Federal tax returns... required to be filed by the taxpayer with respect to such individual for such periods are filed on a basis consistent with the taxpayer's treatment of such individual as not being an employee, then for purposes of applying such taxes for such period with respect to the taxpayer, the individual shall be deemed not to be an employee unless the taxpayer had no reasonable basis for not treating such individual as an employee... A taxpayer shall in any case be treated as having a reasonable basis for not treating an individual as an employee for a period if the taxpayer's treatment for such period was in reasonable reliance on... "long-standing recognized practice of a significant segment of the industry in which such individual was engaged."

 The taxpayer has the burden of proving that he satifies the requirements for Section 530 relief. Springfield v. U.S., 873 F. Supp. 1403, 1412 (S.D. Cal, 1994); In re Arndt, 158 Bankr. 863, 870 (M.D. Fla. 1993). In an attempt to meet its burden, Show World relies upon the third prong of the reasonable basis test, long-standing industry practice, to assert that the safe harbor provisions of § 530 exempt it from FICA, FUTA and withholding taxes.

 Show World contends there is a long standing industry practice of treating visual telephonic communicators as anything but employees. Affidavit of Ron Martin, dated August 14, 1995, P4; Affidavit of Thomas Parron ("Parron Aff."), dated August 14, 1995, P8. But although there may be an industry practice of not treating these performers as employees, there is no long-standing practice of treating them as falling into another single specific category. Rather, the industry appears to utilize two classifications, tenant and independent contractor. Citing the practice of characterizing booth performers as either tenants or independent contractors, plaintiff has documented the adult entertainment industry's choice to classify its performers as non-employees for employment tax purposes.

 Show World has never treated its visual telephonic communicators as employees for employment tax purposes. As discussed previously, Show World contends that its performers are tenants who pay rent equal to 60% of the deposited coins, sign leases after the first shift, and lose a security deposit of their first days wages (40% of the coins) if they fail to appear for the future shifts contracted to in the lease. If the performer generates no revenue in her booth's coin box, there are no proceeds to divide and Show World gets no rent. A copy of the per diem lease appears in Exhibit 7 of Plaintiff's Notice of Motion. In the alternative, Show World contends that its booth performers, are independent contractors, purchasing their own props and costumes and charging their own rates for various performances agreed upon by the dancer and the customer.

 The relevant issue therefore is whether the safe harbor provision of § 530 protects a company whose alleged industry practice has been to characterize its workers as anything but employees without a consistent opinion as to a single other classification. Based upon the fact that 1) the industry cannot agree on a uniform practice and 2) the language and legislative history of 530 manifests an intent to rectify unfairness and surprise rather than provide a loop hole, this Court answers the question in the negative.

 No Single Industry Practice

 The evidence submitted indisputably demonstrates that no single long-standing industry practice exists. Show World primarily contends that its booth performers are tenants. In a December 23, 1991 letter, plaintiff's counsel alleged that each of its visual telephonic communicators was a tenant and that tenant treatment is "common in the industry." Notice of Cross-Motion, Ex. A, December 23, 1991, letter signed by Leonard Bailin; see also, Parron Aff. P6 ("For purposes of employment taxes, Show World did not treat any booth tenants as employees for any period."). Less than one month later, however, on January 15, 1992, plaintiff's counsel represented that the "entire industry" issues to booth performers Form 1099, the tax form distributed to independent contractors. Id. With evidence of both tenant and independent contractor treatment, it seems clear that the only classification on which the industry agrees is that of non-employee. *fn3" Indeed, it is undisputed that as far as a specific classification is concerned, there is no single long-standing practice in the adult entertainment industry of characterizing visual telephonic communicators. Plaintiff's 3G Statement P13.

 Legislative History of Section 530

 Historically, section 530 was enacted as a fairness provision. Joint Committee Print; JCX-27-92. It was designed to alleviate the burden employers faced when the IRS prevailed in reclassifying workers as employees. Reclassification often resulted in employer liability for substantial portions of employee FICA and withholding tax although the employee might have fully paid all liabilities for self-employment and income taxes. In light of this occurrence, Section 530 was promulgated to ease the employer's burden. As the Second Circuit noted in U.S. v. Mackenzie, 777 F.2d 811 (2d Cir. 1985) cert. denied, 476 U.S. 1169, 90 L. Ed. 2d 977, 106 S. Ct. 2889 (1986), "a good faith taxpayer who was determined to have made an honest mistake might be liable for enormous sums that should have been withheld from employee's paychecks but were instead paid to the workers. Thus, a limited safe haven was set up for those employers that manifested a 'reasonable basis' for their treatment of employees as independent contractors."

 Section 530 was not designed to aid an industry ambivalent about the particular employment classification of its workers. Rather, the statute was designed to protect those who in good faith reasonably relied on a specific practice of classification and were surprised to discover that the IRS took another view.

 The courts have distinguished between reasonable and unreasonable bases. Safe harbor protection was available to a business that provided hospitals with nurses to fill staffing needs when the business had consistently characterized the nurses as independent contractors and followed an industry-wide practice of doing so. Hospital Resource Personnel v. U.S., 860 F. Supp. 1557 (S.D. Ga. 1994). Safe harbor protection was not available "where various segments of an industry [were] using contradictory practices." Springfield at 1412.

 The lack of a single practice within the adult entertainment industry, combined with section 530's circumscribed nature and its underlying objective of mitigating the harshness of reclassification by preserving fairness, deprives Show World of safe harbor protection. Section 530 was simply not intended to be a loop hole for taxpayers bent on avoiding known tax ...

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