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'Attorney Incubator' Firm is Employer, Must Pay Employment Taxes

By Robyn Hagan Cain on April 04, 2012 | Last updated on March 21, 2019

Leave it to a lawyer to argue that associates are independent contractors and a law firm is an "attorney incubator" for tax purposes.

No judgment, mind you. We appreciate any creative argument to limit tax liability.

The Fifth Circuit Court of Appeals, however, does not share our appreciation for inventive ways of avoiding employment taxes. Recently, the New Orleans-based court ruled in an unpublished opinion that a Baton Rouge law firm's associates were employees -- not independent contractors -- for tax purposes, according to Forbes.

The petitioner in this case, Donald G. Cave, A Professional Law Corp., (Firm) was an S-corporation for federal income tax purposes in 2003 and 2004. Donald G. Cave, the attorney and sole owner behind the S-Corp, maintained an active trial practice with the Firm. He also performed employer-type services for the Firm, like hiring workers, (e.g. attorneys, law clerks, and support staff), setting support staff hours, determining compensation and bonuses, and approving payroll.

Donald Cave considered the Firm an "attorney incubator" because he hired recent law school graduates with little prior professional experience. There are several facts that support his contention. The Firm exercised "little control over the associates, who were not required to work from the Firm's principal office, to work set hours, or to account for their time. Associates didn't have written employment contracts or noncompete agreements.

There's also plenty of evidence to support the government's associates-were-employees position.

  • There is no indication that the associates had clients or cases outside of the Firm.
  • None of the associates had clients or cases prior to starting at the Firm.
  • Cave referred cases to associates to help them develop their practices, and the associates occasionally worked on Cave's cases.
  • The associates received incentives for bringing in clients.
  • Fees that the associates generated helped pay the Firm's expenses.

The Internal Revenue Service went after the Firm for failure to pay employment taxes; the Firm asserted its "attorney incubator" and 'we're-all-just-contractors' theories, which both failed. The tax court, which must give deference to the IRS Commissioner's determinations, agreed that Cave and the associates were the Firm's employees.

The Fifth Circuit Court of Appeals affirmed the decision, concluding that the tax court did not clearly err in its determination that the Firm's associates were employees rather than independent contractors.

If you wanted to facilitate an actual attorney-contractor relationship, here are a few things the Fifth Circuit has indicated that you should avoid:

  • Fronting attorney expenses (e.g., food, travel, bar dues).
  • Providing all office space, equipment, and support staff.
  • Long-term, continuous relationships with contractors.

Our advice: Don't set up an attorney incubator populated with contractors-in-name-only just to avoid employment taxes; the IRS will find you and make you pay. Like they always do.

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