When the Internal Revenue Code is silent or unclear on a particular tax issue or issues, the CPA must consult other authorities such as Treasury Regulations, Revenue Rulings and/or court decisions. Sometimes it may be necessary to support your position by using information from several tax authorities.

Kom Rhode is a CPP graduate who was a pre-veterinarian major with a CIS minor. She is a six- time Olympian from 1996 through 2016 and has won three gold medals, one silver and two bronze medals in sheet and trap events. In order to cope with the stress of Olympic Games, she developed an interest in designing action video games. She is certified by The Video Game Institute, an internationally recognized institution. Kim was recently hired by On Target Productions, Inc.

On Target Productions, Inc. treats one of its computer programmers, Kim Rhode, as an independent contractor. Kim Rhode’s one-year contract with On Target provides her with office space, secretarial support, a computer and software. Kim sets her own hours, but typically works 60 hours per week at On Target. Kim will not be receiving compensation from any other source during the contract period. The contract calls for Kim to develop six computer games for the pre-teen and teenage market. The contract requires Kim to program all six games herself (rather than hiring anyone else to program). Kim has full discretion as to the type of games. For example, at Kim’s discretion, one or more games could be related to a sport, show violence, have educational value, etc. Every two months, Kim is expected to complete a game and give it to On Target management for review, testing, production & distribution. On Target does not have the power to discharge Kim unless two or more program due dates are missed. On Target believes that Kim is motivated to perform well in order to obtain future contracts with On Target. However, there is no legal obligation for On Target to offer future contracts or for Kim to accept them.

If Kim’s software is commercially successful (i.e. many copies are sold), Kim will receive a significant royalty. During the 1-year development period, On Target pays Kim a $3,000 monthly “advance.” Yet, Kim could be earning at least $5,000 per month in salary as an employee of one of On Target’s competitors. The advances will be subtracted from Kim’s future royalties on the software. If there are no future royalties (i.e. the software does not sell) or if the royalties are not large enough to fully absorb the advances, Kim is still allowed to keep the advances. Kim does not have to repay On Target for any advances under any conditions.

Tax research question:

A) Is Kim an employee or an independent contractor for Federal employment tax purposes? Perform the necessary tax research and write a memorandum to the tax file supporting your decision. Advise On Target Productions in a client letter as to your research findings and recommendation.

Partial List of Resources –Revenue Ruling 1987-41, 1987-1 CB 296IRS Publication 15

B) Assume Kim is providing services to a California employer would Kim be an employee or independent contractor for California employment tax purposes? Perform the necessary tax research and write a memorandum to the tax file supporting your decision.