By John Stambaugh

Don Everhart was a contractor licensed by the city of Chicago. During the 2000 tax year he was hired by Ronald Muhammad to remodel Mr. Muhammad's rental property. This arrangement seems very straight forward and not subject to interpretation. But Everhart didn't see it that way and neither did the IRS, consequently they went to United States Tax Court to settle their differences.

Muhammad and Everhart entered into an oral contract for Everhart to remodel and rehabilitate Muhammad's rental property. To finance the project Muhammad obtained a rehabilitation loan of about $33,000 from Wells Fargo Bank. On his loan application Muhammad listed Everhart as the general contractor.

In August and October Wells Fargo issued checks jointly payable to Muhammad and Everhart totaling about $33,000. Both men endorsed the checks, and Muhammad deposited them into his personal checking account. Wells Fargo issued a 2000 tax year Form 1099 in the amount of about $33,000 to Everhart. The $33,000 was shown on the Form 1099 as nonemployee compensation.

During 2000 Muhammad paid Everhart via checks on Muhammad's personal checking account about $24,000. In August 2000 Don Everhart signed a document acknowledging his receipt of $28,000 for labor and material furnished for the renovation of Muhammad's rental property.

The IRS audited Everhart's 2000 income tax return and noticed he had not reported the $33,000 Form 1099 issued to him by Wells Fargo in his tax return. Everhart stated what he received from Muhammad was not income. Instead, he argued because of the contractor relationship he (Everhart) was merely a conduit between Muhammad and the subcontractors that had been hired to do the work.

In tax court Everhart tried to make the case he functioned merely as a conduit through which Muhammad purchased labor and material for the renovation project. The result, he argued, was payments he received from Muhammad were not taxable to him.

The tax court judge pointed out Everhart failed to provide any legal basis for his position being a contractor resulted in him being merely "conduit." Instead, the tax court cited Code Section 61, which defines gross income as "all income from whatever source derived."

The tax court noted even if Everhart was right in his "conduit" argument he still would have to substantiate the money he received was not includable in his 2000 income tax return. There was no such substantiation.

The tax court judge noted Everhart had a loose working relationship with Muhammad and would supply sums of money Everhart would use to pay off renovation expenses. Any money left over was surplus or profit and was Everhart's to keep.

The tax court ruled Everhart was in the trade or business of being a contractor. The funds he received from Muhammad were Everhart's to do with as he would. The fact he paid the renovation expenses and kept any surplus was simply the definition of being in a business.

Everhart's lack of basic knowledge about tax law resulted in a big loss in tax court. He found out his "conduit" theory had no legal basis and no support in the tax law.

Stambaugh is a local certified public accountant with more than 18 years experience in business tax planning and tax preparation and a master's degree. He can be reached at 234-2438.

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