NELLY LLC v. UNITED STATES OF AMERICA, INTERNAL REVENUE SERVICE
MEMORANDUM AND/OR OPINION SIGNED BY HONORABLE TIMOTHY J. SAVAGE ON 4/19/17. 4/20/17 ENTERED AND COPIES E-MAILED.(ti, )
IN THE UNITED STATES DISTRICT COURT
FOR THE EASTERN DISTRICT OF PENNSYLVANIA
NELLY HOME CARE, INC.
UNITED STATES OF AMERICA
UNITED STATES OF AMERICA
April 19, 2017
In this dispute over a $4,000 tax refund, Nelly Home Care, Inc. and Nelly LLC
(collectively “Nelly”) move for an award of $100,180.15 for attorney’s fees and costs
pursuant to 26 U.S.C.A. § 7430(a).1 Nelly contends it is entitled to the fees and costs
because it won on summary judgment. The government argues that, even though the
plaintiffs were successful, Nelly is not a prevailing party under the statute because the
government’s position was “substantially justified.”
We conclude the government was substantially justified in its position.
Consequently, Nelly is not entitled to attorney’s fees under § 7430(a). Therefore, we
shall deny Nelly’s motion.
Nelly sued the United States for a refund of the employer’s share of employment
taxes in the total amount of $4,000 paid between 2008 and 2012.2 Nelly claimed it was
The two Nelly companies each brought an action.
See Compl. (Civ. A. No. 15-439, Doc. No. 1); Compl. (Civ. A. No. 15-444, Doc. No. 1).
Documents from the record refer to Civ. A. No. 15-444, unless otherwise noted.
entitled to safe harbor relief under Section 530 of the Revenue Act of 1978 because it
had a reasonable basis for treating its workers as independent contractors rather than
employees.3 After discovery, Nelly moved for summary judgment and Judge Dalzell
granted the motion.
The parties did not dispute the material facts.
Helen Carney formed and
managed both Nelly LLC and its successor, Nelly Home Care, Inc.4 Both companies
were providers of home health care services, matching companions with elderly clients.5
Carney herself was a companion before starting her own business.6 While working as a
companion, she learned that some home care service providers treated their workers as
After forming Nelly LLC in 2004, Carney conducted a survey of twenty home care
companies to determine how they classified their companions for tax purposes.8 Seven
of these companies classified companions as independent contractors.9 The remaining
companies treated them as employees.
Shortly after Carney incorporated Nelly Home Care, Inc. in 2009, she attended a
mandatory conference at the Pennsylvania Department of Health.10 At the conference,
Compl. ¶ 20.
Carney Dep. (Doc. No. 13-3) at 12:11–24, 17:20–25.
Id. at 100–112.
Id. at 37:7–10.
Id. at 186:8–15, 278:2–12.
Mot. for Summ. J. Ex. 16 (Doc. No. 13-3).
Id.; see also Gov’t. Resp. (Doc. No. 22) at 9.
Carney Dep. at 210.
Carney was told that home care registries, the classification under which Carney
registered Nelly Home Care, Inc., treated workers as independent contractors.11
In the meantime in 2007, the IRS audited Carney’s personal income tax returns
for the 2004 and 2005 tax years relative to her reported income and expense
Carney provided the IRS with information about Nelly LLC, including
documents relating to gross receipts, expenses, and copies of independent contractor
agreements.13 As a result of the audit, the IRS concluded Carney had underreported
her income, commingled business and personal accounts, and charged 80% of her
personal expenses through Nelly LLC.14
Consequently, the IRS adjusted Carney’s
personal tax liability.
The IRS again audited Carney’s personal income tax returns in 2011. This time,
the audit was resolved with a “no change” determination.15
The IRS later commenced an employment tax audit of Nelly LLC and Nelly Home
Care, Inc.16 It determined that both companies owed a combined total of $4,000 in back
employment taxes for tax years 2008–2012.17 Nelly paid the tax and promptly sought a
refund.18 After hearing nothing from the IRS for six months, Nelly initiated this action,
Mot. for Summ. J. Ex. 10 (Doc. No. 13-3); see also 28 Pa. Code § 611.5.
Id. Ex. 5.
Id.; see also Decl. of Revenue Agent Seong Y. Lee (Lee Decl.) (Doc. No. 22-2) ¶ 5.
Lee Decl. at ¶ 5.
Decl. of Revenue Agent Benjamin Hosford (Doc. No. 22-3) ¶ 3.
Decl. of Revenue Agent Tara Wigginton (Doc. No. 22-4) ¶ 2.
Compl. ¶¶ 11–14.
claiming it was entitled to relief under the safe harbor provisions of Section 530 of the
Revenue Act of 1978.19
To invoke the safe harbor of Section 530, the taxpayer must establish that it had
a reasonable basis for treating the worker as an independent contractor based on
either: (1) legal precedent; (2) a prior audit; or (3) a recognized practice of a significant
segment of the relevant industry. Nu-Look Design, Inc. v. C.I.R., 356 F.3d 290, 294 (3d
In addition to these statutory bases, there is a judicially created “any
reasonable basis” safe harbor. See Boles Trucking, Inc. v. United States, 77 F.3d 236,
239 (8th Cir. 1996). If the employer-taxpayer establishes any of these bases, it is
relieved from liability for paying the employer’s share of employment taxes for a worker
it had incorrectly treated as an independent contractor.20
The government argued that Nelly did not meet any of the statutory safe
harbors.21 First, it argued Nelly failed to meet the industry practice safe harbor because
it did not demonstrate that a significant portion of the home health care services industry
classified workers as independent contractors.22 Second, it contended that the prior
audit safe harbor did not apply because Nelly was not the taxpayer audited in 2007,23
which is a requirement for the prior audit safe harbor provision of Section 530.
The government also argued that Nelly failed to establish any reasonable basis
for treating its workers as independent contractors to satisfy the judicially created safe
See, e.g., Mot. for Summ. J. (Doc. No. 13).
Nelly did not argue that it was entitled to the legal precedent safe harbor of Section 530.
Gov’t Resp. at 19.
Id. at 14.
harbor.24 To support its position, the government emphasized that Nelly had obtained
worker’s compensation insurance for its companions, which is typically provided for
employees and not independent contractors,25 and it had failed to obtain advice from an
accountant or lawyer on how to classify its workers.26
Judge Dalzell granted Nelly’s motion for summary judgment. He concluded that
although Nelly was not protected by the statutory industry practice or prior audit safe
harbors, Nelly had a reasonable basis for treating its companions as independent
In reaching this conclusion, Judge Dalzell considered the cumulative
effect of Carney’s experience and research, the personal IRS audits which included a
review of Nelly’s business practices, and Pennsylvania regulations. He found that these
factors together provided a reasonable basis for Nelly’s decision to classify companions
as independent contractors.28 Accordingly, he entered judgment in favor of Nelly and
against the government in the amount of $4,000.00.
In proceedings brought against the government for tax refunds, “the prevailing
party may be awarded a judgment or a settlement for (1) reasonable administrative
costs incurred in connection with such administrative proceeding within the Internal
Revenue Service, and (2) reasonable litigation costs incurred in connection with such
court proceeding.” 26 U.S.C.A. § 7430(a).
Id. at 22.
Saiz Decl. (Doc. No. 22-1) ¶ 5.
Carney Dep. at 137–38.
Nelly Home Care, Inc. v. United States, 185 F. Supp. 3d 653, 660 (E.D. Pa. 2016); see also
Mem. Op. (Doc. No. 25). Judge Dalzell did not consider whether Nelly was entitled to Section 530’s legal
precedent safe harbor because Nelly did not argue that it was a basis for granting it relief.
Id. at 10–11.
The statute defines a prevailing party as “any party . . . which . . . has
substantially prevailed with respect to the amount in controversy, or . . . substantially
prevailed with respect to the most significant issue or set of issues presented.” 26
U.S.C.A. § 7430(c)(4)(A). However, there is an exception. Where the United States is
a defendant and establishes that its position in the proceeding was substantially
justified, the plaintiff is not treated as a prevailing party even though the plaintiff
prevailed. 26 U.S.C.A. § 7430(c)(4)(B). The United States bears the burden of showing
that its position was substantially justified. Ctr. for Family Med. v. United States, 614
F.3d 937, 941 (8th Cir. 2010).
“Substantially justified” means the government had a reasonable basis in both
law and fact. Pierce v. Underwood, 487 U.S. 552, 565 (1988). The position taken need
not have been correct, only reasonable.
In determining whether the government’s position was substantially justified, the
court first considers “the available objective indicia of the strength of the Government’s
position.” Nat’l Org. for Marriage, Inc. v. United States, 807 F.3d 592, 597 (4th Cir.
2015) (quoting United States v. Paisley, 957 F.2d 1161, 1166 (4th Cir. 1992)); see also
Gonzalez v. Free Speech Coal., 408 F.3d 613, 618 (9th Cir. 2005). Objective indicia
include the terms of any settlement, the stage of litigation where the merits were
decided, and the views of other courts on the merits. Pierce, 487 U.S. at 568. If the
objective indicia are inconclusive, the court makes its own assessment of the merits of
the government’s position. Nat’l Org. for Marriage, 807 F.3d at 598 (citing Paisley, 957
F.2d at 1166).
Here, the objective indicia are inconclusive. There was no settlement. Because
the case was decided on summary judgment does not mean the government’s position
was not substantially justified. See Wiertzema v. United States, 747 F. Supp. 1363,
1365–66 (D.N.D. 1989). The facts were undisputed. With respect to the legal question,
there were no cases where courts had considered the position taken by the government
in this litigation.
Nelly did not succeed in demonstrating that it was entitled to relief under the
statutory bases under Section 530. Instead, it convinced Judge Dalzell that it had a
“reasonable basis” for classifying its companions as independent contractors despite
the absence of a statutory basis. The reasonable basis ground is fact-specific and is
subject to varying interpretations of the facts and circumstances of the case.
reasonable basis result could have gone either way.
Indeed, having reviewed the
record, we cannot say we would have ruled as Judge Dalzell had.
Nelly’s survey of other home care companies revealed that only seven of the
twenty companies treated workers as independent contractors. It was not unreasonable
for the government to question Nelly’s relying on a minority of home care companies’
treatment of workers as independent contractors because it was not a significant portion
of the industry.
The prior audit was of Carney’s personal tax returns.
It was not of Nelly’s
returns. Hence, the prior audit safe harbor was clearly not available.
That the government did not win on the merits does not establish that its position
was or was not substantially justified. Instead, the rationale for the decision is the “most
powerful” indicator of whether the government’s position was substantially justified.
Paisley, 957 F.2d at 1167 (internal citations and quotations omitted).
There was no legal precedent, decisional or regulatory.
government did not take a position that was contrary to the law. The absence of any
precedent justifies the government’s pressing for a ruling that would not only resolve the
classification issue in this case, but provide guidance in future cases.
Nelly failed to seek advice from an attorney or an accountant about the
permissive classification of its workers. It failed to satisfactorily perform a survey that
showed that its classification was a long-standing practice in a significant segment of
the industry. Finally, it provided worker’s compensation insurance for its companions.
These factors, together with the lack of any legal precedent, are sufficient to support the
reasonableness of the government’s position that Nelly’s workers were employees, not
Because the government’s position was substantially justified, Nelly is not
entitled to attorney’s fees and costs under 26 U.S.C.A. § 7430(a). Therefore, we shall
deny Nelly’s motion for attorney’s fees and costs.
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