Rev. Rul. 74-413

Advice has been requested regarding the status of certain individuals, under the circumstances described below, for purposes of the taxes imposed by the Federal Insurance Contributions Act, the Federal Unemployment Tax Act, and the Collection of Income Tax at Source on Wages (chapters 21, 23, and 24, respectively, subtitle C, Internal Revenue Code of 1954).

A State, under authorization from the United States Department of Labor, has established a program to provide short-term work experience to unemployed persons in activities that provide relief to victims of natural disasters. Funds for the State's program have been made available under the Manpower Development and Training Act of 1962, as amended, 42 U.S.C. 2572 (1970).

The State's employment service is the prime sponsor for the program, and has sole responsibility for the timely initiation, effective operation, and prompt termination of the projects within the State. The day-to-day management of local projects within the State has been delegated to the local offices of the employment service. The State and local employment service offices are responsible for the selection and monitoring of "user agencies," which are defined as any public or private nonprofit organizations engaged in disaster relief activities.

The State employment service assesses the community to locate candidates, advises them of the available work opportunities, and determines their eligibility. Those found eligible are enrolled for a maximum eight week period and referred to the user agency that can provide a work site most appropriate to the participant's skills, most recent occupation and training or future employability. Prior to the actual placement of an applicant, the employment service's job supervisor determines that the user agency is prepared to provide the support and guidance the participant requires. There are no training or employability development services.

The user agency may only assign a participant to work that is directly involved with restoring devastated property or bringing relief to the victims of the natural disaster. The participants may be assigned work on private property only as long as they do not perform construction work. Participants may be scheduled for up to a 40 hour work week. Outside part-time employment is allowed up to a maximum of 20 hours per week with no reduction in the amount of the program's weekly stipend. However, the stipend is reduced by the amount a participant receives for such part-time work in excess of the 20 hours. The participant may be absent for a maximum of 32 hours during the eight week work site program. All participants in the program receive a weekly stipend, which is computed at a set hourly rate. In those instances where the program's hourly rate is in excess of the user agency's hourly rate for similar work it is adjusted downward to the user agency's rate, as long as this does not violate a State or local minimum wage law.

A participant's services will be terminated by the employment service if he has continued unexcused absences, secures full time employment, completes the eight week period, cannot conform to the work routine at the assigned work site, or when the program itself is terminated.

Section 61 of the Code provides that, except as otherwise provided, gross income means all income from whatever source derived, including compensation for services.

An individual is an employee for Federal employment tax purposes if he has the status of an employee under the usual common law rules applicable in determining the employer-employee relationship. Guides for determining whether that relationship exists are found in three substantially similar sections of the Employment Tax Regulations, namely, sections 31.3121(d)-1, 31.3306(i)-1, and 31.3401(c)-1. Generally, the relationship of employer and employee exists when the person for whom the services are performed has the right to control and direct the individual who performs the services not only as to the result to be accomplished by the work but also as to the details and means by which that result is accomplished. That is, an employee is subject to the will and control of the employer not only as to what shall be done but as to how it shall be done. In this connection, it is not necessary that the employer actually direct or control the manner in which the services are performed; it is sufficient if he has the right to do so. The right to discharge is also an important factor indicating that the person possessing that right is the employer.

Rev. Rul. 63-136, 1963-2 C.B. 19, holds that payments made to individuals undergoing training or retraining under either the Area Redevelopment Act or the Manpower Development and Training Act of 1962 are not includible in the gross income of the recipients. These benefit payments were intended to aid the recipients in their efforts to acquire new skills that would enable them to obtain better employment opportunities, and, as such, fall in the same category as other unemployment relief payments.

On the other hand, Rev. Rul. 65-139, 1965-1 C.B. 31, as clarified by Rev. Rul. 66-240, 1966-2 C.B. 19, holds that payments made to enrollees in work-training programs established under Title I-B of the Economic Opportunity Act of 1964, 42 U.S.C. 2701 (1970), are compensation for services that are includible in the gross income of the enrollees under section 61 of the Code. The Revenue Ruling also holds that an employer-employee relationship exists in such a work-training program and that these payments are subject to the withholding of income tax at source on wages. The basis for the conclusion is that the enrollees will receive wages for services performed, even though such services may embody some degree of training.

The facts in this case show that the program was initiated to provide the State with a temporary work force composed of unemployed individuals to clean up the damage resulting from a natural disaster. It is a short term project with the State's interest being mainly in the result to be accomplished by the work to be done, rather than in the training of the participants. The fact that the participants, in many instances, receive the prevailing wage rate indicates that the stipends are paid for services and that an employer-employee relationship exists. In addition, the program's structure indicates that the State has, through its employment service, retained the ultimate right of direction and control necessary to establish such a relationship.

Accordingly, the stipends paid to the participants in the program are compensation for services, and are includible in their gross income under section 61 of the Code. Further, the relationship between the State and the participant is that of employer and employee for purposes of the Federal Insurance Contributions Act, the Federal Unemployment Tax Act, and the Collection of Income Tax at Source on Wages.

However, for purposes of the taxes imposed by the Federal Insurance Contributions Act, section 3121(b)(7) of that Act excepts from the definition of "employment" service performed in the employ of a State or any political subdivision thereof. Section 3306(c)(7) of the Federal Unemployment Tax Act contains a similar provision.

When social security coverage is desired for employees whose services are excepted from "employment," as here, by section 3121(b)(7) of the Federal Insurance Contributions Act, the coverage may be obtained only by means of an agreement between the Secretary of Health, Education, and Welfare, entered into pursuant to section 218 of the Social Security Act as amended, 42 U.S.C. 418 (1970).

Rev. Rul. 63-136 is distinguished since in the instant case the overriding purpose of the program is to provide the participants with compensation for services and not to provide them with training or retraining that would enable them to obtain better employment opportunities.