Rev. Rul. 75-246

Advice has been requested concerning the Federal income and employment tax treatment of payments made and received under titles I and II of the Comprehensive Employment and Training Act of 1973 (CETA), 29 U.S.C. Sections 811-851 (Supp. III 1973).

The stated purpose of the CETA is to provide job training and employment opportunities for economically disadvantaged, unemployed, and underemployed persons and to assure that training and other services lead to maximum employment opportunities and enhance self-sufficiency by establishing a flexible and decentralized system of Federal, state, and local programs.

The CETA authorizes the Secretary of Labor to enter into grant agreements to provide financial assistance from appropriated funds through eligible applicants (including, among others, a qualified prime sponsor such as a state or, within certain limitations, a unit of the general local government) to accomplish the purposes of the CETA.

Title I of the CETA relates to comprehensive manpower services, and title II relates to public employment programs.

The specific questions to be resolved are whether the amounts received by individuals under the programs in various situations are includible in their gross incomes under section 61 of the Internal Revenue Code of 1954, and whether the payer of such amounts is required to withhold and pay employment taxes on such amounts.

Section 61(a)(1) of the Code provides that, except as otherwise provided, gross income means all income from whatever source derived, including compensation for services.

Disbursements by a governmental unit that are made to individuals in the interest of the general welfare where services are not rendered are excludable from the gross income of the recipient. The determination as to whether payments under work-training programs are includible in a participant's gross income rests on whether the activity for which the payments are received is basically the performance of services or is only participation in a training program that promotes the general welfare. If the activity engaged in is basically the performance of services, the payments are compensation for services rendered, and are includible in the gross income of the recipient. Conversely, if the activity amounts only to participation in a training program, the payments are in the nature of relief payments made for the promotion of the general welfare and are excludable from the gross income of the recipient.

In chapters 21, 23, and 24 of subtitle C of the Code, employers are charged with the duty of withholding Federal income tax and collecting and paying Federal employment taxes with respect to wages paid to their employees. These provisions are found in section 3402 of the Code, relating to the Collection of Income Tax at Source on Wages; sections 3102 and 3111 of the Federal Insurance Contributions Act (FICA), relating to the deduction and payment of FICA taxes; and section 3301 of the Federal Unemployment Tax Act (FUTA), relating to the payment of FUTA tax.

For purposes of withholding income tax, deducting and paying FICA taxes, and paying FUTA tax, the term "wages" is defined, with exceptions not here material, as all remuneration for employment. Sections 31.3401(a)-1, 31.3121(a)-1, and 31.3306(b)-1, respectively, of the Employment Tax Regulations.

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 the 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.

The above income tax and employment tax principles are illustrated in a number of revenue rulings, such as Rev. Rul. 63-136, 1963-2 C.B. 19, which holds that benefit payments made to individuals under the Area Development Act or the Manpower Development and Training Act of 1962 are not includible in the gross income of the recipient because they are intended to aid the recipient in his efforts to acquire new skills that will enable him to obtain better employment opportunities and, therefore, are in the nature of unemployment relief payments made for the promotion of the general welfare.

Rev. Rul. 74-413, 1974-2 C.B. 333, holds that payments to participants in a state program established to provide short-term employment in disaster relief activities for unemployed individuals and funded under the Manpower Development and Training Act of 1962, are compensation for services and are includible in the participants' gross incomes under section 61 of the Code and subject to income tax withholding under section 3402, but not subject to FICA and FUTA taxes because the participants are employees of the state excepted from employment for purposes of the FICA and FUTA taxes. Rev. Rul. 63-136 is distinguished in Rev. Rul. 74-413 since the overriding purpose of the program in the latter Revenue Ruling 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.

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 the work-training program established under title I-B of the Economic Opportunity Act of 1964 are includible in an enrollee's gross income, since the enrollee is receiving "wages" for services performed, even though such services embody some degree of training.

Rev. Rul. 71-425, 1971-2 C.B. 76, holds that payments made by a state welfare agency in lieu of (and in amounts no greater than) the normal relief allowance, to participants in work-training programs under title V of the Economic Opportunity Act of 1964, are not includible in the gross income of the recipient and are not wages for employment tax purposes, since the payments are measured by the personal or family need of the recipient rather than the value of any services performed.

The above principles are applied to the case of a state that, as a prime sponsor under titles I and II of the CETA entered into a grant agreement with the United States Department of Labor to provide comprehensive manpower services and public employment programs that include both work experience and classroom training activities. The situations that developed in this case and the income and employment tax treatment of payments made in each situation are set out below.

Situation (1).--The trainee is given vocational and occupational training, and educational training designed to upgrade basic skills (such as remedial education), in a classroom or institutional setting. The training is provided by both public and private agencies in courses having a duration of 104 weeks or less. The trainee performs no services for the training agency. The trainee receives from the state as prime sponsor an allowance, described below, for his participation in the training activity.

The basic allowance paid to a trainee who is not a recipient of public assistance is an amount equal to the minimum hourly wage under the Fair Labor Standards Act (currently $2), increased by $5 per week for each dependent over two up to a maximum of $20 per week for six or more dependents, plus additional reasonable allowances, where appropriate, for meals, travel, transportation, subsistence, emergency, and other purposes, up to a maximum of $5 per week.

The trainee who is a recipient of public assistance is paid an incentive allowance of $30 per week in lieu of basic allowances.

Income tax treatment accorded payments in Situation (1).--Because the participant is merely engaged in a training program in which he performs no services for the training agency, the payments he receives are in the nature of relief payments made for the promotion of the general welfare. Accordingly, such payments are not includible in the gross income of the recipient under section 61 of the Code.

Employment tax treatment accorded payments in Situation (1).--Since the trainee performs no services for the training agency and the allowance paid to him is not directly related to any services performed, there is no employer-employee relationship between the trainee and the training agency, and the allowance the trainee receives is not remuneration for employment. Accordingly, the payer of the allowance is not obliged to withhold income tax, nor to deduct and pay FICA taxes, nor to pay FUTA tax, with respect to the allowances.

Situation (2).--The trainee is given on-the-job training by a privately owned construction company selected by the state as the prime sponsor. The facts show that the company has and exercises the degree of direction and control over the trainee to establish an employer-employee relationship under the usual common law rules. The company receives the trainee's services and pays the trainee initially at the regular entry wage for the position for which training is being given. The company's training expenses are reimbursed by the prime sponsor at a maximum of 50 percent of the amount paid to the trainee.

Income tax treatment accorded payments in Situation (2).--Because the activity in which the trainee is engaged is basically the performance of services, the amounts he receives therefor are compensation for services rendered, even though the services embody some degree of training. Accordingly, such payments are includible in the gross income of the recipient under section 61 of the Code.

Employment tax treatment accorded payments in Situation (2).--The payments made by the company to the trainee are based on an hourly rate for the time spent and are part of the company's wage structure. The payments maintain their character as wages even though the services for which they are made embody some degree of training for which the company is reimbursed. The facts show that an employer-employee relationship exists under the usual common law rules. Accordingly, the payments made by the company to the trainee are "wages" with respect to which the company is required to withhold income tax under section 3402 of the Code, to deduct and pay FICA taxes under sections 3102 and 3111 of the Federal Insurance Contributions Act, and to pay FUTA tax under section 3301 of the Federal Unemployment Tax Act.

Situation (3).--The trainee is given work experience in a public employment program under title II of the CETA by a medical clinic owned and operated by a city. The facts show that the city has and exercises the degree of direction and control over the trainee to establish an employer-employee relationship under the usual common law rules. In addition to the work experience, the program involves a small amount of counseling and classroom training. The city receives the trainee's services, and the trainee receives $2 per hour for the time during which he receives work experience, counseling, and classroom training. One-fourth of the amount per hour paid the trainee is paid from funds furnished to the city by the state as the prime sponsor.

In addition, the trainee may receive an allowance, on the basis of need, to cover certain expenses incident to the training. Items for which such allowances may be provided include travel and transportation expenses; payments for auto insurance, to make the trainee's presence at the clinic possible; or expenditures for work clothing, without which he could not engage in the work training experience.

Income tax treatment accorded payments in Situation (3).--Because the activity in which the trainee is engaged is basically the performance of services, even though such services embody some degree of training, the $2 per hour the trainee receives therefor is compensation for services rendered. Accordingly, such payments are includible in the gross income of the recipient under section 61 of the Code.

However, any allowance that the trainee receives is provided only to make possible the trainee's participation in the training program. Therefore, such payments are in the nature of relief payments made for the promotion of the general welfare and are excludable from the gross income of the recipient.

Employment tax treatment accorded payments in Situation (3).--Except for allowances, payments made by the city to the trainee are based on an hourly rate for the time spent and are part of the wage structure. The payments maintain their character as wages even though the trainee is absent briefly from the job to attend school and receive counseling, and even though one-fourth of the amount per hour paid the trainee comes from funds furnished to the city by the prime sponsor. The facts show that an employer-employee relationship exists under the usual common law rules. Accordingly, in making the per-hour payments to the trainee, the city is required to withhold income tax on the payments under section 3402 of the Code.

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" services 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. Accordingly, the city is not required to deduct and pay FICA taxes nor to pay FUTA taxes with respect to the payments.

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 state and 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).

With respect to any allowance of the kind described in this situation, since such payments made to the trainee are in the nature of relief payments made for the promotion of the general welfare and are excludable from the gross incomes of the recipients, they are not remuneration for services and are not "wages." Accordingly, the payer of such allowances is not obligated to withhold income tax nor to deduct and pay FICA taxes, nor to pay FUTA tax with respect thereto.