Sargent v. Commissioner
929 F.2d 1252 (1991)
Rule of Law:
An individual is an employee of their personal service corporation (PSC), and not the entity to which services are provided, if there is a valid employment contract between the individual and the PSC, and a subsequent contract between the PSC and the third-party service recipient recognizing the PSC's role.
Facts:
- Gary Sargent and Steven Christoff, professional hockey players for the Minnesota North Stars Hockey Club, each sought legal advice regarding incorporation.
- Sargent formed a PSC called Chiefy-Cat, Inc., becoming its sole shareholder, president, and director.
- Sargent signed an exclusive employment contract with Chiefy-Cat, agreeing to provide his services as a hockey player to the corporation.
- Chiefy-Cat then entered into a contract with the North Stars Club to provide Sargent's services to the team.
- The North Stars Club paid Chiefy-Cat for Sargent's services.
- Chiefy-Cat paid Sargent a salary, withheld taxes, and contributed the remaining funds to a qualified corporate pension plan.
- Christoff engaged in a substantially identical arrangement, forming his own PSC, RIF Enterprises, Inc., which contracted with him and the North Stars Club.
- Neither player was considered an employee of the Club for the purposes of the National Hockey League's pension plan; instead, the Club paid their PSCs the amount it would have otherwise contributed.
Procedural Posture:
- The Commissioner of Internal Revenue issued Notices of Deficiency to Gary Sargent and Steven Christoff, asserting they owed additional income tax.
- Sargent filed a petition with the United States Tax Court to contest the deficiencies.
- Christoff subsequently filed his own petitions with the U.S. Tax Court.
- The cases were consolidated for trial in the U.S. Tax Court.
- The Tax Court ruled in favor of the Commissioner, holding that the players were employees of the hockey club and the income paid to their PSCs was taxable to them individually.
- Sargent and Christoff, as Appellants, appealed the Tax Court's decision to the United States Court of Appeals for the Eighth Circuit.
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Issue:
Are professional athletes considered employees of their personal service corporations (PSCs) for federal income tax purposes when they have a valid employment contract with the PSC and the PSC, in turn, has a valid contract to provide their services to a professional sports team?
Opinions:
Majority - Bogue, Senior District Judge
Yes. The athletes are employees of their respective personal service corporations. The court's determination of an employer-employee relationship hinges on the legal right to control, which is established through contracts, rather than the practical, on-field control exerted by a team's coach. The court established a two-part test: 1) the service provider must be an employee of the corporation under a contract giving the corporation the right to direct or control them, and 2) a contract must exist between the corporation and the service-recipient that recognizes the corporation's controlling position. Here, both athletes had employment contracts with their PSCs, and the PSCs had contracts with the hockey club, satisfying both elements. The Tax Court's focus on the players being part of a 'team' was an arbitrary and flawed analysis, inconsistent with prior rulings like Pflug, where an actress under a studio's direct control was still considered an employee of her PSC. The assignment of income doctrine does not apply because the PSCs were legitimate, functioning business entities that filed tax returns, withheld taxes, and maintained pension plans, not mere shams to evade taxes.
Dissenting - Arnold, Circuit Judge
No. The finding that the taxpayers were employees of the Minnesota North Stars Hockey Club was not clearly erroneous. The reality of the situation is that the North Stars' coach had the absolute right to control, and did in fact control, the players' conduct on the ice. The majority's acceptance of a legal fiction where the coach's orders are hypothetically relayed through the PSCs to the players is fanciful and ignores the practical control that defines an employment relationship in this context.
Analysis:
This decision solidifies the legitimacy of personal service corporations for professional athletes and entertainers, prioritizing formal contractual relationships over the practical, on-the-job control exercised by teams or studios. It provides a clear legal framework, establishing that as long as the corporate form is respected and the requisite two-part contractual structure is in place (individual-to-PSC and PSC-to-team), the PSC will be recognized as the true employer for tax purposes. This precedent effectively gives high-income individuals in team or production-based professions a roadmap to legally utilize corporate pension plans for tax deferral, shifting the focus of inquiry from who gives daily instructions to who holds the contractual right to control the service provider.
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