Is a commission-only encyclopedia sales representative an employee (exempt) or an independent contractor who owes New Mexico gross receipts tax on his commissions?

Plain-English summary

Kent Jones sold encyclopedias for Encyclopaedia Britannica on commission from 1986 to 1996. The company hired him as an independent contractor: it withheld no income, Social Security, or workers'-comp amounts, issued him a Form 1099 each year for "nonemployee compensation," and paid him only when he made a sale (no base salary). He set his own schedule, chose which sales leads to buy, paid his own travel and expenses, and reported the income on a federal Schedule C, paying self-employment tax. In 1997 the Department assessed him about $770 in gross receipts tax plus penalty and interest for 1993 (Assessment No. 2110387), on the theory that his commissions were taxable business receipts.

Mr. Jones argued he was really an employee, whose commissions are exempt from gross receipts tax under § 7-9-17. The Hearing Officer disagreed and denied the protest, finding him an independent contractor.

• The test is the right to control. Under the common-law/Restatement (Second) of Agency test adopted in Harger v. Structural Services, an employee surrenders his physical activities and time to the employer's control, while a contractor agrees to accomplish a result. Considering the totality of the circumstances, Britannica controlled the result (a legal, binding, FTC-compliant sale) but not the details of Mr. Jones's work.
• FTC-compliance rules go to the result, not the manner. The company's insistence on a signed "courtesy checklist" and no misrepresentation ensured the sale was legal and binding — like requiring a builder to meet code — and did not make him an employee.
• He controlled the details. He worked no set hours, sometimes went weeks without selling, decided which leads to take, paid his own expenses, and was paid commission-only. (His following a "bossy" counter-location coordinator was personal preference, not proof of company control.)
• Consistency matters. He treated the income as business income (Schedule C, self-employment tax) for federal purposes and never amended to call it wages; New Mexico requires a taxpayer to treat a transaction the same way for federal and state tax (Stohr, Co-Con). Tax exemptions are also strictly construed against the taxpayer, and the assessment is presumed correct.

So his commissions were subject to gross receipts tax, and the assessment stood.

What this means for you

Independent sales reps and 1099 contractors

If you're paid on commission, get a 1099, have no taxes withheld, set your own schedule, and cover your own expenses, New Mexico is very likely to treat you as an independent contractor — which means your commissions are subject to gross receipts tax, not exempt employee wages. A company's rules that ensure a sale is legal and enforceable (compliance checklists, no-misrepresentation policies) go to the result of your work and won't, by themselves, make you an employee.

Anyone deciding whether they're an employee or a contractor

The dividing line is control over how you do the work, not just what result is required. Set your own hours, supply your own tools, bear your own expenses, and take the risk of unpaid effort, and you look like a contractor. Also, be consistent: you generally cannot report income as self-employment business income on your federal return and then claim to be an employee to escape state gross receipts tax.

Accountants and tax professionals

This is a thorough right-to-control analysis under Harger and the § 7-9-17 regulations (3 NMAC 2.17.7 and 2.17.10). Note the two reinforcing doctrines: exemptions are strictly construed against the taxpayer, and the consistency rule (Stohr, Co-Con) bars treating the same income as business income federally and as exempt wages for New Mexico gross receipts tax. A client claiming employee status should have consistent federal reporting to match.

Common questions

Q: The company had lots of rules — didn't that make him an employee?
A: No. The rules the company enforced — a signed courtesy checklist, no misrepresentation, FTC compliance — went to the result (a legal, binding sale), not to how or when Mr. Jones did his work. He controlled the details of his sales activity, which points to independent-contractor status.

Q: Aren't commissions exempt from gross receipts tax under § 7-9-17?
A: Only commissions paid to employees are exempt. Because Mr. Jones was an independent contractor, his commissions were taxable business receipts, not exempt employee compensation.

Q: Does it matter how he reported the income federally?
A: Yes. He reported the commissions as business income and paid self-employment tax federally. New Mexico requires consistent treatment, so he could not report the income as self-employment business income for federal tax and simultaneously claim to be an employee to avoid state gross receipts tax.

Q: Does this decision apply to my situation?
A: Not directly. A Decision and Order resolves one taxpayer's protest on its specific facts and the law in effect at the time. It illustrates how New Mexico distinguishes employees from independent contractors, but your facts may differ.

Citations and references

Statutes and regulations:

• § 7-9-17 NMSA 1978 — exempts the receipts of employees from wages, salaries, commissions, and other remuneration for personal services
• § 7-1-7 NMSA 1978 — an assessment is presumed correct
• § 7-1-24 NMSA 1978 — taxpayer protest procedure
• 3 NMAC 2.17.7 — indicia the Department considers in determining employee status; 3 NMAC 2.17.10 — a commissioned salesperson with no withholding, over whom the company controls only the result, is not an employee

Case law cited:

• Harger v. Structural Services, Inc., 121 N.M. 657, 916 P.2d 1324 (1996); Restatement (Second) of Agency § 220 — the right-to-control test for employee vs. independent contractor
• Tafoya v. Casa Vieja, Inc., 104 N.M. 775, 727 P.2d 83 (Ct. App. 1986) — manner and method of payment as evidence of control
• Mears v. Bureau of Revenue, 87 N.M. 240, 531 P.2d 1213 (Ct. App. 1975); Archuleta v. O'Cheskey, 84 N.M. 428, 504 P.2d 638 (Ct. App. 1972) — presumption of correctness
• Stohr v. New Mexico Bureau of Revenue, 90 N.M. 43, 559 P.2d 420 (Ct. App. 1976); Co-Con, Inc. v. Bureau of Revenue, 87 N.M. 118, 529 P.2d 1239 (Ct. App. 1974) — exemptions strictly construed; consistent federal and state treatment required

Source

• Listing: New Mexico Decisions & Orders
• Decision post: Kent and Jorge Jones
• Decision PDF: D&O 98-10

Original ruling text

BEFORE THE HEARING OFFICER
OF THE TAXATION AND REVENUE DEPARTMENT
OF THE STATE OF NEW MEXICO

IN THE MATTER OF THE PROTEST OF
KENT AND JORGE JONES 98-10
ID. NO. 02-327016-00 0
ASSESSMENT NO. 2110387

DECISION AND ORDER

This matter came on for formal hearing on February 5, 1998 before Margaret B. Alcock,

Hearing Officer. Kent H. Jones (“Mr. Jones”) appeared on his own behalf. The Taxation and

Revenue Department ("the Department"), was represented by Bruce J. Fort, Special Assistant Attorney

General. Based upon the evidence and the arguments presented, IT IS DECIDED AND ORDERED

AS FOLLOWS:

FINDINGS OF FACT

1. From 1986 through May 1996, Mr. Jones worked as a sales representative for

Encyclopaedia Britannica (“the company”). In 1996, the company discontinued the use of in-state sales

representatives and began conducting all of its solicitations by mail.

2 When the company hired Mr. Jones, it told him that he was responsible for making all

required tax payments on his commissions. Mr. Jones understood he was being hired as an independent

contractor and accepted the job on that basis.

3. The company did not withhold income taxes, social security taxes or workmen’s

compensation insurance on behalf of Mr. Jones. Each year, the company issued Mr. Jones a federal

Form 1099 reporting his commissions as “nonemployee compensation” (Department Exhibit A)

4. Mr. Jones was given three days of classroom training before beginning his work as a

sales representative.

5. The 1991 Sales Representatives’ Training and Policy Manual (Taxpayer Exhibit 6)1

required the company’s sales representatives to fully comply with Federal Trade Commission (FTC)

orders and regulations. The company also provided its sales representatives with checklists instructing

them not to misrepresent any facts in the course of their sales presentation or take any action that would

violate FTC requirements (Taxpayer Exhibit 5).

6. Highlights of FTC requirements were set out in the company’s training and policy

manuals (Taxpayer Exhibit 6, Section II, pp. 1-2; Taxpayer Exhibit 8, p. 151). Certain FTC

requirements were also included on a “Full Service Courtesy Checklist” (Taxpayer Exhibit 2) that had

to be signed by both the sales representative and the customer whenever a set of encyclopedias was

sold.

7. The company would not accept an order without a signed courtesy checklist. The

courtesy checklist required the sales representative to:

present a business card and give the customer the opportunity to read it;

give the customer a price list;

give the customer two completely filled out copies of the sales contract and
oral and written disclosure of the customer’s 3-day cancellation right;

give the customer a copy of his completed credit application;

explain to the customer that the primary purpose of the representative’s presenta-
tion was to give the customer an opportunity to acquire the company’s products;

explain the company’s Instant Research Service, the full details of which were
set out on the reverse side of the courtesy checklist;

give the customer a copy of the Lifetime Education Folder containing a delivery
and replacement guarantee, and information on the Instant Research Service.

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Although the assessment period covers calendar year 1993, rather than 1991, Mr. Jones testified that the training
and policy manual introduced as Taxpayer Exhibit 6 was representative of manuals used during the entire period he
worked for the company.

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8. Sales Representatives obtained the names of potential customers from “leads” provided

by their district manager. The leads were developed from responses to advertisements the company

placed with different media. Each lead contained the prospect’s name and address and a lead message

that alerted the sales representative to the type of offer involved (Taxpayer Exhibit 6, Section II, p. 36).

9. Sales representative were required to pay for leads obtained from the company. The

cost of the lead was based on the type of advertising that generated the lead. Accordingly to a list set

out in the training and policy manual, a national advertising lead generated through major publications

cost $6.00; a television lead cost $8.00; a direct mail lead cost $10.00. Certain leads, such as telephone

inquiry and referral leads, cost up to $50 or 50% of the sales representative’s commission, but were

only charged if the lead resulted in a sale (Taxpayer Exhibit 6, Section II, p. 37).

10. Leads were offered to sales representatives at the discretion of the district manager.

Sales representatives were not required to accept leads. Mr. Jones would not accept leads in an out-of-

town location unless there were enough leads to make it worth his while to travel to that location.

11. The company also sold its products at counter locations in shopping malls, airports,

fairs, etc, where there was usually one person designated by the company to oversee the display and

operation of the counter. When sales representatives chose to sell at counter locations, they were

required to conform to the hours set by the mall, airport, fair, etc

12. The cost of counter space rental, drayage, electricity and display usage was shared

among the sales representatives participating in those events (Taxpayer Exhibit 6, Section II, p. 38).

13. If a sales representative used the facilities of the company’s local office, he could be

charged up to $25 per week for using the telephone, plus the cost of long-distance calls; $1.00 to $2.00

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per week as a postage fee for sending orders to the home office; and $1.00 to $2.00 per week for use of

the copying machine (Taxpayer Exhibit 6, Section II, p. 38).

14. Sales representatives were required to order and pay for their business cards through the

company. See, Taxpayer Exhibit 4.

15. Sales representatives made a refundable deposit of $65.00 to use the company’s sales

kit. They had the option of purchasing additional sales and promotional materials (Taxpayer Exhibit 6,

Section II, p. 39).

16. Sales representatives were responsible for all travel expenses they incurred in their sales

activities, including transportation, parking, motels and food.

17. Sales representatives were paid a commission on sales made within their assigned

territory. The company did not pay a base salary or stipend or make any payment for sales

presentations that did not result in a sale.

18. The amount of a sales representative’s commission varied depending on the number of

sales made. The more sales made by a representative during a specified period, the higher his

commission on each sale.

19. Sales representatives were also eligible for bonus payments. Bonuses were paid for

securing a cash payment or a high down payment, for making a sale based on certain types of leads, and

for recruiting new sales representatives (Taxpayer Exhibit 6, Section II, pp. 24-25).

20. The training and policy manual states that “a Representative will be free to exercise his

own judgment as to the persons from whom he will solicit such orders and the time and place of such

solicitations...” (Taxpayer Exhibit 6, Section II, p. 42).

21. Mr. Jones did not work a full-time or regular schedule and sometimes went for several

weeks without engaging in any sales activity for the company. Mr. Jones had control over his schedule,

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although he usually kept his district manager apprised of his decision not to work during certain

periods.

22. Mr. Jones spent about half his time selling at counter locations and half his time selling

on the road. Mr. Jones worked 4 to 5 hours a day when he was on the road.

23. Sales representatives were trained and strongly urged to follow the company’s sales

presentation materials, which included examples of how to approach sales prospects and how to handle

different situations that might arise during the presentation (Taxpayer Exhibit 6, Section I and Taxpayer

Exhibit 7).

24. The only requirements placed on sales representatives was that they avoid misrepre-

sentation and follow FTC orders and the procedures set out on the courtesy checklist. A sales

representative who wanted to use his own sales materials was required to obtain approval from the

company’s legal department to insure the materials complied with FTC rules and regulations (Taxpayer

Exhibit 6, Section II, p.2).

25. Mr. Jones reported and paid self-employment taxes to the federal government and

reported his commission income and business deductions on Schedule C of federal Form 1040

(Department Exhibit A). Mr. Jones did not understand that his status as an independent contractor

would make him liable for payment of New Mexico gross receipts tax on his commissions.

26. In 1997, the Department determined that Mr. Jones failed to report gross receipts tax on

commissions reported as business income on his 1993 federal income tax return. On February 25,

1997, the Department issued Assessment No. 2110387 for $770.10 gross receipts tax, $77.02 penalty

and $1,232.17 interest for calendar year 1993.

27. On March 7, 1997, Mr. Jones filed a written protest to the Department’s assessment.

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DISCUSSION

I. Employee v. Independent Contractor.

Mr. Jones maintains that he is not liable for gross receipts tax on his sales commissions

because he was an employee of Encyclopaedia Britannica and was therefore entitled to the exemption

found in Section 7-9-17, NMSA 1978, which states:

Exempted from the gross receipts tax are the receipts of employees
from wages, salaries, commissions or from any other form of
remuneration for personal services.

The Department argues that Mr. Jones was an independent contractor whose self-employment

income did not qualify for the exemption provided in Section 7-9-17.

In determining whether a person is an employee or an independent contractor, the common

law meaning of those terms will apply unless there is persuasive evidence of a contrary legislative

intent. Harger v. Structural Services, Inc., 121 N.M. 657, 663, 916 P.2d 1324, 1330 (1996). In

Harger, the New Mexico Supreme Court adopted the approach set out in the Restatement (Second)

of Agency § 220(1) (1958) to determine a worker’s status as an employee or an independent

contractor:

The important distinction is between service in which the actor’s
physical activities and his time are surrendered to the control of the
master, and service under an agreement to accomplish results or to
use care and skill in accomplishing results. Those rendering service
but retaining control over the manner of doing it are not servants.

Among the factors to be considered are: whether the party employed engages in a distinct

occupation or business; whether the work is part of the employer’s regular business; the skill

required in the particular occupation; whether the employer supplies the instrumentalities, tools, or

the place of work; the duration of a person’s employment and whether that person works full-time or

regular hours; or whether the parties believe they have created the relationship of employer and

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employee, insofar as this belief indicates an assumption of control by one and submission to control

by the other. Id., comments h-m. The manner and method of payment is also relevant to the issue of

control. Harger, 121 N.M. at 667, 916 P.2d at 1334; Tafoya v. Casa Vieja, Inc., 104 N.M. 775, 777,

727 P.2d 83, 85 (Ct. App. 1986). While all of these factors may be considered, it is the totality of the

circumstances that should determine whether the employer has the right to exercise essential control

over a particular worker.

The Department has adopted a regulation under Section 7-9-17 that uses similar criteria to

determine whether a worker qualifies as an employee. Regulation 3 NMAC 2.17.7 (formerly GR

17:1) provides as follows:

7.1 In determining whether a person is an employee, the department
will consider the following indicia:

1. is the person paid a wage or salary;

2. is the “employer” required to withhold income tax from the
   person’s wage or salary;

3. is F.I.C.A. tax required to be paid by the “employer”;

4. is the person covered by workmen’s compensation insurance;

5. is the “employer” required to make unemployment insurance
   contributions on behalf of the person;

6. does the person’s “employer” consider the person to be an
   employee;

7. does the person’s “employer” have a right to exercise control
   over the means of accomplishing a result or only over the
   result (control does not mean “mere suggestion’).

7.2 If all of the indicia mentioned in 3 NMAC 2.17.7.1 are present,
the department will presume that the person is an employee.
However, a person may be an employee even if one or more of the
indicia are not present.

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A second regulation under Section 7-9-17 deals specifically with commissioned salespersons.

Regulation 3 NMAC 2.17.10 (formerly GR 17:5) states:

A salesperson who sells for a company on a commission basis is not
an employee of the company where the company exercises no direct
control over the details of performance of the salesperson’s duties
beyond general statements about the scope and nature of the
salesperson’s obligations under the contract between the salesperson
and the company. In addition, where commissions paid to a
salesperson are not subject to withholding taxes or social security
taxes, the salesperson is not considered an employee of the company.
Therefore, receipts from commissions paid to such salesperson for
selling property in New Mexico are subject to the gross receipts tax.

Mr. Jones argues that the first sentence of Regulation 3 NMAC 2.17.10 controls the outcome of this

case. He reads the regulation to set up an “either/or” test: a person is an employee if a company

exercises some direct control over the person’s activities or withholds taxes from his commissions.

Because Mr. Jones believes that Encyclopaedia Britannica exercised direct control over his sales

activities, he maintains that the second sentence of the regulation, as well as the factors set out in

Regulation 3 NMAC 2.17.10, are irrelevant.

Mr. Jones’ reading of the Department’s regulations is too narrow. It must be noted that the

method of paying a worker is a consideration in determining the existence of control over that

worker. The second sentence of Regulation 3 NMAC 2.17.10 simply highlights one of the factors to

be used in determining the existence of control discussed in the first sentence. The seven indicia

listed in Regulation 3 NMAC 2.17.7.1 also bear on the issue of whether a worker’s “physical

activities and his time are surrendered to the control of the master.” Restatement (Second) of

Agency § 220(1) (1958). While no one factor is conclusive, all must be considered in determining

whether Mr. Jones was working as an employee or an independent contractor.

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II. Burden of Proof.

There is a statutory presumption that the Department’s assessment of gross receipts taxes is

correct. Section 7-1-7, NMSA 1978; Mears v. Bureau of Revenue, 87 N.M. 240, 241, 531 P.2d 1213,

1214 (Ct. App. 1975). In order for the taxpayer to be successful, he must clearly overcome this

presumption. Archuleta v. O'Cheskey, 84 N.M. 428, 431, 504 P.2d 638, 641 (Ct. App. 1972).

Moreover, where an exemption from tax is claimed, the exemption is strictly construed in favor of the

taxing authority. Stohr v. New Mexico Bureau of Revenue, 90 N.M. 43, 46, 559 P.2d 420, 423 (Ct.

App. 1976), cert. denied, 90 N.M. 254, 561 P.2d 1347 (1977); Rock v. Commissioner, 83 N.M. 478,

479, 493 P.2d 963, 964 (Ct. App. 1972).

III Application of Law to Facts.

In arguing that Encyclopaedia Britannica exercised direct control over his sales activities, Mr.

Jones relies on the company’s admonitions not to misrepresent any facts in the course of a sales

presentation or take any action that would violate FTC rules or regulations. Mr. Jones maintains that

the company’s refusal to accept an order that was not accompanied by a signed courtesy checklist

establishes that the company exercised direct control over its representatives’ sales activities. A

requirement that sales representatives provide assurances that they have complied with applicable law

goes to the product of their work, i.e., a legal and binding contract of sale, not to the details of

performance.

When a construction contractor is hired to build a house, the owner will require him to comply

with local building codes. In that case, a government inspector determines whether the completed

house--the result of the contractor’s work--meets this requirement. In the case of Encyclopaedia

Britannica sales representatives, there was no tangible product that could be examined to determine

whether a sales presentation complied with FTC rules and regulations. Accordingly, the company

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required its representatives to provide a signed statement that would assure the company that applicable

laws were followed and the sale would be binding on the customer. This requirement goes to the sales

representatives’ agreement to accomplish a specific result and does not indicate an employer/

employee relationship.

With regard to the details of performance, Mr. Jones had a great deal of control over his sales

activities. He was not required to work a specific number of hours or weeks during the year. Mr. Jones

testified that he set his own schedule and sometimes went for several weeks without engaging in any

sales activity for the company. When Mr. Jones was ready to work, it was up to him to take the

initiative to obtain leads from the district manager, usually by attending weekly sales meetings. Mr.

Jones was not required to accept any particular lead and would only take leads that were likely to

provide him with sufficient business to make it worth his time and travel expenses. The only time Mr.

Jones worked set hours was when he chose to engage in sales activities at a counter location. In those

cases, the hours were set by the entity that operated the facility in which the counter was located, i.e.,

the mall, fair, theme park, etc.

Sales representatives were strongly encouraged to use the company’s sales materials, which

included a formal presentation and suggestions on how to handle various situations, such as a

customer’s concern over the price of a set of encyclopedias or hesitancy to make a final commitment to

purchase. Nonetheless, it was up to the individual sales representative to determine whether and when

to use a particular selling technique. It was also up to the sales representative to determine whether to

continue a presentation or terminate the presentation because the prospect was not sufficiently

interested. Sales representatives were not prohibited from using their own sales materials as long as the

company’s legal department confirmed that the materials met FTC rules and regulations.

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Acknowledging there was no supervision of his in-home sales presentations, Mr. Jones testified

that he was subject to supervision when he participated in sales at counter locations. The company

usually assigned one person, who Mr. Jones thought was an employee,2 to oversee the operation of

counter locations at fairs and malls. There was one woman with whom Mr. Jones worked on a regular

basis when selling at counter locations. According to Mr. Jones, she told him where to put displays,

when to take breaks, etc. On cross-examination, it became apparent that the primary reason Mr. Jones

followed her instructions was because she was “a very bossy woman” and he did not want to risk a

confrontation with her. There is no evidence of the extent to which the company instructed or required

individual sales representatives to take direction from the person assigned to oversee the counter

locations.

Sales representatives were required to pay all the expenses of their sales activities, including the

cost of leads, the shared cost of counter locations, sales and promotional materials, transportation,

parking, motels and food. To the extent a representative used the company’s local office, he could be

charged a fee for use of the telephone, copying machine and postage to send orders to the home office.

Sales representatives such as Mr. Jones were paid a commission on completed sales. If Mr. Jones spent

a substantial amount of time making sales presentations that did not result in a sale he did not receive

any base salary or other compensation for his time.

At the time Mr. Jones was hired, he was told that he would be responsible for making all

required tax payments on his commissions. The company did not withhold income taxes, social

security taxes or workmen’s compensation insurance on Mr. Jones’ behalf. At the end of each year, the

company issued a federal Form 1099 to Mr. Jones reporting his commissions as “nonemployee

compensation.” Mr. Jones testified that he knew the company was hiring him as an independent

2
Salespeople on employee status included district field trainers, assistants to division managers, branch managers,
district managers and division managers (Taxpayer Exhibit 6, Section II, p. 45).

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contractor and accepted the job on that basis. In 1993 he reported and paid self-employment taxes to

the federal government and reported his commission income and business deductions on Schedule C of

federal Form 1040.

It should be noted that while Mr. Jones insists he was an employee and not an independent

contractor, there is no indication that he has amended his federal and state income tax returns to

reflect his income as wages rather than as business income. New Mexico case law holds that a

taxpayer must treat transactions uniformly for all purposes within the tax laws. The taxpayer may not

treat a transaction one way for purposes of federal tax and another way for purposes of state gross

receipts tax. Stohr v. New Mexico Bureau of Revenue, 90 N.M. 43, 46, 559 P.2d 420, 423 (Ct. App.

1976), cert. denied, 90 N.M. 254, 561 P.2d 1347 (1977); Co-Con, Inc. v. Bureau of Revenue, 87 N.M.

118, 121-122, 529 P.2d 1239, 1241-1242 (Ct. App.), cert. denied, 87 N.M. 111, 529 P.2d 1232 (1974).

Considering the totality of the circumstances surrounding Mr. Jones’ sales activities, it is clear

that Encyclopaedia Britannica did not exercise control over his time and physical activities, nor did it

control his means of accomplishing sales of encyclopedias. Rather, Mr. Jones was engaged to obtain

a particular result--a legal and binding contract for the sale of Britannica products. Mr. Jones

engaged in his sales activities as an independent contractor.

CONCLUSIONS OF LAW

1. Mr. Jones filed a timely, written protest to Assessment No. 2110387 pursuant to

Section 7-1-24, NMSA 1978, and jurisdiction lies over the parties and the subject matter of this protest.

2. Mr. Jones was not an employee of Encyclopaedia Britannica and is not entitled to claim

the exemption from gross receipts tax provided in Section 7-9-17, NMSA 1978.

For the foregoing reasons, the Taxpayers’ protest IS HEREBY DENIED.

DONE, this 18th day of February 1998.

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