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An upstate appellate court last week shot down a time-honored custom among New York City personal injury law firms — treating associates who refer cases to their own firms as independent contractors for tax purposes. In an opinion by Justice Thomas E. Mercure, the Appellate Division, 3rd Department unanimously rejected the claim of Fuchsberg & Fuchsberg and said the firm must withhold and remit income taxes on behalf of associates who are rewarded for referrals. Further, it held that the “safe harbor” provisions of �530 of the Federal Revenue Act of 1978 do not protect the Manhattan personal injury firm from tax liability. Last week’s decision in Fuchsberg & Fuchsberg v. Commissioner of Taxation and Finance, 95085, marks the second appellate victory for the state in this matter. After initially prevailing before an administrative law judge, the firm lost before the Tax Appeals Tribunal and, now, the Appellate Division. The matter arose after the state challenged a compensation plan that Fuchsberg & Fuchsberg had used for 19 years. Like other firms, the Fuchsberg practice paid associates a set salary, duly withholding payroll taxes on that salary. However, it also paid associates a bonus of up to 50 percent of a negligence case contingency fee when they referred the case to the firm. Fuchsberg & Fuchsberg did not withhold payroll tax on the bonus, claiming that its associates were acting as independent contractors when they referred cases to their employer. The state acknowledged that the Fuchsberg associates reported the bonus income and timely paid all required taxes. However, the state pursued the matter to establish that law firms must withhold taxes from referral rewards offered to employees. Last week’s ruling was a major step toward establishing that rule, which stands until and unless the Court of Appeals reverses. “In our view, substantial evidence supports the Tribunal’s determination that case referral to petitioner was a normal and customary duty of petitioner’s associates and, thus, the referral fees paid were wages for income tax purposes,” Justice Mercure wrote. The court noted that a former Fuchsberg employee, Mark Bower, testified that associate referrals are a critical component of the firm’s business and that associates are expected to offer Fuchsberg & Fuchsberg referral cases on a right of first refusal basis. It also noted that the firm’s managing partner, Abraham Fuchsberg, testified that there is an implicit understanding that associates will offer referrals to their firm before offering them to another practice. On the safe harbor issue, the 3rd Department agreed with the Tax Appeals Tribunal. Under �530 of the Federal Revenue Act, if the employer “did not treat [the] individual as an employee for any period” it is eligible for relief from the withholding obligations. But here, even though the firm argued that associates were not working for Fuchsberg & Fuchsberg when they were networking and drumming up business, the associates were inarguably employees during that period, Justice Mercure said. “Inasmuch as petitioner treated its associates as employees and filed tax returns consistent with that treatment, the Tribunal properly concluded that safe harbor relief is unavailable here,” Justice Mercure wrote. He was joined on the opinion by Presiding Justice Anthony V. Cardona and Justices Karen K. Peters, Edward O. Spain and Anthony J. Carpinello. Assistant Solicitor General Andrew D. Bing represented the tax commissioner. Stephen Hochberg appeared for the firm.

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