The New Health Care Tax Credit: Another Reason to Get Worker Classification Right

Independent contractor vs. employee is an issue that never seems to go away for many employers. 

It's been a regular topic on this blog since 2007.

Now there’s a new concern about employee classification on the horizon. It’s an outgrowth of the Affordable Care Act.

Case in point: “small employers” who may be eligible for a small business tax credit to help cover the cost of providing health insurance benefits to employees. Before we get to the details, let's start with the basics.

Worker Classification Enforcement

Simply stated, an independent contractor is a self-employed person who is hired by a company or individual to perform a specific task. They are not employees of the company, and don't receive  a paycheck, don't have taxes withheld, and don't receive benefits. Employees, on the other hand, do on all three counts.

Of course, it's not that simple. Whether a worker is an independent contractor or employee is determined by the ubiquitous legal concept: "facts and circumstances".

Thus, it's subjective depending which of the enforcement agencies are involved, i.e., the Internal Revenue Service, the Department of Labor, and the various States. Each of which can have their own definition of what constitutes an independent contractor. The financial consequences of worker misclassification can be costly.

The IRS focuses on back taxes and penalties and whether workers should be included in retirement plans. The Department of Labor wants to know whether workers should be classified as employees and eligible for overtime, minimum wage and other rights under the Fair Labor Standards Act. The States are looking to see if employers are liable for workers compensation and unemployment taxes.

The Small Business Health Care Tax Credit

Now enter the new tax credit under the Affordable Care Act. into the employee classification mix. You can find the details here.

The key point here is this: An employer may qualify for an employer health care tax credit if it employs fewer than 25 full-time equivalent employees making an average of about $50,000 a year or less. The tax credit can be worth up to 50% of an employer's contribution toward employees' premium costs, and up to 35% for tax-exempt employers.

Rick Norris, a Los Angeles-based CPA, sees a potential problem. He asks the question, The Health Care Act Tax Credit: Another Battleground in the Employee/Independent Contractor Classification War? in a recent issue of  Health Care Reform Magazine.

Here's what he says,

The law seems cut and dry, but could become complicated as the IRS set out on its mission to redefine “employee.” Take for example, an employer who employs 10 full time employees who earn less than $25,000. Since the employer pays over 50% of the employees insurance premiums, it seems that the employer should be entitled to the full Health Care Act tax credit in 2010. Two years later, the IRS performs a payroll audit and finds that the employer paid an additional 10 salespersons approximately $50,000 each and treats them as independent contractors. To the dismay of the employer, the IRS reclassifies the ten as employees and assesses heavy payroll taxes, penalties and interest on the employer for 2010 and 2011.

The next question, however, is does this reclassification invalidate the employer’s Health Care Act tax credit, assuming the ten employees push him above the eligibility thresholds?

Or, in a similar scenario what if the federal or state labor boards, instead of the IRS, audit the employer and find him in non-conformity with the labor laws by classifying employees as independent contractors as opposed to employees? Will that trigger a recapture of the Health Care tax credit taken on the business tax returns, along with penalties and interest?

My conclusion is the same as Rick's. If you have any concerns about how you are classifying workers; consult with your tax advisor. Even if you think you’re on solid ground, consider a periodic review of how you classify your workers.  

Image: TaxCalcUSA.

Posted In Affordable Care Act , Independent Contractor or Employee
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Looking at 2013 401(k) testing in the rear view mirror

We just drove past it.

The “it” is the March 15 deadline for 401(k) testing to determine whether Highly Compensated Employees (“HCEs”) contributed more than the IRS allows when compared to the Non-HCEs.

Looking back, some 401(k) plans passed. Other did not. The ones that did not had some decisions to make. They could

  • Return the excess deferrals to the HCEs, or
  • Make a fully vested contribution called a Qualified Non-Elective Contribution (“QNEC") to Non-HCEs in an amount sufficient to pass the 401(k) discrimination test

It could be an easy decision. Take the case of one employer who who had the choice of 1) returning approximately $17,000 in excess deferrals plus earnings to the HCEs; or 2) making a $150,000 QNEC contribution to NHCEs. The decision, of course, was Option 1.

For other employers, the options could be reversed. That is, a relatively small QNEC eliminates the need to return any contributions to the HCEs.

And for other employers, some place in between.

That was 2013 in the rear view mirror. Time to consider the road ahead and what can be done to avoid returning 401(k) contributions to the HCEs. Here are a few options for employers in this situation to consider:

Safe Harbor Contribution

Subject to IRS rules, an employer can automatically pass the 401(k) discrimination test, i.e., no returns to HCECs, if the employer makes one of two kinds of safe harbor contributions. Either 3% of compensation to all eligible employees, or a matching contribution of 100% up to the first 3% of contributions, 50% up to the next 2% or contributions with a 4% maximum.

Unfortunately, it would also be looking in the rear view mirror for 2014. In order to have a Safe Harbor plan, an employer must provide notice to the employees not more than 90 days, nor less than 30 days prior to the start of the plan year. Thus, December 1, 2014 is the notice deadline to have a safe harbor plan in 2015.

Targeted Employee Communication.

The objective here, of course, is to increase participation by the Non-HCEs to minimize or eliminate returns to the HCEs. This may require different communication methods based on the specific demographics of the plan. It may not be socio-economics that drives the communication methods. It may be generational. For the first time in our history, there are four generations in the workforce.

Automatic Enrollment.

Simply stated, the employer automatically enrolls employees at a specific contribution level. While employees have the option to opt out, only about 10 actually do. Part of the Pension Protection Act of 2006, automatic enrollment has been slow to catch on with the employers. But, with the growing realization that retirement readiness is a significant problem, more employers are adopting it.

Implementing automatic enrollment doesn’t have to be a daunting process. It can be made simpler using resources available from the aptly named Retirement Plan Simpler.

There are no guarantees that either targeted employee communication or automatic enrollment will be successful in increasing employee participation. But even if either one increases employee participation by just a little bit, that’s not such a bad thing is it?

Any resemblance between this March 15 and the Ides of March is purely coincidental.


Posted In 401(k) Plans
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The Retirement Income Crisis as an Infographic

SEP: The Procrastinators Pension Plan

Every year about this time, as we get closer to tax filing time, I get a few calls from those business owners who couldn’t quite get around to setting up a retirement plan before the end of the year. They ask the question with not a lot of hope in their heart: “Can I still set up a retirement plan for last year?”

Fortunately for them, there is such a possibility. I call it the "procrastinator’s pension plan,” but you probably heard of it under the name that Congress gave it: Simplified Employee Pension (SEP), which is an IRA-based retirement plan that a business owner can adopt for a prior year. Here are a few of the details:

  • Any employer can set up one up using IRS Form 5305-SEP.
  • No filing fee is required.
  • It must be offered to all employees who are at least 21 years of age, employed by the employer for three of the last five years and had compensation of $550 for 2012 and for 2013.
  • Only employer contributions can be made in an amount not to exceed 25% of compensation or $51,000.
  • Contributions must be immediately 100% vested.

As you can see, it’s not as nearly as flexible as a traditional profit sharing or 401(k) plan, but, hey, it can be done now.

“Now” means that the business owner has to establish and fund the SEP by the due date of his or her 2013 business tax return, including extensions. For calendar year tax payers, the due date depends on the type of business organization:

  • Sole Proprietorship reporting on Schedule C of Form 1040: April 15, 2014 (Oct. 15, 2014 if an extension is filed)
  • Partnership filing Form 1065: April 15, 2014 (Sept. 15, 2014 if an extension is filed) if you file for an extension)
  • Corporation filing Form 1120 or 1120S: March 15, 2014 (Sept. 15, 2014 if an extension is filed).

There are a lot more details, of course, and taxpayers should talk this over with their tax advisers now. Time is running out.

You can order the T-shirt pictured above from Skreened if you get around to it. 

This post originally appeared on the Be Advised Blog of Employee Benefit Advisor for which I am a member of the Editorial Advisory Board.

Posted In 401(k) Plans , Individual Retirement Accounts
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Retirement plan beneficiary designations shouldn't be one and done

What did Amy Winehouse, Jimi Hendrix, Heath Ledger, and Whitney Houston have in common?

No. not just being in the celebrity spotlight, but rather, estate planning done wrong or not at all.

You can add one more celebrity to the list who Darla Mercado writes about in her InvestmentNews article, He needed a script: Actor Philip Seymour Hoffman left a legal mess behind.

Mr. Hoffman, who died February 2, 2014, did have a will that was signed on October 7, 2004. But in the almost 10 years that followed, it became out-of-date because of changing circumstances.

For retirement plan participants changing, or for that matter, changed circumstances, can also affect those beneficiary designations.

There is, of course, ERISA’s spousal consent rule for beneficiary designation which simply stated provides

  • In defined benefit plans and some defined contribution plans, the death benefit for a married participant must be in the form of a spousal annuity unless spousal consent is obtained in another form, a lump sum if it's available.
  • The spousal consent rule also applies to most defined contributions plans, such as 401(k) and profit sharing. The surviving spouse must be the sole and direct beneficiary of the participant unless he or she provides spousal consent subject to special rules.

But sometimes changing circumstances intervene to invoke the Law of Unintended Consequences.

Those changed circumstances could be a divorce, remarriage, birth or death of a loved one,  or even a pre-nuptial agreement. Changes in the law can also impact beneficiary designations such as the recent Supreme Court's Windsor decision.

This decision and subsequent Internal Revenue Service and Department of Labor guidance had the immediate effect of granting same-sex couples who are married under state law the same federal rights, protections, and responsibilities that are afforded to married opposite-sex couples under the Internal Revenue Code and ERISA.

In plain English, it means the Windsor decision affect those situations in which a “spouse” could be involved such as lump sum death benefits, annuity benefits, and spousal consents.

One final note: retirement plan beneficiary designations are not governed by a will.  Retirement plan participants should consult with an experienced attorney about completing beneficiary designation forms as part of an overall estate plan, and then reviewing them on a regular basis. 

Posted In 401(k) Plans , 403(b) Plans , Defined Benefit Pension Plans
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Automatic Enrolment in the United Kingdom: Lessons for the United States

England and America are two countries separated by a common language.
--George Bernard Shaw

It's not just the language that separates us and the British. It's our attitude towards automatic enrollment in retirement savings plans.

Spelling aside, automatic enrolment has been the law in U.K. since October, 2012. Here in the U.S., the Pension Protection Act of 2006 addressed the legal aspects by adding provisions for automatic enrollment and the Qualified Default Investment Arrangement (QDIA), but did not make it mandatory.

We’ve been supporters of automatic enrollment since its inception as an effective way to deal with what everyone now acknowledges as the “retirement savings crisis”.  

But it’s never really taken off in the United States; and now, it may have taken a step back. Robert Steyer writes in Pension and Investments that adoption of automatic enrollment is slowing down (login may be required).

But whether automatic enrollment eventually becomes law in the U.S. as some advocate, e.g., the President's myRA proposal, there are some important lessons we can learn from the nascent British experience.

One of the U.K.'s leading advocates for automatic enrolment is The National Association of Pension Funds (NAPF) "whose membership includes 1,300 pension schemes which collectively manage assets of £900bn ($1.5 trillion U.S.) and provide retirement income for nearly 16 million people".

In October, 2013, the NAPF published a report, Automatic enrolment, one year on, which reviewed the results of their survey of the first year's experience for both employers and employees.

The NAPF reported that employers said:

  • Preparation is the key to successful implementation.In some cases, employers started planning years in advance. Smaller employers need to start planning as soon as possible.
  • Communications are an essential component of automatic enrolment. Employers typically put strong emphasis on clear and engaging communications.
  • The automatic enrolment regulations are too complex. This complexity is a disincentive for employers to go above the minimum.

Employees, they reported, said:

  • They welcome the fact that they have been automatically enrolled. They see pension saving as an important and positive thing to do.
  • Employees are still not very engaged with pensions. Employees rely on their employer to pick a good scheme and manage it for them.
  • Although they are happy to be saving, many employees are aware that the current minimum contribution rates are probably too low. There is an appetite amongst some workers to save more.

Not much different from our own experience with clients who have taken the automatic enrollment route; and, we see success with open enrollment in much the same way. That is, you can't start early enough:

  • Planning
  • Engaging with with service providers
  • Starting the communications campaign

Implementing automatic enrollment doesn’t have to be a daunting process. It can be made simpler using resources available from the aptly named Retirement Plan Simpler, a non-profit coalition of the American Association of Retired People (AARP), the Financial Industry Regulatory Authority (FINRA), and the Retirement Security Project. Their common mission is to encourage savings through automatic 401(k).

Picture credit: scienceprogress blog.

Posted In 401(k) Plans , Automatic Enrollment
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The Venn of the New Business Environment

 Source: If I Had A Hammer, Thomas Friedman, New York Times Op Ed

Posted In Audio/Visuals , Small Business , Whatever
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Independent Contractors and the Power of Myth


One of the Top Ten Great Urban Myths is that Albert Einstein failed math in school about which he replied:

I never failed in mathematics,” he replied. Before I was fifteen I had mastered differential and integral calculus.

The myth, however, still persists.

We have our own myths in the benefit world, or at least some employers do when it comes to who is and who isn’t an independent contractor. Here are just a few.

Myth #1. He must be an independent contractors since I only employed him for a short period of time.

Myth #2. She is an independent contractor for someone else so she must be an independent contractor for me.

Myth # 3. I have a written agreement between myself and the worker that says so.

Myth #4. Other companies in my industry use only independent contractors so it must be o.k.

But it isn't a myth that the Internal Revenue Service, the Department of Labor, and the various States have stepped up investigation of employee classification.

The IRS focuses on back taxes and penalties and whether whether workers should be included in retirement plans. The Department of Labor wants to know whether workers should be classified as employees and eligible for overtime, minimum wage and other rights under the Fair Labor Standards Act. The States are looking to see if employers are liable for workers compensation and unemployment taxes.

Add all those up, and the cost of getting it wrong can be very, very expensive.

So what exactly is the difference between an independent contractor and an employee? The answer to that question is one of those legal concepts: "facts and circumstances".

In basic terms, it's about control. The IRS works through a list of 20 different factors in concluding whether a sufficient degree of control exists for an employer-employee relationship. The criteria for which are under the Common Law Rules:

  • Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
  • Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
  • Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

So "facts and circumstances" can be subjective. Your view vs. the IRS view. Add to it that each State can also have its own definition of what constitutes an independent contractor, and it's more complicated than the myths would suggest.

If you're at all concerned about your workers are classified, let an experienced employment lawyer separate fact from fiction. And even if you're not concerned, consider having your situation reviewed at least once a year. It is, you know, W-2 time.

                                                            *        *        *

There is one urban myth, however, about Einstein that's true. Albert Einstein was a ladies man. How do I know? Warren Zevon said so. Check it out on his last appearance on Letterman on October 30, 2002 singing Genius. He was indeed.

Posted In Independent Contractor or Employee
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The Impact of Peer Pressure on Workplace Ethics

When we think about lying, cheating, and stealing in the workplace, we may think it's always bad people doing bad things. But sometimes good people lose their moral compasses because of peer pressure.

That was the conclusion of the recent study, Underestimating Our Influence Over Others' Unethical Behavior and Decisions conducted by Bohns,  Roghanizad, and Xu at the University of Waterloo in Ontario, Canada.

The British Psychological Society reported on this study in their blog post, It's Easier Than You Think To Get People To Commit Bad Deeds, published on their Research Digest blog.

The study, they say, suggests that many people will agree to perform a bad deed rather than say no to avoid social discomfort.

But here’s the thing. It’s also easier than you think to get people to do the right thing. They go on to point out the

"... truly startling finding from this work, the researchers said, is not how many people are willing to lie or vandalise, but rather "the lack of awareness people appear to have of this tendency when they are in a position to influence someone else's ethical behaviour."

And maybe this lack of awareness can be addressed by education. The financial service industry often gets maligned, and sometimes deservedly so. However, the organizations that represent financial service providers do emphasize ethics, and in many cases, make it a continuing education requirement.

In my world, it's the American Society of Pension Professionals and Actuaries (ASPPA). An interactive Ethics Workshop will be a major part of ASPPA's five regional conferences in 2014 called ASPPA On Tour. The first one is on Thursday and Friday, January 23-24, 2014 in Los Angeles. If you're in the benefit business and in the neighborhood. please stop by.

Image Source: Richard Niolon Ph.D.

Posted In Ethics , Fiduciary Issues
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