More On Tax Planningfrom The Advisor's Professional Library
- IRAs: Eligibility The eligibility rules for contributing to traditional and Roth IRAs are complicated. Learn how to effectively use them in retirement plans.
- Health Insurance: Health and Medical Savings Accounts A Health Savings Account is a trust created exclusively for the purpose of paying qualified medical expenses of an account beneficiary. Although they are popular, they are not without their pitfalls and the regulations can be complicated. Learn more about how to avoid federal taxation on the accumulation and distributions of HSA.
The Affordable Care Act (ACA) mandate that will require employers with more than 50 full-time employees to provide health coverage for those employees or pay a penalty that can reach $3,000 per employee has many small business clients scrambling to plan for years ahead. Because independent contractors are not counted toward the 50-employee limit, some small business clients may be tempted to reclassify common law employees as independent contractors to avoid the mandate.
Unfortunately, the IRS and Department of Labor have caught on to this trick, and scrutiny over worker classification has never been more thorough. This heightened scrutiny is raising the stakes for small business clients—getting it wrong could subject these clients to substantial tax liability, as well a large employer status under the ACA—and the accompanying penalties.
Repercussions of ACA Large Employer Status
Under the Affordable Care Act, only those employers with 50 or more full-time employees are subject to the so-called “employer mandate,” which requires the employer to provide employees with health insurance that meets certain minimum coverage requirements or pay a penalty. While the mandate has been delayed until 2015, small business clients should begin planning now to determine whether they will cross the threshold.
In general, a full-time employee means a common law employee who works (on average) 30 or more hours per week for a one-month measuring period. Employers are permitted to exclude seasonal employees who work fewer than 120 days per year from the calculation. As previously noted, independent contractors are excluded from the calculation as well.
In addition to retroactive liability for employment taxes for misclassified workers, which alone can be a crushing expense for a small employer, if the IRS requires an employer to reclassify employees so that the employer crosses the 50-employee threshold, failing to offer health coverage will subject the employer to a $2,000 per-employee penalty. This penalty kicks in if the employer fails to offer coverage to 95% of all full-time employees and even one employee obtains insurance coverage independently through an exchange and is eligible for a government subsidy.
Further, if the employer is offering coverage, but this coverage is deemed unaffordable or fails to provide certain minimum benefits, crossing the 50 full-time employee threshold can subject the employer to a $3,000 per-employee penalty if those employees obtain subsidized coverage through an exchange.
Independent Contractor Vs. Employee
Classifying workers as employees or independent contractors involves a fact-intensive inquiry that each small business client must undertake to properly determine the number of employees that must be counted toward the ACA threshold. The IRS has indicated that the traditional common law test for determining employment status should be used in calculating the number of full-time employees for purposes of the ACA.
The common law classification rules require that the employer examine 20 factors in determining employment status; in the case of a small business, every employee counts. The analysis often hinges on the degree of control that the employer exercises over the worker’s performance. In other words, the question is whether the employer has the right to control not only what work will be done, but also how the work will be accomplished.
Factors that tend to be important in the analysis include whether:
(1) the worker is required to follow the business owner’s instructions
(2) any training requirements are imposed upon the worker by a business owner
(3) there is a continuing relationship between the worker and business owner
(4) work is performed on the business owner’s premises
(5) the worker’s travel expenses are paid by the business owner
(6) the work-related tools are provided by the business owner
(7) the business owner pays for administrative support.
The penalties for misclassification of workers as independent contractors have always been steep, but with the advent of the additional ACA penalties the stakes have never been higher. Because these increased penalties are combined with heighted IRS and DOL scrutiny, it is more critical than ever that your small business clients know the rules so that they can properly classify their workers.
For additional coverage of this issue and similar ones, we invite you to sign up with AdvisorOne’s Summit Business Media partner, National Underwriter Advanced Markets, for a free trial.
You may also be interested in signing up for a free trial with another Summit Business Media partner, Tax Facts Online.