The Tax Cuts and Jobs Act (“TCJA”) creates, modifies or eliminates a number of employment and employee fringe benefit related provisions of the Code. Both employers and employees need to be aware of these changes. Accordingly, this installment of our ongoing review and analysis of the TCJA focuses on these employer and employee fringe benefit provisions.
On April 11, 2017, we discussed what constitutes Tax Reform. On April 24, 2017, we explored the process by which Tax Reform will likely be created by lawmakers. In this blog post, we focus our attention on the likely timing for Tax Reform.
When will we see Tax Reform? At this point in time, it is anyone’s guess. There are lots of external factors that impact the timing and possibility that Tax Reform in any shape or form will become a reality.
New Administration Doubles Down on Tax Reform Efforts
President Trump made it clear, both during his campaign and shortly after he entered the White House, that Tax Reform is a top priority. In fact, in an address to both branches of Congress on February 28, 2017, he stated that his administration “is developing historic [Tax Reform] that will reduce the tax rate on our companies so they can compete and thrive anywhere and with anyone …. it will be a big, big cut.” In addition, he indicated that his administration will provide “massive” tax relief for the middle class.
As many employers have painfully learned, misclassifying employees as independent contractors can be an expensive mistake. Worker misclassification may become even more costly in 2014, when a new potential trap for the unwary will exist. If a non-complying employer gets caught in this new trap, it could be faced with significant monetary penalties.
Beginning in 2014, as a result of the Patient Protection and Affordable Care Act, employers who misclassify employees as independent contractors may be subject to an additional penalty regime. Section 4980H(a) of the Internal Revenue Code (the “Code”) imposes a penalty on “large employers” who fail to offer full-time employees health insurance with a minimum level of coverage. Because employers generally do not provide health care coverage to independent contractors, reclassification of an independent contractor to a full-time employee could trigger this penalty.
Large Employers and Full-Time Employees
The new penalty applies only to “large employers.” Whether an employer is a large employer is not always a simple determination. In general, a large employer is any employer with fifty or more full-time employees.
A full-time employee is an individual who works at least thirty hours per week. Currently, the Internal Revenue Service (“IRS” or “Service”) proposes the term “employee” include an individual who is an employee under the “common-law standard.” Prop. Treas. Reg. § 54.4980H–1(a)(13). A determination under the common law standard hinges on whether the employer has the right to control the individual who performs the services. Whether or not the “employer” exerts actual control is irrelevant. In determining whether the employer has the right to control, the Service analyzes numerous factors. Due to the large number of factors, the Service’s determination of whether an employer has the right to control a worker is highly subjective and its determinations are not always consistent.
Beginning in 2014, an employer may be subject to a penalty attributable to each month when:
- It is a “large employer” (because of reclassification or otherwise);
- It fails to offer all of its full-time employees (and dependants) the opportunity to enroll in “minimal essential coverage” under an “eligible employer-sponsored plan”; and
- At least one full-time employee is certified to the employer as having, for that month, enrolled in a qualified health plan with respect to which an “applicable premium tax credit or cost-sharing reduction” is allowed or paid.
IRC § 4980H(a). For each month the employer is noncompliant, the penalty is equal to:
- The applicable payment amount per month (currently 1/12 of $2,000 or $166.67, adjusted for inflation after 2014), multiplied by
- The number of full-time employees during any month (reduced by 30).
The penalty can be surprisingly high. Consider the following example:
Example. For all of 2014, an employer reports it has forty-five full-time employees and thirty-five independent contractors. On audit, it is determined the independent contractors are actually full-time employees and, therefore, the employer is a “large employer.” If one reclassified employee receives a tax credit, the employer becomes subject to the 4980H(a) penalty because it fails to offer minimum essential coverage and has eighty full-time employees.
$100,000 Penalty. For 2014, (for eighty employees) the penalty would be (80 – 30) × $2,000, or $100,000. In other words, for each employee over the thirty-employee threshold, the employer owes $2,000 ($166.67 × 12 months), for a total penalty of $100,000 ($2,000 × 50 (that is, 80 ? 30)).
Section 4980H(a) of the Code imposes the penalty on large employers who fail to offer their full-time employees health insurance meeting a minimum level of coverage and where at least one employee receives a tax credit or cost sharing reduction. This penalty could be triggered by an unsuspecting, otherwise compliant employer, if the government reclassifies one or more of its independent contractors as employees. In such cases, the employer could easily face a huge additional penalty.
Incorrectly classifying workers could become very costly with the addition of this new penalty to the government’s arsenal. As exemplified above, some employers could face penalties in excess of $100,000 per year. Thus, it is very important employers evaluate whether their independent contractors are at risk of being reclassified as employees.
Larry J. Brant is a Shareholder in Garvey Schubert Barer, a law firm based out of the Pacific Northwest, with offices in Seattle, Washington; Portland, Oregon; New York, New York; Washington, D.C.; and Beijing, China. Mr. Brant practices in the Portland office. His practice focuses on tax, tax controversy and transactions. Mr. Brant is a past Chair of the Oregon State Bar Taxation Section. He was the long term Chair of the Oregon Tax Institute, and is currently a member of the Board of Directors of the Portland Tax Forum. Mr. Brant has served as an adjunct professor, teaching corporate taxation, at Northwestern School of Law, Lewis and Clark College. He is an Expert Contributor to Thomson Reuters Checkpoint Catalyst. Mr. Brant is a Fellow in the American College of Tax Counsel. He publishes articles on numerous income tax issues, including Taxation of S Corporations, Reasonable Compensation, Circular 230, Worker Classification, IRC § 1031 Exchanges, Choice of Entity, Entity Tax Classification, and State and Local Taxation. Mr. Brant is a frequent lecturer at local, regional and national tax and business conferences for CPAs and attorneys. He was the 2015 Recipient of the Oregon State Bar Tax Section Award of Merit.
Upcoming Speaking Engagements
- "Tax Law Update for Family Law Practitioners," Oregon State Bar - Family Law Section 2019 Annual ConferenceSunriver, OR, 10.11.19
- "The Road Between Subchapter C and Subchapter S – It May Be a Well-Traveled Two-Way Thoroughfare, but It Isn’t Free of Potholes and Obstacles," New York University 78th Institute on Federal TaxationNew York, NY, 10.20.19-10.25.19
- "The Road Between Subchapter C and Subchapter S – It May Be a Well-Traveled Two-Way Thoroughfare, but It Isn’t Free of Potholes and Obstacles," Oregon Society of Certified Public Accountants (OSCPA) 2019 Northwest Federal Tax ConferencePortland, OR, 10.28.19
- "The Road Between Subchapter C and Subchapter S – It May Be a Well-Traveled Two-Way Thoroughfare, but It Isn’t Free of Potholes and Obstacles," New York University 78th Institute on Federal TaxationSan Francisco, CA, 11.10.19–11.15.19
- "The Oregon Corporate Activity Tax," Oregon Society of Certified Public Accountants (OSCPA) 2020 OSCPA State & Local Tax ConferencePortland, OR, 1.6.20