Sunday, August 1, 2010

Your Independent Contractor Might be an Employee if…

In most cases it is fairly obvious to all concerned whether or not an employer-employee relationship exists. Many employers simply choose not to follow the rules. Virtually everyone has a buddy always going on about not having any employees/sending everyone a 1099 as though this policy proves he or she is way smarter than other business owners. Well, those friends may be singing a new tune before too long. Cracking down on such practices has become a national mandate:

Despite constituting a violation of both federal and state laws, worker misclassification has been widespread for decades due to virtually nonexistent enforcement of existing laws. So, the state legislators have decided we need… more laws! The difference is that the new state laws offer the potential for the misclassified worker to realize personal financial gain for blowing the whistle. Additionally, “commissions” – not courts - are being given the authority to follow up on complaints, conduct hearings, and dole out consequences.

Many of the new laws only apply to the construction and landscaping industries but the requirements to withhold and pay taxes for those who are in fact employees are applicable to all industries. Business owners who are compliant may seek to level the playing field by reporting their noncompliant competitors.

The following form assists the IRS with classifying a worker correctly. Look it over and turn a critical eye on your situation.

Some states have even more restrictive definitions than the IRS including the “rebuttable presumption of employee status.” My personal, unofficial rule of thumb: Assume anyone who is not listed in the phone book as a business is going to be your employee, and budget accordingly.

Here is how I proceed with budgeting for an employee:

  1. Determine my compensation budget for a new position. For example $20,000 for one 1800 hour per year position.
  2. Contact my insurance agent to find out what my worker’s compensation rate is for that classification. (Be sure to ask if there is a minimum annual premium.) Convert to decimal. For example 15% would be .15.
  3. Add 1 plus .12 (estimated FICA, FUTA, and SUTA – varies by state and unemployment experience rating) plus the decimal per my findings for number 2. For example 1+.12+.15=1.27
  4. Divide #1 by #4. This is the annual salary I can afford to offer. For example. $20,000/1.27=$15,750 or $8.75/hour. (Can’t be below minimum wage: $7.25 per hour for DE/MD/PA/NJ/VA at 6/30/2010)
I don’t offer someone $20,000 per year and then claim worker’s comp and matching taxes will bust my budget. It is my responsibility to budget for all the costs of employment. If you offer other benefits you will need to tweak this formula. I strongly recommend providing employees with a total compensation statement along with their W-2 statement each year to let them know the total company outlay resulting from his or her employment.

Even if someone meets the “phone book test” an employer/employee relationship may still exist or develop based on the specific nature of the dealings. The guidance on this topic is voluminous. Each situation must be evaluated individually. A prospective contractor will need to consult with his or her CPA, attorney, and insurance agent to discuss whether a worker may appropriately be classified as an independent and, if yes, the current, related, supporting documentation requirements.

Sometimes the forms and deadlines are more of a payroll deterrent than the expense. Employers often retain a CPA or payroll service to handle this. Fees may be as low as $100 per month. Another alternative is contracting workers through a staffing service. Staffing services employ workers and pay all required taxes and insurance then bill their customers for those expenses plus enough to cover overhead and profit. An business owner may pay the staffing service $13 for every $8 the employee is paid but this may be the best option, especially if subject to a high minimum annual worker’s comp premium and/or a worker is only needed for limited hours of work.

Bottom line: If you know a worker should be an employee then put him or her on payroll. You may be ok with circumnavigating the rules but it is never a safe bet that your workers will remain complicit both during and after the period in which they are depending on you for a living.


Military Spouse Residency Relief Act Employers’ Requirements

On Nov. 11, 2009, President Obama signed S. 475, the Military Spouses Residency Relief Act (P.L. 111-97) (the MSRRA), into law. The MSRRA amended the Service Members Civil Relief Act (P.L. 108-189), retroactively to the beginning of the 2009 tax year. (Residence and domicile have the same definition in this discussion.)

“A spouse of an service member shall neither lose nor acquire a residence or domicile for purposes of taxation with respect to the person, personal property, or income of the spouse by reason of being absent or present in any tax jurisdiction of the United States solely to be with the service member in compliance with the service member military orders if the residence or domicile, as the case may be, is the same for the service member and the spouse.”

It is important to note that if you employ a service member, his or her wages are subject to state income taxes. This law applies only to non-military spouses.

Most states now have a form that eligible spouses submit to employers to take advantage of exemption from state income taxes under this bill. As long as an employer is provided with a completed, signed form and retains the required supporting documentation in the file, the employer is authorized to not withhold state income taxes from the military spouse’s wages. Beyond a request to report suspected inaccurate or fraudulent forms to the state, employers are not required to audit or verify eligibility.

Employers are cautioned against offering advice or assistance with the determination of whether or not circumstances qualify a given employee for the state income tax exclusion under MSRRA. The best policy is to recommend employees retain a CPA for guidance in this area.

I also advise employers to obtain a new form and new documentation annually. To be eligible, the spouse must be in the state pursuant to spouse service member orders. If the service member is permanently reassigned (vs. a temporary duty assignment) and the spouse elects to stay behind he or she now loses the protection of this bill. Additionally, military ID cards do have expiration dates and income will cease to be exempt from state income tax upon the entry of a divorce decree. An employee may not think about reinitiating state withholdings once he or she is no longer eligible for exemption.

If a military spouse employee is a resident of a state that taxes income of military residents who are stationed in other states he or she may need to remit estimated income tax payments to that state. In most cases, employers are NOT required to withhold and remit state taxes to a state other than that in which services are performed.

Below are the links to the forms for DE and our neighbors which are current as of the date of this blog. This discussion is not intended to provide comprehensive information. These requirements may still be in development by the state revenue divisions since the law is fairly new and, as usual, there are a number of not so cut and dry situations which the federal law does not address.

For example: What if you employ a military spouse who is stationed in a neighboring state? What if the spouse and member physically reside in a state other than the state where the service member is stationed? The answers vary by state or are absent.

Additionally, I have noticed that several forms contradict themselves. The federal law (MRRSA) is applicable if the legal residence is the same for the service member and the spouse. Several state forms ask in one area that the employee simply be a legal resident of another state but in another area that the employee “meet all the requirements” of MRRSA. Since states could elect to be more generous with the exclusion than the federal law mandates, errors are sure to abound thanks to the poorly thought-out wording on these forms. 

Again, I recommend placing the responsibility for interpreting the state laws and affirming eligibility100% on the employee. He or she is bearing this burden of proof by supplying the employer with the completed, signed form. Strictly adhere to all the instructions for employers on the forms and as provided in other state publications, if any.

DE: W- 4DE, Annual Withholding Tax Exemption Certification for Military Spouse

Note that DE allows exclusion if service member is stationed in either: DE, MD, NJ, or PA.

MD: MW507, Employee’s Maryland Withholding Exemption Certificate

PA: REV-419 EX Employee’s Nonwithholding Application Certificate

NJ: NJ-165, Employee’s Certificate of Non-Residence in New Jersey

VA: VA-4, Personal Exemption Worksheet

Virtue Isn’t Your ONLY Reward!

All charitable contributions are not alike with respect to tax advantages. Certain contributions qualify for The Neighborhood Assistance Act (NAA) Tax Credit, a Delaware state income tax credit for 50% of the amount contributed. The underlying premise for offering this credit is that a charitable program is more likely to achieve a positive impact if at least one individual and/or business owner is a personally invested stakeholder. The NAA credit also wisely leverages taxpayer dollars. For every $1 in foregone tax revenue, an eligible charitable program receives a $2 contribution.

The Delaware NAA program is overseen by the superb staff of DSHA. The process starts with an annual allocation of tax credits by the state legislature. Once the allocated credits have all been awarded to contributors the program is suspended pending an allocation for the next state year (July 1-June 30). It is not uncommon for the tax credits to be 100% spoken for well before the Delaware fiscal year ends. For this reason, I would recommend planning ahead. If a certain charitable program is near and dear to your heart and you would like to be able to be able to take advantage of this credit then speak to the charity about acquiring NAA approval ASAP.

To get started, the charity must submit general information about the organization (financials, 990, etc.) and a simple application for the program itself. (Some multi-faceted charities have numerous programs.) Once the program has been approved and a contributor identified, the charity submits another short form seeking both approval of the donation and reservation of the credits from the annual allocation.

Many states have programs which are as similar as they are different. Below find a comparison of some of the key features in place as of the date of this bog. Most of these programs are tweaked a little each year. I have also provided the current links to more information and application forms.

Name of Program:

DE      Neighborhood Assistant Act Tax Credit

MD     Community Investment Tax Credit

PA      Neighborhood Assistance Program, Neighborhood Partnership Program

NJ      Neighborhood Revitalization Tax Credit Program

VA      Neighborhood Assistance Program







Entities that may contribute

DE     Businesses and individuals who pay DE income taxes

MD     Businesses subject to income, public service company franchise tax or the insurance premiums tax and individuals who are domiciled in MD.

PA     Business firm (including pass through) authorized to conduct business in this Commonwealth and subject to income tax, bank and trust co shares tax, title insurance company franchise tax, insurance premiums tax, mutual thrift institutions tax.

NJ      Individuals and C Corporations

VA     Businesses and individuals who pay VA income taxes

Acceptable forms of contribution

DE      cash, goods, services, or real property

MD     cash, goods, or real property

PA      cash

NJ      cash

VA     Businesses: cash, goods, stock, real property, professional services, contracting services and rent or lease of the participating nonprofit's facilities. Individuals: cash or marketable securities.

Program eligibility

DE: Provide neighborhood assistance in an impoverished area, or provide neighborhood assistance for low- and moderate-income families. This includes Community Development Corporations or Community-Based Development Organizations. Non-profits may be considered eligible if the assistance meets the NAA Program definition of a qualified purpose, including any of the following: community services; crime prevention; economic development; education; affordable housing.

MD: Project or activity that is either located in or serving a community in a Priority Funding Area. Projects must be located in or serve residents of a Priority Funding Area and typically involve activities such as: education and youth services; housing and community development; job and self-sufficiency training; enhancing neighborhoods and business districts; arts, culture and historic preservation; economic development and tourism promotion; technical assistance and capacity building; services for at-risk populations.

PA: Projects must fall under one of the following categories: Affordable housing; education; health and social services; community economic development; job training; crime prevention; and neighborhood assistance.

NJ: Nonprofit organization programs for housing and economic development in low-low/moderate income neighborhoods.

VA: Providing assistance for impoverished people. Several of the activities sponsored by the program are education, job training, housing assistance, health care clinics and community services.

% of Donation Credited

DE      50%

MD      50% (may take both charitable deduction on state form & credit)

PA      75%-80%

NJ      100%

VA      40%

Minimum/Maximum contribution per year

DE      $5,000 individual/$10,000 business min and $200,000 max

MD     $500 min and $500,000 max

PA      $50,000/yr for 5 years min, $666,666 for one project in one year max

NJ      $25,000 min and $1,000,000 max

VA      $500 min & no max individual/$1,000 min & $437,500 max business

What type of taxes may be offset?

DE      Income tax

MD     Income tax

PA      Corporate Net Income Tax, Bank and Trust Company Shares Tax, Mutual Thrift Institutions Tax, Capital Stock – Franchise Tax, Insurance Premiums Tax or Title Insurance Company Shares Tax.

NJ      Corporate Business Tax, Savings Institution Act, Tax imposed on marine insurance companies, Tax imposed on insurers generally, Sewer and Water Utility Excise Tax, Petroleum Products Gross Receipts Tax

VA      Income

Most Recent Annual Allocation:

DE      $500,000

MD     $1,000,000

PA     unable to determine

NJ      $10,000,000

VA      unable to determine