By now, employees have received their Forms W-2, are in the process of filing their federal, state and local tax returns, and may have identified some errors. That means that this is the time of year that payroll professionals have questions about how to prepare Forms W-2c under different scenarios.
On September 11, 2019, the California Senate passed legislation under AB-5 to codify the California Supreme Court decision in Dynamex and expand and clarify its application. This bill would significantly impact all industries that customarily engage independent contractors.
California’s pioneering independent contractor legislation could have broad implications on the gig economy (e.g., rideshare and delivery drivers) and is certain to trigger a larger national discussion.
California’s pioneering independent contractor legislation could have broad implications on the gig economy (e.g., rideshare and delivery drivers) and is certain to trigger a larger national discussion.
Governor Newsom has signaled his support for the bill and is expected to sign it into law within the coming days.
Background
Prior to
April 30, 2018, and for most matters before theCalifornia
Division of Labor Standards Enforcement,
depending on the remedial nature of the legislation at issue,
the “multi-factor” or the “economic realities” test was applied
under the California Supreme Court case of S.
G. Borello & Sons, Inc. v Dept. of Industrial Relations (1989) 48 Cal.3d 341 (Borello). In applying this economic
reality test, the most significant factor considered was whether the person to
whom service is rendered (the employer or principal) has control or the right
to control the worker both as to the work done and the manner and means in
which it is performed. There were an additional
11 factors also considered.
Effective
April 30, 2018, the California Supreme Court issued a landmark decision in the
matter of Dynamex
Operations West, Inc. v. Superior Court of Los Angeles.
In Dynamex, the California
Supreme Court created a presumption that a worker who performs services is an
employee not an independent contractor and adopted a new worker classification
standard. The result of the Dynamex case
was to replace the Borello standard with
the new ABC test. The Dynamex holding was narrow in its
application as it was limited to wage orders that were issued by the Industrial
Welfare Commission.
For unemployment and disability insurance purposes. whether a worker is an employee or independent contractor is currently determined through the application of the factors contained in common law or employment and statutory provisions of the California unemployment insurance code. The California Employment Development Department provides a questionnaire in DE-38 for this purpose.
Codifies the Dynamex (ABC test) standard. California AB-5 codifies Dynamex (the ABC test) for purposes of
the California labor code, the unemployment
insurance code and for the wage orders of the Industrial Welfare Commission. Accordingly, a person providing labor or
services for remuneration shall be considered an employee rather than an
independent contractor unless the hiring entity demonstrates that all the
following conditions are satisfied:
(A)The person is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.
(B) The person performs work that is outside the usual course of the hiring entity’s business.
(C) The person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.
Retains current exceptions
for the definition of employee. Any exception to the term “employee,” “employer,” “employ,” or
“independent contractor,” and any extensions of employer status or liability, shall
remain in full effect. (California AB-5 2750.3(a)(2).)
Reverts to Borello standard (i.e., old standard) in some cases. If a court of law rules that the new standard (i.e., ABC Test) cannot be applied to a particular case, the determination of employee or independent contractor status shall instead be governed by the old standard (i.e., Borello). (CaliforniaAB-5 2750.3(a)(3).)
Exempts certain occupations from Dynamex (ABC test). The law would exempt specified occupations from the application of the ABC test and would instead subject them to the application of the older standard (i.e., Borello). These exempt occupations would include, but are not limited to, the following: licensed insurance agents, certain licensed health care professionals, registered securities broker-dealers or investment advisers, direct sales salespersons, real estate licensees, commercial fishermen, workers providing licensed barber or cosmetology services, and others performing work under a contract for professional services, with another business entity, or pursuant to a subcontract in the construction industry. (CaliforniaAB-5 2750.3(b).)
Putting power in the hands of working people has never been more critical than now.
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California AB-5 provides that the codification
of the ABC Test is not a change in law, but rather declaratory of existing law
and should apply retroactively to existing claims to the extent permitted by
law.
Generally, and except where otherwise noted
within the law, the other provisions of AB-5 are effective with work performed
on or after January 1, 2020.
Any worker who is an employee by application of this law is not required to be covered by worker’s compensation insurance until July 1, 2020. (AB-5 Assembly floor analysis, 9-10-2019.)
Observations
Tightening the worker
classification rules so that more workers are eligible for benefits, like
unemployment insurance, and protections, like minimum wage and overtime, is
something other states are also considering (e.g., Alaska, New York and
Oregon). There are also federalproposals similar to California AB-5 being promoted by
federal lawmakers with an emphasis of giving gig workers the right to union
representation.
California AB-5 and similar legislation is likely to face fierce challenges from businesses reliant on gig workers, making the outcome uncertain.
Finally, implementation of
the law will be complex requiring detailed guidance from the California agencies
concerned with worker classification.
In the meantime, businesses will need to consider the employment tax and human resources policy changes that will be necessary to comply with California AB-5 once enacted.
As the payroll rules continue to expand in scope and complexity, more businesses are turning to outsourcing. While payroll outsourcing can reduce technology and administrative costs, it does not replace the need for experienced professionals with an understanding of payroll rules and a focus on governance.
In this special report from Ernst & Young LLP, a careful exmaination is given of the roles and responsibilities that continue to apply when the payroll function is outsourced. The report includes a scorecard that readers can use to determine how well they are governing their third-party payroll arrangements.
You can download the full report from the link below.
According
to new
sources, senior White House officials were in preliminary
discussions on August 19, 2019 about a possibility of a reduction in payroll
taxes, as well as other tax breaks, to bolster a slowing economy. In a press conference on August 20,
2019, President Trump denied concerns over the economy but did confirm that his
Administration is looking at payroll and capital gains taxes.
While
President Trump did not elaborate on how he defines payroll taxes, the term is
typically used to describe the Social Security/Medicare (FICA) taxes that are
paid by both employees and employers.
Social Security tax is 6.2% of annual wages up to $132,900 for 2019 and
Medicare tax is 1.45% of all covered wages.
Because
FICA taxes are credited to trust funds that pay for federal retirement and
disability benefits, proposals to reduce employer/employee contributions are
typically dead on arrival. However,
President Obama was successful at enacting economic stimulus legislation that directly
or indirectly put a portion of the FICA tax expense back into workers’ pockets
with subsidies from the general budget.
Payroll
tax cuts under President Obama
To create
economic stimulus in response to the recession that triggered in 2008,
President Obama stewarded two provisions through Congress that put a portion of
worker’s FICA taxes back into the economy. It is emphasized that both
provisions were funded by general revenues thereby adding to the national
debt.
The Making Work Pay tax credit. For 2009 and 2010, a refundable tax credit was available of $400 to working individuals and $800 to working families. The credit was calculated at a rate of 6.2% on earned income for 2009 and 2010 and phased out for taxpayers with adjusted gross income over $75,000 ($150,000 for married couples filing jointly). Employers delivered the credit to their employees by reducing their federal income tax withholding by the amount of the credit as computed for the periodic wage payment. Any portion of the credit that was not delivered by the employer through payroll checks as of December 31 could be claimed by eligible taxpayers on the Form 1040. The cost of the credit was funded by general revenues and not the Social Security trust fund.
Social Security tax cut. In 2011 and 2012, the Social Security tax rate that applied to employees and self-employed individuals was reduced by 2.0% but employers were subject to the full 6.2%. Like the Making Work Pay tax credit, the 2% reduction in workers’ Social Security taxes was funded by general revenues and not the Social Security trust fund.
Observations
Thus far, the President has not
presented a formal proposal to Congress for vote that would offer workers a
reduction in their FICA taxes. It is
worthy to note, however, that should the nation face a recession similar in
severity to that in 2008-2009, we may see a return to those Obama-era payroll
tax cut provisions.
Read this Ernst & Young LLP special report to learn about the state rules governing direct deposit and pay cards that serve to limit the electronic payment options that can be offered to the workforce and view the state survey to see where electronic payments can be mandated.
Effective October 1, 2019, contributions are required to be paid for Massachusetts Paid Family and Medical Leave (PFML) in advance of benefits that will become available on and after January 1, 2021. (EY Payroll Newsflash, Vol. 20, 122, 8-22-2019.)
Following is information to address questions that have been
raised about the tax treatment of Massachusetts PFML contributions.
Tax treatment of
Massachusetts PFML contributions
Based
on the initial rate of 0.75%, the allocation of PFML contribution rates
beginning October 1, 2019 is 0.62% for medical leave and 0.13% for family leave
on covered wages up to the Social Security wage limit of $132,900 for 2019.
Employers
with fewer than 25 employees.
100% of the contributions are paid by employees; however, employers may pay some
or all of the employee contribution.
Employers
with 25 or more employees.
Employees are responsible for 100% of the family leave contribution of
0.13%. Employers may withhold up to 40%
of the medical leave portion of the contribution from employees’ wages. Based
on the medical leave rate of 0.62%, employers must calculate their
contributions at a minimum of 0.372% and may withhold up to 0.248% of
employees’ wages and up to 100% of required contributions for family
leave.
The portion of the contribution
required to be paid by employers is not included in federal or Massachusetts
taxable wages but if the employer pays the employee portion of the
contribution, that amount is included in federal and Massachusetts taxable
wages. (IRS Reg. §
31.3401(a)-1(b)(6); IRC §3306(b)(6); IRC §3121(a)(6); Mass. Gen. L. Chapter 62 § 1.)
Example 1: If the employer pays on behalf of their
employees any portion of the PFML contributions in (1) above, that amount is
included in federal and Massachusetts taxable wages. Note that the portion paid by the employee
must be deducted on an after-tax basis (and cannot be deducted on a pre-tax
basis).
Example 2: If the employer pays the employer portion shown in green below, this amount is not included in federal or Massachusetts taxable wages, but if the employer pays on behalf of employees any portion of the amount shown in black below, this amount is included in federal and Massachusetts taxable wages. Note that the portion paid by the employee must be deducted on an after-tax basis (and cannot be deducted on a pre-tax basis).
For information concerning the tax treatment of leave benefits provided under paid family and medical leave plans Ernst & Young LLP’s special report.
The API published a story on September 13, 2013 stating that under federal law employers cannot force employees to take plastic pay and that withdrawal fees also cannot be imposed on them.
The movement to electronic filing and the increased complexity in the rules governing payroll have resulted in an understandable trend of outsourcing payroll and employment tax. But, when it comes to outsourcing, out of sight does not mean out of mind.
Handing your payroll and employment tax processing to a third party is no different from hiring employees to do the work. The company’s executives continue to be liable for compliance, meaning, oversight of the work is still an inside job.
When it comes to payroll outsouring, out of sight should not be “out of mind”
Occasionally, a big story hits the news about a less than upstanding payroll company absconding with their clients’ tax deposits. When this sort of new breaks, the importance of third-party oversight gets some focus. Recently, for instance, the IRS added a web page (http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Third-Party-Arrangement-Chart) explaining the steps employers should take to confirm and review third-party returns and tax payments.
Invest in your internal resources
The job of supervising payroll/employment tax vendors requires substantial internal expertise.
Take earnings and deduction codes for instance. The task of reviewing the plan or policy and choosing a preconfigured template requires an understanding of the federal, state and local employment tax rules. Vendors are not responsible for choosing the wrong configuration templates, or correctly identifying exceptions that may apply.
Payroll vendors are frequently tasked with creating a general ledger interface; however, there are numerous transactions outside of regular pay data that must also be correctly recorded. Analysis of general ledger codes and their balances are required too if there are changes in the company’s organization structure that reach to where and how payroll transactions are booked. Accuracy of general ledger entries is not only important for financial statements–they may also come under close scrutiny for purposes of tax enforcement, workers’ compensation, and other employment related audits.
Having individuals within the organization who have cross-functional knowledge of accounting, payroll and employment tax is key to the effective and efficient management of human resources. The rules governing payroll and employment are routinely evolving, as are the technologies necessary to comply with them. That’s why investing in payroll training and informational resources is also important.
Falling into complacency is tempting when trusted payroll vendors are relied on for the heavy lifting. That’s why the supervisory role should be carefully defined with performance monitored and rewarded.
Do you outsource payroll/employment tax?
Tell us what steps you take to supervise your vendors, and how your performance is measured.
Here is an interesting article on the high risk businesses take in calling their workers independent contractors to avoid the Obamacare employer mandate.
