Category: General

In 2020 and 2021, many companies have experienced “workforce fluctuations.” If your business has engaged independent contractors to address staffing needs, be careful that these workers are properly classified for federal tax purposes.

Tax obligations

The question of whether a worker is an independent contractor or an employee for federal income and employment tax purposes is a complex one. If a worker is an employee, the company must withhold federal income and payroll taxes, and pay the employer’s share of FICA taxes on the wages, plus FUTA tax. Often, a business must also provide the worker with the fringe benefits that it makes available to other employees. And there may be state tax obligations as well.

These obligations don’t apply if a worker is an independent contractor. In that case, the business simply sends the contractor a Form 1099-NEC for the year showing the amount paid (if the amount is $600 or more).

No uniform definition

The IRS and courts have generally ruled that individuals are employees if the organization they work for has the right to control and direct them in the jobs they’re performing. Otherwise, the individuals are generally independent contractors, though other factors are considered.

Some employers that have misclassified workers as independent contractors may get some relief from employment tax liabilities under Internal Revenue Code Section 530. In general, this protection applies only if an employer filed all federal returns consistent with its treatment of a worker as a contractor and treated all similarly situated workers as contractors.

The employer must also have a “reasonable basis” for not treating the worker as an employee. For example, a “reasonable basis” exists if a significant segment of the employer’s industry traditionally treats similar workers as contractors. (Note: Sec. 530 doesn’t apply to certain types of technical services workers. And some categories of individuals are subject to special rules because of their occupations or identities.)

Asking for a determination

Under certain circumstances, you may want to ask the IRS (on Form SS-8) to rule on whether a worker is an independent contractor or employee. However, be aware that the IRS has a history of classifying workers as employees rather than independent contractors.

Consult a CPA before filing Form SS-8 because filing the form may alert the IRS that your company has worker classification issues — and inadvertently trigger an employment tax audit. It may be better to properly treat a worker as an independent contractor so that the relationship complies with the tax rules.

Latest developments

In January 2021, the Trump Administration published a final rule revising the Fair Labor Standards Act’s employee classification provision. The rule change was considered favorable to employers.

The Biden Administration initially delayed the effective date and then issued a Notice of Proposed Rulemaking (NPRM) to withdraw the rule. After reviewing approximately 1,000 comments submitted in response to the NPRM, it withdrew the rule change before the deferred effective date. Contact your tax advisor for any help you may need with employee classification.

© 2021

After almost 40 hours of debate over four days, the House Ways and Means Committee on September 15 approved a tax package that would increase rates on high-net-worth individuals and corporations and affect cross-border activity and pass-through entities, advancing the tax elements of the Biden administration’s “Build Back Better” agenda.

The package advanced on a largely party-line 24-19 vote – no Republicans voted for it, and only one Democrat, Rep. Stephanie Murphy, D-Fla., voted against it.

As the next step in the legislative process, the legislation now goes to the House Budget Committee, where it will be combined with bills from other House committees and eventually brought before the full House for a vote as the reconciliation legislation.

Individuals

The draft legislation would raise the top individual marginal tax rate from the current 37% to 39.6% for taxable income over $450,000 for married individuals filing jointly and surviving spouses, $425,000 for head of households, $400,000 for single individuals, $225,000 for married individuals filing separately, and $12,500 for estates and trusts. The proposal would be effective for taxable years beginning after December 31, 2021.

The capital gains tax rate would rise to 25% from 20% for transactions by high-income individuals made after Sept. 13, 2021.

The bill would also create a 3% surcharge on modified gross adjusted income above $5 million, and set a limit on contributions to large individual retirement accounts.

The bill would extend the holding period to obtain long-term capital gains treatment for gain allocated to carried interest partners from three to five years. The three-year holding period would remain in effect with respect to any income attributable to real property trades or businesses and for taxpayers (other than an estate or trust) with adjusted gross income of less than $400,000.

Business Provisions

The legislation would introduce a graduated income tax rate structure for most corporations, with a top corporate tax rate of 26.5%. Corporations with taxable income that does not exceed $400,000 would be subject to a new 18% tax rate (lower than the current 21% rate), while those with income that exceeds $400,000 but does not exceed $5 million would be subject to a 21% tax rate, and those with income in excess of $5 million would be subject to the top 26.5% rate.

On the international front, the bill would reduce the Section 250 deduction for global intangible low-taxed Income (GILTI) to 37.5%, resulting in an effective tax rate of 16.5% based on a corporate tax rate of 26.5%. The GILTI would be calculated on a country-by-country basis. Other international tax provisions include:

• The deduction for qualified business asset investment (QBAI) would be reduced to 5%;
• The foreign tax credit haircut would be reduced to 5%;
• The tax on foreign-derived intangible income would rise to an effective rate of 20.7% based on a corporate tax rate of 26.5%;
• Excess foreign tax credit carryforwards would be allowed for five years but carrybacks would be disallowed; and
• A new limitation on interest expense deductions for some multinational corporations would be introduced.

What’s Not in the Bill

The Ways and Means tax bill does not include any changes to the cap on individual itemized deductions for state and local taxes, which was introduced in 2017’s tax reform. Ways and Means Chairman Richard Neal (D-MA) has said he is committed to include “meaningful SALT relief” in the final legislation.

A provision to end the tax-free step-up in basis above a $1 million threshold that was proposed by the Biden administration is also not included in the Ways and Means bill.

 

Written by Todd Simmens. Copyright © 2021 BDO USA, LLP. All rights reserved. www.bdo.com

 

Section 1202 of the Internal Revenue Code is growing in popularity among investors and may become even more valuable in 2022.

Section 1202 allows founders and investors of corporations to exclude up to 100% of their capital gains derived from the sale of qualified small business stock (QSBS) held for more than five years (subject to limitations). Because the gain exclusion percentage for a shareholder depends on the QSBS issuance date, as time goes on more investors are becoming eligible for the full, 100% exclusion—and thus its rise in popularity.

Further, the 2021 Green Book proposes far-reaching changes to the taxation of long-term capital gains, which are taxed at graduated rates under the individual income tax. Today, the highest rate is generally 20% (23.8% including the net investment income tax, if applicable, based on the taxpayer’s modified adjusted gross income (AGI)).

Under the Green Book proposal, long-term capital gains of taxpayers with AGI of more than $1 million would be taxed at ordinary income tax rates to the extent that the taxpayer’s income exceeds $1 million ($500,000 for married filing separately), indexed for inflation after 2022. Currently, the highest rate for individuals is 37% (40.8% including the net investment income tax), though the Green Book also includes a proposal to raise the individual rate to up to 39.6% (43.4% including the net investment income tax).

While reinvestments into Qualified Opportunity Zones, like-kind exchanges for real property (possibly limited going forward), and reinvestment of proceeds into qualified replacement property from sales of corporate stock to an Employee Stock Ownership Plan of 30% or more of the corporation’s outstanding stock provide some deferral opportunities, Section 1202 is the only provision that provides an exclusion opportunity for QSBS. The higher that the capital gains tax rate goes up, the greater the potential tax benefit of utilizing an available Section 1202 exclusion.