Accounting and Taxes Toolkit

Linda Heuer,
Eide Bailly Employee Benefits:
952.918.3519
lh****@********ly.com
www.eidebailly.com

Joel Germershausen,
Eide Bailly:
952.918.3567
jg************@********ly.com
www.eidebailly.com

Changes ahead for
pre-tax employee
benefit plans

Health care reform through the Patient Protection and Affordable Care Act of 2010 will bring sweeping changes to the health care industry.  Flexible benefit plans as well as Health Reimbursement Arrangements (HRAs) and Health Savings Accounts (HSAs) have also been affected.

So writes Linda Heuer, principal with Eide Bailly Employee Benefits in Bloomington. Her list for items to watch includes the following:

1. The first change that is effective for plan years beginning January 1, 2011, is that Flexible Benefit Plans, HRAs and HSAs will no longer be able to reimburse for over the counter (OTC) medicines (except insulin) without a prescription.

2. Over the past several years, many flexible spending accounts have utilized a debit card to allow for easier processing of claims for both the employee and the third party administrator. With the new regulations, the over the counter items that may be purchased with a flexible spending debit card will be limited to non-medicine or non-drug OTC items such as bandages, blood sugar test kits and test strips, according to Heuer.

OTC items that will not be able to be purchased using a debit card include acid controllers, allergy and sinus products, pain relief products, stomach remedies, and many more. These expenses will need to be submitted manually for reimbursement, along with the prescription.

3. Another change effective January 1, 2011, is an increased penalty, to 20 percent, for non-medical expense withdrawals from an HSA. The HSA participant will be responsible to report these non-medical expenses and pay the penalty, Heuer writes.

4. Effective January 1, 2013, pre-tax salary reduction contributions to medical reimbursement accounts in flexible benefit plans will be limited to $2,500 per taxable year. In most cases, a “taxable year” is the same as a calendar year. The limitation will be adjusted annually for inflation.  

5. Also effective January 1, 2011, small employers’ cafeteria plans can qualify as simple cafeteria plans and avoid the nondiscrimination requirements of a traditional cafeteria plan under various IRS regulations. An employer is eligible to establish a simple cafeteria plan if, at any time in the last year, it had an average of 100 or fewer employees, Heuer writes.

A simple cafeteria plan also must meet minimum eligibility and participation requirements. The requirements are met if all employees who work at least 1,000 hours for the previous plan year are eligible to participate and all employees have the same election rights under the plan.  Certain employees may be disregarded in applying these requirements.

Be careful when
calling people
employees, contractors

Many companies have elected to use contract employees, consultants or subcontractors to reduce payroll costs. The logic behind doing this is to bring in a person for a specific job or project, then have them off the payroll after that project is complete, according to Joel Germershausen, a CPA and tax manager at Eide Bailly in Bloomington.

There is no requirement to provide these workers with health insurance, and the worker is responsible for remittance of payroll taxes on the money earned, he writes. However, when choosing this route, there are many factors for employers to consider to ensure the person hired is truly considered an independent contractor for wage and payroll tax withholding in the eyes of the Internal Revenue Service.

According to Germershausen: In determining the classification of a worker as an employee or independent contractor the IRS lays out a “20-factor test,” which has been developed based on common law principles. The test is based on the facts and circumstances of each case and essentially involves three “categories” used in the determination: behavioral control, financial control and the type of relationship between worker and employer.

Behavioral control refers to the level of control the employer has over the worker. One of the biggest things the IRS will look for when determining the classification of an employee is whether the worker is required to comply with the employers’ instructions about when, where and more importantly, how work is performed. Training provided by the employer to the worker is another example of behavioral control.

Financial control tests come into play more often than not when there is skilled labor performed.  When determining financial control, the IRS will look at factors such as who pays business and/or traveling expense, who furnishes the tools and materials used in the performance of the job and who bears the realization of profit or loss on a project. If the employer reimburses business expenses for the worker and provides the tools and materials necessary to complete a project, the worker would most likely be considered an employee subject to payroll withholding, writes Germershausen.

The third category of tests relates to the type of relationship between employer and worker. Factors such as the worker making services available to the general public on a consistent basis or providing more than minimal services to several unrelated parties at the same time generally indicate an independent contractor relationship between the parties. However, if either the employer or worker has the right to discharge or terminate the relationship, respectively, an employer-employee relationship exists, according to Germershausen.

Another test used to determine if a worker is an employee or an independent contractor is the Department of Labor’s “economic reality test.” This test looks at the relationship between the worker and the employer to determine if the worker is economically dependent upon the employer for continued employment.

If the worker relies on a lone employer as their primary source of income, that worker would likely be considered an employee. On the other hand, if the workes had several sources of income from independent employers, that worker would be considered an independent contractor, Germershausen writes.

To-do list
1. Why should employers care whether they classify people as employees or independent contractors? The simple fact is that the IRS absolutely loves to reclassify workers paid as independent contractors as employees, according to Joel Germershausen, Eide Bailly in Bloomington. This has become a highly scrutinized area, and often a lucrative area for the IRS.

2. For any worker that is determined to be misclassified, the employer is always liable for the employer share of the FICA taxes. Additionally, the IRS can assess up to three years of unremitted employee FICA taxes and income tax withholding. An example of the severity of the penalties is illustrated using a worker who was paid $40,000 and issued a 1099-MISC. If the misclassification was unintentional, the penalties calculate to just shy of $4,400. If the IRS can prove that the misclassification was intentional, the penalties alone come to a staggering $16,000. 

3. The enactment of health care reform earlier this year is another reason to classify properly. There are several provisions of the act that classify a business based on number of full-time employees or full-time equivalent employees. For example, for tax years beginning after December 31, 2009, a tax credit is provided for an “eligible small employer” for nonelective contributions to purchase health insurance for its employees.

4. One of the requirements to qualify as an eligible small employer is having no more than 25 full-time equivalent employees. For many small businesses that use independent contractors, having a contractor reclassified as an employee could bump the business out of qualification for this credit, according to Germershausen.