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Is this individual an employee?


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A small office has 2 owners and 2 employees.  As of 7/1/18, one of the owners is selling his share of the business to the other owner.  The former owner will still continue to work as an independent contractor for the business and will report to the same office  and be paid via 1099.

As of 7/1/18, should the former owner be considered an employee given that he is still doing mostly the same work as before even though he is being paid via 1099 and considered himself an independent contractor?  He also expects to make some payments to the business to cover a portion of the costs of the other 2 employees who may do some work for him that could include work not related to the company business (but directly for him).

The company has a 401k plan that he participates in so whether he is an employee or not needs to be determined after 7/1/18 to know if he can still actively participate in the plan.

If not an employee and if he starts his own business (self-named) as a sole prop, given he is paying some fees for the other 2 employees, do you think there is a concern that he would have to include them in his own 401k plan?

Thanks for any advice.

 

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Facts and circumstances - it sure sounds like an employee even if paid via 1099 since continue to work in the same office after the sale of the business.  However, I think that is a determination that should be made through a legal opinion.  He has the same issue with the new business with the two "employees".  By paying fees, do you mean payment for services performed for new co.?  It sounds like they would be doing work for him.  You then have the same question - are they a true employee or an independent contractor - facts and circumstances determination. If treated as an employee, then could include eligibility requirements for those employed after a certain date assuming they worked limited hours. 

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The IC question, I think, depends on who has control over this person's work activity? Even if doing the "same job" as when he was an owner, that by itself wouldn't necessarily mean he is an employee now. As an owner, did he come an go as he pleased, have the freedom to complete various tasks according to his own schedule, and from wherever he wanted (home, office, road, etc.)? If he has autonomy in providing services to the business, I think he is a contractor. Certainly wouldn't hurt to get the opinion of accountant (if qualified) or legal counsel.

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RatherBeGolfing:  Is there something in the facts provided which I missed that says the plan excludes individuals classified by the employer as ICs?   

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29 minutes ago, jpod said:

RatherBeGolfing:  Is there something in the facts provided which I missed that says the plan excludes individuals classified by the employer as ICs?   

What is teh definition of comp for the plan?  I don't think 1099 income falls under the any of the usual suspects:  415, simple 415, withholding, or W2.

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The existing plan does use W2 compensation.  

By paying fees, he will pay a portion of the rent (for the office space he is using) as well as a portion of the existing company's staff. who will be doing some work for him.  Some/most of this "work" will actually be for the current company.  I am not sure if his payments for the staff support will be only for work he does not related to the existing business, or if it will be for only work actually for the existing business, or both.  

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30 minutes ago, Santo Gold said:

By paying fees, he will pay a portion of the rent (for the office space he is using) as well as a portion of the existing company's staff. who will be doing some work for him.

Sounds like there are shared employees; a whole 'nother issue.

Ed Snyder

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I think we're missing the point.  Unless the Plan has the magic "Microsoft" language in it, it will say, presumably, that employees are eligible.  That calls for an analysis of whether someone who you are not treating as an employee is really an employee under the common law definition.  If he is, he is eligible.  Also, most likely the definition of compensation speaks in terms of how the compensation is supposed to be treated, not how it is actually treated.  This is not dancing on the head of a pin.  However, under these circumstances it sounds like a simple fix is to amend the plan to say that [NAME OF PRIOR OWNER] shall no longer be eligible to participate effective 7/1/18.    

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2 hours ago, RatherBeGolfing said:

For plan purposes, he is an IC because that is how the employer is treating him, even if the IC/EE is misclassified.  As long as the employer treats him as an IC he is not an employee and therefore cannot participate.  

This, I think, is the exact opposite of the ruling in the Microsoft decision.

That said, post-Microsoft, many plans include a clause that excludes "employees treated as independent contractors" (or similar language) as a class. OP, you should check your document to see if it includes this language. If it does then you should be perfectly fine to exclude the former owner.

If the former owner wants to continue to participate, then you should have him (as a sole proprietorship) adopt the plan as an adopting employer. That way, whether he is an employee or not, the exclusive benefit rule is satisfied.

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6 minutes ago, C. B. Zeller said:

This, I think, is the exact opposite of the ruling in the Microsoft decision.

That said, post-Microsoft, many plans include a clause that excludes "employees treated as independent contractors" (or similar language) as a class. OP, you should check your document to see if it includes this language. If it does then you should be perfectly fine to exclude the former owner.

If the former owner wants to continue to participate, then you should have him (as a sole proprietorship) adopt the plan as an adopting employer. That way, whether he is an employee or not, the exclusive benefit rule is satisfied.

Yea I realize I should have worded it differently.  I didn't mean to say he is ineligible even if he is misclassified, but rather that this is an employment issue first.

If he is an IC, he cannot participate as an employee (because he is not an employee)

If he is an employee treated as IC, he is either improperly excluded (because he is an employee), or properly excluded if the document uses a clause you discussed above.

Even if he is supposed to be eligible because of misclassification, wouldn't the classification have to be addressed first since he wouldn't have comp as an employee as long as he is classified as an IC (1099'd as non employee wages)?
 

 

 

 

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1. It's likely he is NOT an independent contractor as described in the information.  Unless he is going into business to provide whatever these services are to other entities besides his old partner, he will not meet any rational reading of the rules.  We hear this brilliant idea all the time; it just doesn't work.

2. In Mass, if you misclassify a worker, the penalty is 300% of the normal penalties for failure to withhold and submit and is automatic. That is, the ASSUMPTION is MA is that you are an employee, and have to prove that you are not.

3. His old partner will be subject to massive penalties at the Fed level for failure to withhold if the ex-partner is really an employee.  I had two dentists years ago who were employing additional dentists in their practice as independent contractors.  I told them they were wrong but they kept that design.  The IRS came in and hit each of the dentists with over $100k in penalties, even though the ICs paid ALL OF THEIR TAXES.  It was a failure to withhold penalty, and it is brutal.  Plus, MA has an automatic tripling of penalties. Note: the problem is NOT the problem of the IC; it is his old partner's risk.

4. The plan most likely has the microsoft language (I haven't seen one without that for many years), which will protect the plan from having to provide benefits for the individual who is re-classified as an employee.  Assuming he would still be an HCE, that should not pose a problem.

5. If the "IC" set up his own plan, he risks all kinds of problems if he is reclassified as an employee. 

Just a typical bad idea dealing with IC status.

Lawrence C. Starr, FLMI, CLU, CEBS, CPC, ChFC, EA, ATA, QPFC
President
Qualified Plan Consultants, Inc.
46 Daggett Drive
West Springfield, MA 01089
413-736-2066
larrystarr@qpc-inc.com

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Wow, that's a massive penalty structure. A very powerful incentive to be careful! Have you had anyone since, to whom you related this situation, who still ignores your advice on this? (Just curious - is the Mass penalty 300% of the Federal penalty, or 300% of the otherwise applicable State level penalty?)

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In my mind too many people are confusing issues here. 

The first issue that needs to be addressed is this person an IC or an employee.  Please note that determination is a legal one not one done by agreement.  It doesn't matter what the guy thinks or the person paying him thinks.  You don't agree to be an IC.  You either are an employee or an IC under the law.  You hear people say this all the time-  I signed a contract saying I am an IC.  This isn't an issue you can settle via contract.   Likewise merely paying them and issuing a 1099 means nothing.  If the person is an employee and you give them a 1099 all that mean is you have given them the wrong form and failed to withhold the legally required taxes.  I can not stress this enough these two parties do NOT get to negotiate if this person is an employee or not.  It is a legal question based on facts and law. 

So step one is determine if these person is in fact an employee or an IC. 

Step two is then decide if this person is in the plan or not.  Yes, if the person is misclassified the Microsoft language might still keep them out.  But that language was supposed to be about you really think the person is an IC and much later you find out that isn't true via a court or other legal ruling.  It wasn't supposed to be a weapon to allow you to declare people IC incorrectly.  You might say intent doesn't matter but as Larry points out misclassifying people has it own legal problems. 

So I would advise these people to go back to step one and get a legal ruling if this person is an employee or IC.  If an employee then work on getting the plan amended to do what they want to do if the rules will allow it.  If an IC than clearly the person can be kept out of the plan. 

At risk of beating a dead horse but in the OP this statement is legally incoherent. 

As of 7/1/18, should the former owner be considered an employee given that he is still doing mostly the same work as before even though he is being paid via 1099 and considered himself an independent contractor?

There is no such thing as an employee who gets paid via a 1099 and what they consider themselves to be is irrelevant. 

And if a person is being given a 1099 properly then they aren't an employee. 

That question is at the heart of your problem.  You are being given a set of mutual exclusive choices and are being asked to make them work together.

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8 hours ago, Belgarath said:

Wow, that's a massive penalty structure. A very powerful incentive to be careful! Have you had anyone since, to whom you related this situation, who still ignores your advice on this? (Just curious - is the Mass penalty 300% of the Federal penalty, or 300% of the otherwise applicable State level penalty?)

I have given severe warning to some clients, and almost all of them have seen it my way.  Some have gone as far as to hire outside counsel (see my last paragraph in this response) for an opinion they can hopefully count on. 

Here is some specific info from the article I am attaching which is a wonderful explanation of the issues, especially as it relates to MA; there are the penalties assessed by the state which are both criminal and dollar amounts, and then there is the civil actions that aggrieved employees can bring which is where 3x the damages plus atty fees and cost.

Read these two paragraphs:

The Attorney General can issue civil citations and institute criminal prosecution for both intentional and unintentional violations of the MICL. Willful violations can result in fines up to $25,000 or imprisonment for up to one year for a first offense, and fines up to $50,000 or imprisonment for up to two years for subsequent violations. Non-willful violations can result in fines up to $10,000 or imprisonment for up to six months for a first offense, and fines up to $25,000 or imprisonment for up to one year for subsequent violations.

Employees also may file civil actions for themselves and others similarly situated seeking treble damages, attorneys’ fees and costs. This is a fertile area for claims, and recoverable money damages can be substantial. For example, if a group of workers treated as independent contractors worked over forty hours per week without receiving one and one-half times their regular rate of pay, damages may include three times the owed overtime pay for a period going back as far as three years.

And I've attached a nice long article that shows just how terrible the situation is in MA. This is not something that you want to take lightly, especially in MA.

Derrin Watson, a well known participant in this board, is the author of the text Who's The Employer and can be hired by clients to give an opinion on the status of individuals vis a vis independent contractor vs employer.

mass-independent-contractor-law.pdf

Lawrence C. Starr, FLMI, CLU, CEBS, CPC, ChFC, EA, ATA, QPFC
President
Qualified Plan Consultants, Inc.
46 Daggett Drive
West Springfield, MA 01089
413-736-2066
larrystarr@qpc-inc.com

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