employee gets both w-2 and 1099 income

[himt4]

A prospective new client has one employee (about the same age as the client). Client wants a new class allocation profit sharing plan for 2005 and wants max 42000 for himself and wants to give the employee something but nothing overly generous. Client says employee was paid $80,000 in w-2 and $30,000 in 1099 earnings for 2004 and will get about the same in 2005.

So how much do I need to obsess about this 1099 income.

On one hand, I say that 1099 income doesnt count and I should ignore it.

But on the other hand, I say that this $30,000 probably isn't legitimate 1099 income and should've been w-2 income.

On the other hand, If the client's accoutant said that this 1099 was ok, who am I to sugget otherwise.

Obviously for the client, if there was some way to include the 1099 for 2004, the employee would be an HCE and would only need to get 3% top heavy for 2005, otherwise employee as an NHCE will need to get like 17% for the client to get his 42000.

Is there any way I can include the 1099?

If I don't include it, do I need to do anything to cover my ***.

I would also like to know, in your expeience, what would be a real life example of an employer paying his employee both w-2 income and 1099 income legitimately.

[E as in ERISA]

Royalties for literary works or music? If the "employer" is a small publisher, he might be paying the other for various services in an employee capacity. But if there are royalties from publications or music they've created together, he would then 1099 him for those. Not common. But that's what comes to mind. But it can be way more complicated than that.

[GBurns]

"Who am I to suggest otherwise"

depends on what your function is and how much you need to CYA.

An employer should not have an employee who gets a 1099. Employees get W2s. There have been recent cases of employers getting penalized for this sort of thing. Whatever that employee does could only be done either during regular working hours or after. If after there are not many ways for it not to be OT. Whatever job it is it is probably done under the direction of the employer and the person doing it would not qualify as an IC.

If it is "royalties from publications or music they've created together" the payments would be coming to them (as partners/creators etc) from a licensee or user, not from this employer. A 1099 in that case would be from somewhere else.

What is done that causes the 1099 versus what is done for the W2?

[himt4]

Let's say the Employer should not have paid the $30,000 to the employee as 1099 money in 2004 and that instead it should have been additional w-2 earnings that would have made total w-2 $110,000. Can I make the decision that this means the employee is an HCE (based on the ShOULD and not the reality). Would this be like making two wrongs into a right (wrong #1, employer inappropriately paid employee money as 1099. wrong #2: I count 1099 income as plan compensation).

I want to count the 1099 money. I just want to know who should make the decision to count it?

If I count it, and the plan is audited, could the auditor penalize the plan for counting 1099 money?

If I don't count it, and the plan is audited, could the auditor penalize the plan for not counting the 1099 money?

[Belgarath]

How does your plan document define plan compensation? I'm assuming that it does not include 1099 income?

I see the issue of whether it is properly 1099 or W-2 as an employer/tax counsel issue. If you question it and they come back and confirm that it is correct, then you only need to be concerned with the plan definition of compensation. If the IRS audits the employer and determines that compensation was reported incorrectly, then of course there may be plan ramifications, but you should then be able to charge for your time to fix it.

[himt4]

Belgarath, what if I question it and they come back that it was INCORRECT and the client gives me a letter telling me that it was incorrect, could I count it? the document hasn't been written yet, so maybe I could add "1099 income that should have been w-2 income" into the definition of Compenstion.

[Belgarath]

If it turns out that it is incorrect, then presumably the employer will have to issue a corrected W-2. Since your plan will be using W-2 compensation then you have to count it, unless your plan has allowable categories of compensation excluded, such as overtime or bonuses, and this is legitimately reclassified into one of those classifications. But that doesn't sound like what you are doing here.

[JanetM]

If it should be W-2 comp and the employer corrects from 1099 classification, he also has to ante up for social security and medicare on those amounts so he is legal. He doesn't have much time left before year end to get this sorted out.

[himt4]

Its actually the 2004 1099 income that would be beneficial to have reclassified (in order to make the employee HCE for 2005). But if counting it means that employeer will have to redo the 2004 w-2's and 1099, then its obvious to me that this prospective client will not want to mess with anything like that.

So I will have to ignore the 1099 income. I will tell the client I am ignoring the 1099 income on the understanding that he had tax/legal counsel advise him that the 1099 was legitimate.

[Lori Friedman]

An employer should not have an employee who gets a 1099. Employees get W2s. There have been recent cases of employers getting penalized for this sort of thing.

Although unusual, there are legitimate situations when an employee can receive both W-2 and 1099 compensation (for services provided concurrently, and not because the individual's status changes during the year). The 1099 work has to satisfy the general requirements for independent contractor services and be completely unrelated to the employee's other job duties.

Here's a real example. One of my clients has an office worker who's also an accomplished musician. The organization sometimes hires the individual to play the piano at receptions, holiday parties, and other events. The individual always has the choice of accepting or declining an event, and he controls all aspects of his performances (musical selections, when he takes his breaks, etc.). The piano playing has absolutely nothing to do with his regular administrative office job. The IRS agreed that the organization can issue both a W-2 and a 1099 to this person, and it does so every year.

But, this sort of situation will raise a huge flag with the IRS. The employer must have very valid reasons for taking this approach and be prepared to explain those reasons.

[Guest bruss]

This client is a potential nightmare. We had a client audited, they had issued 1099s to several employees, not only did they have to pay back fica taxes they had to contribute to these employees 401k plan accounts plus earnings for several years, using the deferral percentages the employees had used in those years, ...IRS went back four years. Very expensive mistake.

[Lori Friedman]

This client has been audited, and the IRS agreed with the employer's position.

[himt4]

I guess there are a few clear cut legitimate cases of a w-2 employee getting 1099 income where a moonlighting photographer, musician, etc. does a special job for his daytime employer where he works as a clerical worker. And I guess there also a lot of cases where an employer tries to get out of paying fica taxes by giving his employees 1099s when they should have gotten w-2. And that leaves the percentage of cases that are not so cut & dry. How about an insurance agent who employs a secretary/assistant for $30,000 a year and tells her that for any lead she gives him he will give her 10% of any commisions (i.e she is at a neighbor's party and is talking to someone who mentions he is interested in getting life insurance, and she passes that man's name to her employer the next day at work). At the end of the year the insurance agent gives her a w-2 for $30,000 and a 1099 for $10,000. Is this $10,000 legitimate 1099 income or should it have been w-2?

[JanetM]

IMHO, the earnings would seem to be earned in the "normal course of business". As an employee of the firm assistant is simply doing what the business is and getting compensated for it.

[Guest mjb]

How can playing the piano at receptions, parties, etc be within the scope of the duties of an office worker, e.g., administrative assistant, xexoxing, anwering phones, filing documents etc. especially if the employee is free to decline the offer of work which is one of the clearest indicia of a independent contractor. In addition the firm would hire an independent contractor to perform the musical duties, not an employee.

[Lori Friedman]

In PLR 199914044, the IRS ruled that a court reporter who had parallel but disparate job duties had been correctly classified as both an employee and independent contractor of the same organization.

This W-2/1099 situation is sometimes used by national and international labor unions. Certain union employees "moonlight" as mediators in worker grievance and dispute resolution. This sort of work is completely separate and unrelated to the employees' regular job duties for the unions, and:

-- The workers are notified of available cases and can accept or decline for any reason.

-- The unions provide initial training for each worker but don't dictate the terms of continuing education. Although each worker is required to maintain necessary job skills, additional training is at the worker's discretion and personal expense.

-- The unions don't furnish equipment or provide a regular work location for this work.

-- The individuals are usually reimbursed for travel but not for any additional out-of-pocket expenses.

-- The individuals work independently and without supervision.

The IRS has repeatedly given the "green light" to this W-2/1099 practice. It's worth mentioning that these individual workers prefer to have their "moonlighting" work reported on Form 1099. They incur out-of-pocket expenses that can be deducted on Form 1040, Schedule C but would be subject to the 2% floor on Schedule A.

I emphasize again, however, that the IRS scrutinizes this method of worker classification. The various IRS Audit Technique Guides specifically instruct examiners to search for instances when an employer has issued both a W-2 and a 1099 to the same individual. The employer must have a reasonable and defensible position. Given what's at stake, it's probably a good idea for any employer to get a PLR before proceeding.

[GBurns]

That was an excellent idea to start this as a topic. It will be much easier to find and I am sure that it will be needed a number of times each year.

While the PLR is good, your Union analogy deals with work that could in some cases be viewed as Union work being done by the employee but paid for by the employer, it would be good and helpful if we could also have some PLRs that dealt with a different arrangement.

Why I do not regard this particular analogy as ample is because many employers pay employees while they are seconded to or doing union activities. So the employer pays salary and also pays for the time spent doing union work.

I would prefer an example where a Warehouse supervisor, for example, also provides janitorial services for which a 1099 is issued. Or a Marketing & Promotions person does chauffeuring of executives and clients at nights and on weekends etc. Something where the 1099 job is one that could have been done by an employee even if on OT.

I hope that someone will have such a cite. It seems that this is a very popular situation.

[Santo Gold]

Glad to take credit for starting a good topic GBurns. If I can't provide insightful answers, I'll at least take a bow for thought-provoking questions.

[GBurns]

I believe in freedom of expression and freedom of thought. Ask any question get any answer. Some answers will be good, some will be bad, some will be in between. But this is the USA and everyone should be free to express their opinion, whether well reasoned or not. An opinion inherently cannot be wrong or right, because it is just an opinion and not a statement of fact. It is for the asker to decide what is useful and what is not.

In the same manner, everyone should be free to ask any question. After all, not one of us knows everything about any subject, although there are some who seem to think that they are the exceptions. But after spending some time on the Forums most people realize who is who and read between the lines when some make personal attacks on others. Invariably the personal attack does not state what is wrong nor what is right, it is just a snide attack with no statement of fact. With no statement of fact, no reader is able to refute, rebut, agree or disagree with the usually vitriolic attack. This way no one can respond to the attack in a rational manner. Cowardly, yes, but it works. Fortunately quite often the Moderator will delete the attacking post. But there is no way to erase it from the minds of those who have read it, and sometimes there are those unthinking few who will use it at a future date.

I cannot speak for Dave Baker or the Moderators, but I do hope that you and many others will not feel intimidated by those who like to make personal attacks, and will post any and all questions to which you need answers or help. The only dumb question is probably the one that was not asked.

A Happy New Year to ALL!!!

[himt4]

Did a couple of threads get crossed here? First Santo Gold takes credit for starting this thread, and then there's mention of some vitriolic attacks, that although I have seeen them in other threads, I havent noticed them in this one.