SH 3% – Can We Exclude a W-2 Contractor Mid-Year?

[kimso]

SH 3% plan. No excluded classes of EEs.  Company is a med practice and I just found out that they have contractors ("Associates") that are paid via W-2. There is one Associate who has met initial eligibility and has been given the Safe Harbor contribution, and for whatever reason, doesn't want to be a part of the plan, including the Safe Harbor contributions. EE is not deferring. What are some of the options? Client doesn't think EE will want to switch to 1099. Client is OK with amending document to add an exclusion, but would this be able to stop the current EE from receiving any future contributions? It is only 1 EE who will be HCE for 2026. If so, would this amendment be allowed, say 8/1?

[WCC]

Maybe someone here will correct me, but I was always taught that as far as the plan is concerned (no comment to any other tax/accounting rules), there is no such thing as a "W-2 contractor". The employer first needs to determine if these individuals are employees or contractors and treat them correct for tax reporting purposes. If they are indeed employees, then follow IRS Notice 2016-16. If the determination is made that the individual in question is an employee (not a contractor), then reducing the group of covered employees is prohibited mid-year. 

D. Prohibited Mid-Year Changes The mid-year changes described in this section III.D are prohibited mid-year changes (for purposes of the provisions in the first paragraph of section III.B of this notice). However, a mid-year change described in section III.D.1-4 is not a prohibited mid-year change under this section III.D if it is required by applicable law to be made mid-year, such as a change mandated by a statutory law change or court decision.

2. A mid-year change to reduce the number or otherwise narrow the group of employees eligible to receive safe harbor contributions. This prohibition does not apply to an otherwise permissible change under eligibility service crediting rules or entry date rules made with respect to employees who are not already eligible (as of the date the change is either made effective or is adopted) to receive safe harbor contributions under the plan.

 

[ESOP Guy]

13 minutes ago, WCC said:

Maybe someone here will correct me, but I was always taught that as far as the plan is concerned (no comment to any other tax/accounting rules), there is no such thing as a "W-2 contractor". The employer first needs to determine if these individuals are employees or contractors and treat them correct for tax reporting purposes. If they are indeed employees, then follow IRS Notice 2016-16. If the determination is made that the individual in question is an employee (not a contractor), then reducing the group of covered employees is prohibited mid-year. 

 

 

You are correct the term "W-2 contractor" is a contradiction.   Independent contractors have their income reported via a 1099 and employees have their income reported via a W-2.  

Also, this isn't something that is negotiated or decided or agreed upon.  There are objective tests to determine if a person is an employee or independent contractor.  The tests can be as clear as mud at times but hard to determine isn't the same thing as people get to just pick.   

My guess if these people had their income reported via a W-2 the company is stuck treating them as employees at this point but wcc is correct first the company needs to figure out if these people are employees or not.  That determination isn't the TPA's job. 

[kimso]

So if they are indeed employees, can they be excluded as a Class "Associates"? Would this specific "Associate" be able to excluded mid year?

[BG5150]

no

even if they will be or are HCEs.  

[Paul I]

It is not an employee's choice whether or not they are a common law employee or an independent contractor, and the designation of an individual as an independent contractor is not at the total discretion of the employer.  There are several tests that the IRS will consider in determining whether an individual is or in not an independent contractor.  This includes things like who controls what the individual's work assignments and work schedule, how much work does the individual perform for other unrelated employers.  This very likely is a situation where the individual cannot be a 1099 employee even if the individual and the employer agreed to it.

One wonders if the individual has considered that as a 1099 worker, the individual will have to pay both the employee and employer payroll taxes.  Since the employee and employer payroll taxes are equal, this is a pretty big hit on income.  There also may be other benefits provided by the employer (including health benefits) for which the individual would no longer be eligible if the individual is no longer an employee.

As far as excluding the individual as employee who is excluded from the plan, this could be done by naming the individual in the plan as excludable.  The employer would not want to do this mid-year and risk breaking the safe harbor.  Excluding all of the Associates would deny other employees the privilege of participating in the plan.

Any exclusion by name or by category will require the excluded individuals who meet the plan's age and service requirements to be included in the 410 coverage testing as otherwise non-excludable employees and the test would fail

To sum it up in plain language, don't do it.