The President released the fiscal year 2016 federal budget proposal on February 2, 2015. The proposal contains several payroll-related items, which are highlighted below.
Standard mileage rate
The standard mileage rate for the charitable contribution deduction would equal the rate set by the IRS for purposes of the medical and moving expense deduction. It would likewise be adjusted annually to reflect the estimated variable costs of operating a vehicle, effective for taxable years beginning after December 31, 2015.
Tip credit repeal
The income tax credit for FICA taxes an employer pays on tips would be repealed, effective for taxable years beginning after December 31, 2015.
Current law. Under current law, employee tip income is treated as employer-provided wages subject to income and employment taxes under FICA. Employees who receive tips of $20 or more in a calendar month are required to report the amount of tips to their employers. Employers are responsible for withholding employee income tax and the employee’s share of FICA taxes and paying the employer’s share of FICA taxes on the reported tips. An eligible employer may claim a credit against the business’s income taxes for FICA taxes paid on certain tip wages. The credit applies to the employer’s share of FICA taxes paid on the portion of tips, when added to the employee’s non-tip wages, in excess of $5.15 per hour. The credit applies only with respect to FICA taxes paid on tips received from customers in connection with the providing, delivering, or serving of food or beverages for consumption if the tipping of such employees is customary. The credit against income tax is for the full amount of eligible FICA taxes. The credit is available whether or not the employee reports the tips on which the employer FICA taxes were paid. The credit is non-refundable and subject to carryback and carryforward provisions. Employers cannot deduct from taxable income the amount of FICA taxes taken into account in determining the credit. A taxpayer may elect not to have the credit apply for a taxable year.
Inefficient and unequitable. The administration believes that the current FICA tip credit is inefficient and inequitable. The favorable tax treatment on tips relative to other cash compensation unduly encourages employers to provide income in the form of tips instead of wages. In addition, while the credit was intended to address underreporting of tip income, the FICA tax gap on tip income remains large in the applicable industries and the credit costs far more than any positive effect on tax compliance. Further, only certain employers in the food and beverage service sectors are entitled to a tax credit for the FICA taxes they pay on employee tip income. No other industries in which the tipping of employees is customary receive a similar tax credit, and the current FICA tip credit is unfair to taxpayers who are voluntarily compliant with tax law without receiving any tax subsidy.
FUTA unemployment surtax
The now expired Federal Unemployment Tax Act (FUTA) 0.2% surtax would be re-instated and made permanent, effective for wages paid on or after January 1, 2016. FUTA currently imposes a federal payroll tax on employers of 6% of the first $7,000 paid annually to each employee. The tax funds a portion of the Federal/State unemployment benefits system. States also impose an unemployment tax on employers. Employers in states that meet certain federal requirements are allowed a credit for state unemployment taxes of up to 5.4%, making the minimum net federal tax rate 0.6%. Generally, federal and state unemployment taxes are collected quarterly and deposited in federal trust fund accounts. Before July 1, 2011, the federal payroll tax had included a temporary surtax of 0.2%, which was added to the permanent FUTA tax rate. The surtax had been extended several times since its enactment in 1976, but it expired on July 1, 2011.
FUTA wage base increase
The FUTA wage base would be increased in 2017 to $40,000 per worker paid annually, the wage base would be indexed to wage growth for subsequent years, and the net federal UI tax would be reduced from 0.8% (after the proposed permanent reenactment and extension of the FUTA surtax) to 0.165%. States with wage bases below $40,000 would need to conform to the new FUTA base. The proposal would also impose a minimum tax rate requirement on states for their state employer tax rates equivalent to roughly $70 per employee beginning in 2017. The provision would be effective upon the date of enactment.
W-2 defined pension plan reporting
Employers would be required to report the amount contributed to an employee’s account under a defined contribution plan on the employee’s Form W-2, effective for information returns due for calendar years beginning after December 31, 2015.
W-2 social security numbers
Code Sec. 6051 would be revised to require employers to include an “identifying number” for each employee, rather than an employee’s SSN, on Form W-2. By revising Sec. 6051 to require an identifying number, the general rules under Sec. 6109 would apply and allow Treasury and the IRS to exercise regulatory authority to require or permit a truncated SSN on Form W-2, effective on the date of enactment.
Employee/independent contractor status
Reclassification. The IRS would be permitted to require prospective reclassification of workers who are currently misclassified and whose reclassification has been prohibited under current law. The reduced employment tax liabilities for misclassification provided under current law would be retained, except that lower penalties would apply only if the service recipient voluntarily reclassifies its workers before being contacted by the IRS or another enforcement agency and if the service recipient had timely filed all required information returns (Forms 1099) reporting the payments to the misclassified workers. For service recipients with only a small number of employees and a small number of misclassified workers, even reduced penalties would be waived if the service recipient (1) had consistently filed timely Forms 1099 reporting all payments to all misclassified workers and (2) agreed to prospective reclassification of misclassified workers. It is anticipated that, after enactment, new enforcement activity would focus mainly on obtaining the proper worker classification prospectively, since in many cases the proper classification of workers may not have been clear. (Statutory employee or nonemployee treatment as specified under current law would be retained.)
Guidance allowed. The Department of the Treasury and the IRS also would be permitted to issue generally applicable guidance on the proper classification of workers under common law standards. This would enable service recipients to properly classify workers with much less concern about future IRS examinations. Treasury and the IRS would be directed to issue guidance interpreting common law in a neutral manner recognizing that many workers are, in fact, not employees. Further, Treasury and the IRS would develop guidance that would provide safe harbors and/or rebuttable presumptions, both narrowly defined. To make that guidance clearer and more useful for service recipients, it would generally be industry- or job-specific. Priority for the development of guidance would be given to industries and jobs in which application of the common law test has been particularly problematic, where there has been a history of worker misclassification, or where there have been failures to report compensation paid.
Required notice. Service recipients would be required to give notice to independent contractors, when they first begin performing services for the service recipient, that explains how they will be classified and the consequences thereof, e.g., tax implications, workers’ compensation implications, wage and hour implications.
The IRS would be permitted to disclose to the Department of Labor information about service recipients whose workers are reclassified.
To ease compliance burdens for independent contractors, independent contractors receiving payments totaling $600 or more in a calendar year from a service recipient would be permitted to require the service recipient to withhold for Federal tax purposes a flat rate percentage of their gross payments, with the flat rate percentage being selected by the contractor.
Effective on date of enactment. The proposal would be effective upon enactment, but prospective reclassification of those covered by the current special provision would not be effective until the first calendar year beginning at least one year after date of enactment. The transition period could be up to two years for workers with existing written contracts establishing their status.
New hire reporting database
The provision would amend the Social Security Act to expand IRS access to NDNH data for general tax administration purposes, including data matching, verification of taxpayer claims during return processing, preparation of substitute returns for non-compliant taxpayers, and identification of levy sources. Data obtained by the IRS from the NDNH would be protected by existing taxpayer privacy law, including civil and criminal sanctions, effective upon enactment. Currently, the IRS may obtain data from the NDNH, but only for the purpose of administering the earned income tax credit (EITC) and verifying employment reported on a tax return.
Penalties indexed to inflation
All civil tax penalties with a fixed penalty amount (including floors and caps imposed with respect to penalties) would be indexed to inflation and the indexed amount rounded to the next hundred dollars, effective on the date of enactment.
Work opportunity tax credit
The proposal would permanently extend the WOTC to apply to wages paid to qualified individuals who begin work for the employer after December 31, 2014.
For individuals who begin work for the employer after December 31, 2015, the definition of a qualified veteran would be expanded. Qualified veterans would now include disabled veterans who use G.I. Bill benefits to attend a qualified educational institution or training program within one year of being discharged or released from active duty, and are hired within six months of ending attendance at the qualified educational institution or training program. Qualified first-year wages of up to $12,000 paid to such individuals would be eligible for the WOTC.
The Indian employment credit would be permanently extended to apply to wages paid to qualified employees in taxable years beginning after December 31, 2014.
In addition, the proposal would modify the calculation of the credit. For taxable years beginning after December 31, 2015, the credit would be equal to 20% of the excess of qualified wages and health insurance costs paid or incurred by an employer in the current taxable year over the amount of such wages and costs paid or incurred by the employer in the base year. The base year costs would equal the average of such wages and costs for the two taxable years prior to the current taxable year.
Small employer health care credit
Currently, the cost to an employer of providing health coverage for its employees is generally deductible as an ordinary and necessary business expense for employee compensation. In addition, the value of employer-provided health coverage is not subject to employer-paid Federal Insurance Contributions Act tax.
Employees are generally not taxed on the value of employer-provided health coverage for themselves, their spouses and their dependents under an accident or health plan. That is, health coverage benefits are excluded from gross income for purposes of income and employment taxes. Active employees may be able to pay for limited amounts of medical care and for their own employee premium contributions on a pre-tax basis through a cafeteria plan.
The Affordable Care Act created a tax credit to help small employers provide health insurance for employees and their families. An employer must make uniform contributions of at least 50% of the premium to qualify for the credit. For taxable years beginning in 2010 through 2013, the credit was available for any health insurance coverage purchased from an insurance company licensed under state law. For taxable years beginning after December 31, 2013, the credit is generally available only for the two-consecutive-taxable year period beginning with the first taxable year in which the employer both offers a qualified health plan to its employees through a small business health options program (SHOP) and claims the credit.
For-profit firms may claim the tax credit as a general business credit and may carry the credit back for one year and carry the credit forward for 20 years. The credit is available to offset tax liability under the alternative minimum tax. For tax-exempt organizations, the credit is refundable and is capped at the amount of income tax withholding for employees and both the employee and employer portion of the health insurance (Medicare) payroll tax. A qualified employer is an employer with no more than 25 full-time equivalent employees during the taxable year and whose employees have annual full-time equivalent wages that average no more than $50,000 (indexed for inflation beginning in 2014).
During 2010 through 2013, the maximum credit was 35% (25% for tax-exempt employers) of the employer’s contributions to the premium. For 2014 and later years, the maximum credit percentage is 50% (35% for tax-exempts). For taxable years 2010 through 2013 eligible employer contributions were limited by the amount the employer would have contributed under the State average premium. For taxable years beginning after 2013, eligible employer contributions are limited by the average premium for the small group market in the rating area in which the employee enrolls for coverage. For example, if the average premium in an employee’s rating area was $5,000, an employer paying for 60 percent of a single plan costing $5,500 per year could claim no more than 60% of $5,000 in qualified employer contributions for purposes of calculating the credit.
The credit is phased out on a sliding scale between 10 and 25 full-time equivalent employees as well as between an average annual wage of $25,000 (indexed for inflation) and $50,000 (indexed for inflation). Because the reductions are additive, an employer with fewer than 25 full-time employees paying an average wage less than $50,000 might not be eligible for any tax credit. For example, an employer with 18 full-time equivalent employees and an average annual wage of $37,500 would have its credit reduced first by slightly more than half for the phase-out based on the number of employees and then by an additional half for the phase-out based on the average wage, thereby eliminating the entire credit.
Credit would be expanded. The group of employers who are eligible for the credit would be expanded to include employers with up to 50 full-time equivalent employees and would begin the phase-out at 20 full-time equivalent employees. In addition, there would be a change in the coordination of the phase-outs based on average wage and the number of employees (using a formula that is multiplicative rather than additive) so as to provide a more gradual combined phase-out. Employers with fewer than 50 employees and an average wage less than $50,000 would be eligible for the credit, even if they are nearing the end of both phase-outs. The requirement that an employer make a uniform contribution on behalf of each employee (although applicable nondiscrimination laws will still apply) would be eliminated. The limit imposed by the rating area average premium would also be eliminated. The provisions would be effective for taxable years beginning after December 31, 2014.
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