ICs generally mean a good deal for employers, including savings on:

• federal and state income tax withholdings,
• unemployment insurance
• workers compensation
• benefits,
• overtime, vacation and sick pay, and
• no union eligibility.

A budget-squeezed employer has to love the idea. Here’s the problem: Federal and state governments are getting squeezed, too, in today’s economy, and they see questionable use of ICs as one of the sources of the squeeze, since the practice generally results in lower tax revenue.

One study by the General Accountability Office, says misuse of ICs lowers income tax revenues by about $4.7 billion annually. And the  University of Missouri–Kansas City Department of Economics estimates that from 2001 through 2005, Illinois lost $124.7 million a year in income taxes as a result of IC misclassification by employers.

You probably can figure out what’s coming.

In August, Congress began reviewing several bills that tighten restrictions on the use of ICs and exact tougher penalties on employers who bend the rules.

Further, states such as Illinois, Massachusetts, New Hampshire, New Jersey and New Mexico already have enacted new laws targeting IC misclassification. The IRS recently announced plans to audit more than 6,000 randomly selected businesses in the next three years to, among other goals, curtail IC abuse and its effect on tax revenues.

That’s a double-whammy, since state and federal governments share info on violations: Get caught by one and you’ll probably pay both.

IRS regs say Payroll must remind employees by 12/1/09 to file an amended Form W-4, Employee’s Withholding Allowance Certificate, if their filing status, exemption allowances or exempt status has changed since they last filed the form. A simple e-mail or paycheck stuffer will do the job. [IRS Regulations Section 31-3402(f)(2)-(1)(c)(3).]

For the procrastinators, there’s a grace period. Exemptions for 2009 don’t expire until 2/15/10. That means, though, that anyone who claimed “exempt” on the W-4 last year but didn’t provide an updated W-4 must be withheld from at the single marital status with zero withholding allowances, starting on 2/16/10. Changing the withholding is usually enough to get an employee’s attention – and have the person provide a new form, pronto.

To cut down on the number of employee questions, it may be useful to provide a copy of Publication 919, How Do I Adjust My Tax Withholding? That’ll help them decide whether the amount they’re having withheld compares to their projected total for the year. This will be especially important for those with earnings exceeding $130,000 (single) or $180,000 (married), so they can make sure they’re not underwithheld.

Note that employees can’t claim exempt if:

• Their income exceeds $950 and includes more than $300 of unearned income (e.g., interest, dividends), and

• Another person can claim them as a dependent on his or her tax return.

While it’s not Payroll’s job to police who claims exempt and who doesn’t, you may keep some people out of trouble with IRS if they’re aware of the guidelines.

Here are three pitfalls to watch out for:

1. You get what you pay for

By and large, the cost savings from a wellness program will be driven by how much you’re willing to spend. Generally, you get what you put into them — both in time and money.

In addition, the program has to be tailored to your specific needs. What works at another company may be a giant flop with your workforce.

2. Tough to administer alone

Most employers find that it’s more effective to outsource wellness. Three reasons:

• Experience. Outsourced vendors have the expertise. They’ve been there, done that — and vendors that’ve been around for a while know how get results.
• Employees’ trust. Many employees are more involved in wellness programs when there’s no fear their employer is looking over their shoulders.
• Legal protection. Outsourcing helps insulate you from later claims that the company fired an employee because of his or her health risks.

3. Tax problems

Some of the most popular incentives offered to employees in wellness plans (think subsidized gym memberships) are taxable as compensation.

If you offer wellness participants discounts on their premiums, the Internal Revenue Service (IRS) caps the incentive at 20% of the total cost of coverage. Beyond that, Payroll has to withhold taxes or you could run afoul of the IRS.

Most of the 2009 retirement plan limits are unchanged because the Consumer Price Index didn’t meet the statutory thresholds that cause them to increase.

Here are IRS’ annual cost-of-living adjustments that apply to how much employees can contribute to qualified retirement plans, and other related items:

• Maximum 401(k), 457(e)(15) elective deferrals – remains at $16,500 for 2010
• Catch-up contributions for 401(k), 403(b) and 457 plans for employees age 50 or over – $5,500 in 2009 and 2010
• SIMPLE deferrals – $11,500 in 2009 and 2010
• Catch-up contributions for SIMPLE plans – remains $2,500 in 2010
• SEPs [408(k)(2)(C)] – is unchanged from 2009, at $550
• Maximum compensation for benefit accruals [401(a)(17) and 404(l)] (plan year and limitation year limit) –$245,000 for 2009 and 2010
• Max. annual additions/benefits [415(c)(1)(A)] (limitation year limit) for defined contribution plans – 100% of compensation or $49,000, the same as in 2009
• Max. additional additions/benefits [415(b)(1)(A)] (limitation years ending after 12/31/09) for defined benefit plans – remains $195,000 in 2010
• Highly compensated employee under Section 414(q)(1)(B) – will be unchanged in 2010, at $110,000
• Key employee-officer in a top-heavy plan – remains $160,000 in 2010, and
• Definition of a “control employee” for fringe benefit valuation purposes – will be $95,000, unchanged from 2009. The compensation amount under Section 1.6121(f)(5)(iii) remains at $195,000 in 2010.

Click here to see the full IRS announcement on  adjustments.

Good news: The feds are eliminating paperwork associated with one common fringe benefit — company-provided cell phones.

The Internal Revenue Service (IRS) ruffled employers’ feathers this summer when it decided to unearth a seldom-used, 20-year-old law requiring companies to tax employee’s cell phones.

Many employers paid little attention to the old rules — which said personal calls on employer-provided cell phones were taxable — until the IRS announced it would simplify the rules for how these phones would be taxed.

No matter what the new rules would be, Benefits pros were almost certainly looking at added paperwork.

Imagine constantly having to determine which calls employees make — say to a friend in the office, for example — are personal (and taxable) and which aren’t.

It’d be a huge headache.

Well now employers don’t have to worry about it.

After reviewing the proposed new rules, the IRS backed off its stance and has decided to halt taxation on personal calls altogether.

IRS Commissioner Doug Shulman recently issued this statement: “Although some of the proposed changes would add clarity, the current law will inevitably leave widespread confusion among employees and businesses. Therefore, Secretary Geithner and I ask that Congress act to make clear that there will be no tax consequence to employers or employees for personal use of work-related devices such as cell phones provided by employers. The passage of time, advances in technology, and the nature of communication in the modern workplace have rendered this law obsolete.”

During the past few quarters, IRS erroneously sent many employers a notice proposing a federal tax deposit penalty (CP 207) because it said the Schedule B was missing. In fact, the agency says it had a problem with scanning technology and didn’t properly process the returns. The notice asks recipients to submit Schedule B, even though they’d already done so with their paper filed returns.

While resending the Schedule B will be a hassle, IRS needs the resubmission to correct the penalty issue, IRS Branch Chief Amy Stanton, Wage & Investment Division, told attendees of an Oct. 1 payroll teleconference. Employers should sign the notice and staple to it the resubmitted form.

Here are a few guidelines that’ll help IRS better use its scanning technology (and reduce the number of problems for you):

• Make sure your forms are legible, and
• Write within margins and on the lines.

The agency says it’ll have the problem resolved for third-quarter reporting.

The IRS just announced it will launch a major employment tax audit initiative.

It’s planning 6,000 random audits in the next three years, starting this November.

3 areas to check

As for which bases you want covered, there are three specific targets the IRS has identified:

• employee fringe benefits
• executive pay, and
• independent contractor classifications.

You still have a few months before the audits begin.

Now’s the time to make sure your company is not only in compliance, but has the proper paper trail to support all decisions.

It couldn’t hurt to perform a “mock audit” of these areas to see if your company’s vulnerable.

That can save you from having to open your wallet too wide if the IRS does pay you a visit.

Those trying to boost their retirement savings can’t seem to catch a break. First the market freefalls, and now Uncle Sam may put the squeeze on how much you’re allowed to contribute. 

Lower 2009 inflation is likely to require employers to make changes in next year’s 401(k) plans, according to a report released by Mercer.

On Oct. 15 the Internal Revenue Service (IRS) is expected to announce changes required to 2010 retirement plan contributions.

Changes may include:

• A $500 cut in the maximum amount employees can contribute, and
• A $5,000 slice off the maximum income eligible for an employer contribution.

The limits for defined-contribution and defined-benefit plans — including the amount employees can sock away in 401(k)s — are adjusted each year using a formula based on inflation. And as a result of negative inflation this year, 401(k) contribution limits for 2010 may not get a cost-of-living increase.

Although it’s not entirely clear whether the IRS would actually go through with lowering contribution limits based on the formula, should it do so, this would be the first time limits have been adjusted downward.

Currently, employees can contribute up to $16,500 in their 401(k)s on a pre-tax basis or $22,000 if they’re 50 or older. But that amount could be reduced by $500, down to $16,000.

What employers will have to do

If lower contribution limits are set, plan sponsors will need to alter forms and warn workers to cut back if they will max out.

Workers will also have to be notified if lower limits affect benefit accruals in pension plans.

2 ways to ease the pain

Should lower limits get established, some employees are bound to be upset.

Two ways to ease the blow:

• Check whether your 401(k) plan allows after-tax contributions, or
• Encourage employees to set money aside in an IRA, or some other tax-efficient investment.

It’s likely some version of the newest healthcare reform proposal to come out of Washington will not only become law, but also change the way you do your job — as early as Jan. 1 — particularly in five areas.

The Senate Finance Committee just released its 10-year, $856-billion proposal, which would extend health coverage to 29 million uninsured Americans.

The package, authored by Chair Max Baucus (D-MT) and referred to as a “Chairman’s Mark” because there’s no legislative language drafted yet, is considered a compilation of the most popular (i.e., effective, but conservative and least expensive) ideas presented thus far. It’s likely that some version of this plan will pass after the typical party revisions and compromises.

Here are some key stipulations and  proposed effective dates where appropriate:

1. Additional information reporting duties. Under current law, Payroll isn’t required to report the value of employer-provided health insurance benefits to IRS on the Form W-2. However, some employers voluntarily report in Box 14 the salary reduction amount under a cafeteria plan resulting in tax-free employee benefits.

The Mark proposes requiring companies to report on the W-2 the value of the employer-provided benefit for each person’s health insurance

If someone received coverage under multiple plans (e.g., medical, dental, vision), Payroll would report the aggregate value. Generally, use the same value for all similarly situated employees with the same category of coverage (e.g., single or family health insurance).

Effective: first taxable year after 12/31/09.

2. More payroll deductions. The proposal creates a refundable tax credit for eligible individuals and families who purchase health insurance through proposed new state cooperatives (i.e., “exchanges”). Those opting for this coverage would pay premiums through payroll deductions.

There’d be a fall enrollment period, during which applicants would have to provide info from their previous year’s tax return to qualify for coverage during the next calendar year.

Employers who don’t offer such coverage will have to repay the credit amounts. The assessment may be capped at $400 per worker (all workers, not just those who qualify for tax credits). Note that employees who are offered affordable coverage through their employer can’t get the tax credit – so in those cases, the employer assessment shouldn’t apply.

Illegal immigrants wouldn’t be eligible for the credit. To prevent them from participating, personal data (i.e., name, Social Security Number and date of birth) would have to be verified against SSA’s database. Those in the U.S. legally but whose status is expected to expire in less than a year aren’t allowed to take the credit.

Effective: not specified.

3. Stricter reimbursement rules for qualified medical expenses. The Mark proposes no longer allowing the cost of over-the-counter (OTC) medicines (except those prescribed by a doctor) to be reimbursed through a health flexible spending account or health reimbursement account. In addition, the cost of these medicines couldn’t be reimbursed on a tax-free basis through a health spending account or an Archer medical spending account.

Effective: taxable years beginning after 12/31/09.

4. Creation of a Simple Cafeteria Plan. This change eases the participation restrictions, allowing more small businesses to offer tax-free benefits to employees. The proposal exempts employers who make contributions for employees under a simple cafeteria plan from pension plan nondiscrimination requirements applicable to highly compensated and key employees.

The safe harbor also applies to the nondiscrimination requirements for specific qualified benefits offered under the cafeteria plan, including group term life insurance, coverage under a self-insured group health plan and benefits under a dependent care assistance program.

This provision would apply to employers with an average of 100 or fewer employees during either of the two preceding years.

Effective: taxable years beginning after 12/31/10.

5. Loosening of long-term care insurance restrictions. Under current law, employees participating in a cafeteria plan can’t pay premiums for long-term care insurance not otherwise paid for by their employers on a pre-tax basis through salary reduction. That’s because any product advertised, marketed and offered as long-term care is a nonqualified benefit specifically not permitted under a cafeteria plan.

The Chairman’s Mark, however, would allow reimbursement for employee-paid premiums for a qualified long-term care insurance contract through a flexible spending arrangement (whether or not under a cafeteria plan) and therefore be excluded from gross income.

Effective: taxable years beginning after 12/31/10.

Here’s why: A growing number of banks are refusing to accept IRS’ paper coupons, Form 8109, Federal Tax Deposit Coupon, in favor of electronic payments. Over the past year, almost two dozen major banks and credit unions have stopped accepting the coupons – and more are certain to follow suit as the idea gains popularity, IRS representative Annette Dean said during a recent conference call.

Financial institutions aren’t required to accept the coupons (and IRS can’t force them to), so many are making the business decision to stop accepting coupons because they: 1) require exception processing, and 2) cost between $2 and $5 each to process.

Instead, IRS wants to help support Treasury’s electronic payment goal by encouraging small businesses that aren’t mandated e-filers to enroll in the Electronic Federal Tax Payment System (EFTPS).

Businesses that aren’t electronically depositing their tax deposits will feel subtle pressure from the feds as they continue educating employers about EFTPS. Plus, they may also end up frustrated as they search for a financial institution that will accept 8109s (or, even worse, find a bank that currently accepts coupons, only to discover that shortly it won’t).

It seems paper coupon holdouts don’t have much time or support left. In addition to financial institutions, IRS already has many large payroll processors in its corner: Most automatically remit the taxes through EFTPS for all clients. The agency’s hoping to steer the smaller service providers in the same direction with bulk processing.

Employers that want to continue paper filing but haven’t received a supply of pre-printed coupons from the agency can use Form 8109-B, available on IRS’ Web site.