In the past few years I've spoken with hundreds of small business owners. A common theme I hear from a certain group is the desire to stay below 50 employees. That seems to be the magic number for many who have either been there before and shrunk back or are approaching that number for the first time like a medieval knight galloping toward the dark forest.
What is it about the number 50 that makes it so significant? For some it is fear of having to comply with certain legislation, namely the Affordable Care Act and the Family Medical Leave Act. It was after the passage of the ACA back in 2010 when I started noticing the I'm never going to have 50 employees (again) talk. For others it is linked to the realization that there are added complexities related to managing an organization once it gets above 50 employees, and they may not possess the skills or the desire to run an organization that large.
This second group is certainly understandable. James Fischer points out in Navigating the Growth Curve that organizational complexity and management priorities typically change at the 10, 20, 35, 57 and 95 employee marks. This means entrepreneurs that have grown their businesses through each of the first three organizational transitions and are now approaching 50 employees recognize that they will soon be facing another plateau. Busting through this ceiling will require investment and organizational realignment before another growth phase can begin. They may be happy with the results the organization is getting in that 35-57 employee phase and comfortable with their ability to manage an organization that size. They may strategically opt to remain in that space.
It's the first group that may be missing an opportunity. If fear of the ACA is the only thing holding them back, then they should consider this: If they do not offer health insurance, employees who weren't able to get it through a spouse or parent probably opted to remain uninsured. But the ACA includes an individual mandate, which means those employees must have health insurance now or face tax penalties.
Let's take the case of Bob, a single guy age 30 who works for a company with 35 employees that doesn't offer health insurance. Bob is uninsured, but being healthy, he never thought much about the risk. The owner has said he'll never grow to 50 employees because of the ACA. Bob files his 2015 taxes and gets popped with a big fine he wasn't expecting. He finds out the fine will be even larger in 2016. He goes to healthcare.gov and buys insurance to avoid the fine next year. He finds he earns too much to qualify for the cheap, government-subsidized insurance, so he has to pay the entire premium out of pocket. Bob loves working at his company, but he knows that a larger competitor in the area offers health insurance that is partially subsidized by the company. 30 days later, Bob turns-in his two week notice.
Of all the options available to Bob's company to defend against this type of turnover, the best financial alternative might simply be to provide a qualified plan to its employees. Many small companies are going to find that not having a plan is more of a deterrent to recruiting and retention than it used to be and there is basically no competitive advantage to be gained by not offering insurance. So that magic number, 50, is really a windmill not a dragon.
If avoiding this legislation has created an artificial barrier to growth, a company that would otherwise be happy to continue growing should partner with a knowledgable HR professional, commercial insurance agent and finance professional. With their help, it can position itself to bust through the 57 employee plateau and charge ahead toward the next plateau, which won't occur until approximately the 95 employee mark.
Monday, August 3, 2015
Time to rethink that 1099 strategy?
I had seen their trucks all over town. How many employees do you have?, I asked.
Six employees, he answered, plus 20 service techs that we 1099.
Using 1099 as a way to avoid workers comp risk, unemployment risk, and even payroll tax withholding headaches has been a strategy used by many employers for years. Some owners see this as little more than driving 62 in a 55 zone. Yes, technically I'm speeding, but I doubt I'll get caught. Besides, the rules are pretty vague and I'm confident I can justify it if I'm forced to.
On July 15 the Department of Labor released a guidance that defines independent contractor more narrowly than ever before, making those rules a little less vague. And it signaled its intent to prioritize the enforcement of what it considers to be abuses of this practice. This action also emboldens the IRS and the state enforcement agencies to go after employers who utilize a 1099 workforce strategy.
So, what's the risk if I can't convince them that my 1099s are legit? The penalties start at 1.5% of wages, plus interest, plus 100% of the FICA tax the employer should have paid, plus at least 20% of the FICA tax the employee should have paid, going back three years (no matter whether the contractor paid his/her taxes or not). That's if you properly filed the 1099s. If you messed that up, the fines are even more substantial. If the IRS determines you knew the rules but you intentionally violated them to avoid taxes, they can even file felony charges. If convicted, you could potentially spend a year in prison and pay fines of up to $100,000.
That's no speeding ticket, what should I do? Consult with an HR professional or labor attorney to help you determine which of your 1099 relationships are likely to be considered legitimate by the DOL and/or IRS. They can help you ensure that you have the right documentation in place to demonstrate that the 1099 relationship is appropriate in those cases. They can also help you evaluate alternative workforce strategies for those that will likely be considered illegitimate. If the best alternative is to bring them onboard as employees, they can assist with that migration and any policy implications that result - such as regulations that now may apply to your organization, like FMLA or ACA.
Why do they care? It's all about tax dollars. When you pay an employee on Friday, you withhold taxes and send it in immediately. When you pay a 1099, the government has to wait until that individual files his or her taxes (presumably quarterly) to get its money. A lot of them don't file until the end of the year (if at all). In addition the state and federal unemployment coffers are still strapped as a result of the great recession. 1099 workers often don't pay into the unemployment system like employers do. All levels of government prefer the steady stream of cash that comes from regular payroll withholdings.
It's so much easier simply writing one check and being done with it? Being a small business owner is hard work. The best surround themselves with smart people to help them navigate through these types of changes and manage their risk so they can focus on their customers and their business. Regulatory changes are never going to stop. In this case, you might as well develop an alternative workforce strategy, because a 1099 strategy is rife with unacceptable risk and it's time to rethink its use.
Six employees, he answered, plus 20 service techs that we 1099.
Using 1099 as a way to avoid workers comp risk, unemployment risk, and even payroll tax withholding headaches has been a strategy used by many employers for years. Some owners see this as little more than driving 62 in a 55 zone. Yes, technically I'm speeding, but I doubt I'll get caught. Besides, the rules are pretty vague and I'm confident I can justify it if I'm forced to.
On July 15 the Department of Labor released a guidance that defines independent contractor more narrowly than ever before, making those rules a little less vague. And it signaled its intent to prioritize the enforcement of what it considers to be abuses of this practice. This action also emboldens the IRS and the state enforcement agencies to go after employers who utilize a 1099 workforce strategy.
So, what's the risk if I can't convince them that my 1099s are legit? The penalties start at 1.5% of wages, plus interest, plus 100% of the FICA tax the employer should have paid, plus at least 20% of the FICA tax the employee should have paid, going back three years (no matter whether the contractor paid his/her taxes or not). That's if you properly filed the 1099s. If you messed that up, the fines are even more substantial. If the IRS determines you knew the rules but you intentionally violated them to avoid taxes, they can even file felony charges. If convicted, you could potentially spend a year in prison and pay fines of up to $100,000.
That's no speeding ticket, what should I do? Consult with an HR professional or labor attorney to help you determine which of your 1099 relationships are likely to be considered legitimate by the DOL and/or IRS. They can help you ensure that you have the right documentation in place to demonstrate that the 1099 relationship is appropriate in those cases. They can also help you evaluate alternative workforce strategies for those that will likely be considered illegitimate. If the best alternative is to bring them onboard as employees, they can assist with that migration and any policy implications that result - such as regulations that now may apply to your organization, like FMLA or ACA.
Why do they care? It's all about tax dollars. When you pay an employee on Friday, you withhold taxes and send it in immediately. When you pay a 1099, the government has to wait until that individual files his or her taxes (presumably quarterly) to get its money. A lot of them don't file until the end of the year (if at all). In addition the state and federal unemployment coffers are still strapped as a result of the great recession. 1099 workers often don't pay into the unemployment system like employers do. All levels of government prefer the steady stream of cash that comes from regular payroll withholdings.
It's so much easier simply writing one check and being done with it? Being a small business owner is hard work. The best surround themselves with smart people to help them navigate through these types of changes and manage their risk so they can focus on their customers and their business. Regulatory changes are never going to stop. In this case, you might as well develop an alternative workforce strategy, because a 1099 strategy is rife with unacceptable risk and it's time to rethink its use.
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