January 16, 2018

The GOP tax overhaul signed by the President contains changes to certain tax rules that may be of interest to employers. While we previously discussed some of the broader changes regarding the repeal of the “individual mandate” of the Affordable Care Act (“ACA”), we now want to take a closer look at two other issues.

Transportation Fringe Benefits

Employers frequently provide subsidized transportation benefits to their employees or allow employees to make pre-tax salary reductions for qualified transportation fringe benefits. Before the recent tax changes, this was a win/win for employers and employees alike.  Employers were able to deduct their payments under these programs as business expenses and employees didn’t have to include them in their taxable income. The employer and employee also achieved payroll tax (FICA, FUTA, etc.) savings. 

Under the new tax bill, employees can continue to exclude from their taxable income the value of any employer provided transportation subsidies. However, employers are no longer able deduct the amounts paid under these programs as business expenses. The benefits appear to still be excluded from payroll taxes (FICA, FUTA, etc.).  Though we are in need of additional clarification from the IRS, it seems the employer will not be able to deduct these benefits, even if they are funded via employee pre-tax deductions from payroll. 

The Unintended MEWA

The tax bill also provides certain pass-through business entities (Partnerships, S Corporations and certain LLCs) with a tax deduction of up to 20% of their qualified business income. This deduction doesn’t apply to certain fields such as health, law, accounting, performing arts, consulting, athletics, and financial services, so not all professions are able to use this section to their advantage.

This has led some commentators to speculate that employees may try to take advantage of this deduction by establishing a pass-through entity, having that entity hire them, and then having their former employer engage that entity to provide their services.  This would allow the income to flow through the pass-through entity, instead of being paid as regular wages from the employer.  However, our understanding is that the pass-through entity (and its employees) would most likely be treated as an independent contractor of the employer. This means the (now former) employee would also be an independent contractor.  Any such arrangement should be vetted by experienced tax and employment advisors.

For example, Ellen Employee is the CEO of ABC Widgets and she’s covered as an employee under the ABC Widgets health plan. Ellen decides to form CEO LLC, which she will own 100%. CEO LLC will be engaged to perform CEO-type services for ABC Widgets and will provide Ellen to ABC Widgets to perform these services.  ABC Widgets will, in turn, pay CEO LLC for these services instead of paying Ellen her salary. This means that, instead of receiving W-2 wages from ABC Widgets, Ellen now has business income from CEO LLC, which for purposes of this hypothetical, would allow her to use the 20% deduction, theoretically reducing her tax burden.

From a health plan perspective however, ABC Widgets doesn’t own CEO LLC and CEO LLC and Ellen are now independent contractors of ABC Widgets. Because Ellen is now an independent contractor, then continuing to allow her to participate in the employer’s group health plan would unintentionally cause that plan to be a Multiple Employer Welfare Arrangement (“MEWA”).

As a MEWA, ABC Widgets would be required to file Form M-1 each year in addition to Form 5500 and be subject to state regulation. MEWAs are highly regulated and investigated by states. Some states prohibit them altogether; other states prohibit them from being self-funded. On the other hand, it’s possible the IRS may view this as the improper classification of Ellen as a contractor rather than an employee, which could create an entirely different set of potential woes for her and the employer. 

Takeaways

HR and benefits professionals will need to coordinate with their payroll vendors to make sure that transportation fringe benefits are separately identified. This will allow them to report their taxes properly on those benefits.

If HR or benefits professionals get wind of employees looking to create pass-through entities to replace their current work arrangements, they should consult with tax and employment advisors on the tax effects and potential impacts on their group health plan and other benefits.

View more compliance articles in our Compliance Directory.

NOTICE OF DISCLAIMER

The information herein is intended to be educational only and is based on information that is generally available. HUB International makes no representation or warranty as to its accuracy and is not obligated to update the information should it change in the future. The information is not intended to be legal or tax advice. Consult your attorney and/or professional advisor as to your organization’s specific circumstances and legal, tax or other requirements.