Though there has been a movement through the years to increase productivity with automation, manufacturing remains a labor-intensive industry. This will not come as earth-shattering news, but employment costs, e.g. payroll taxes, continue to trend upward. Additionally, it has become increasingly difficult to hire and retain highly-regarded, quality employees.
There are, however, opportunities within the Internal Revenue Code (IRC) which can help a company limit payroll taxes while boosting an employee's overall compensation package – non-taxable fringe benefits and the use of “accountable” expense reimbursement plans. This article will provide an overview of these opportunities and discuss the option for manufacturers to fill their needs with the use of independent contractors and temporary labor.
Generally, fringe benefits given to an employee in consideration for the performance of services will be considered taxable income. However, tax legislation establishes criteria for non-taxable benefits. The fringe benefit can be in the form of property, services, cash, or cash equivalents. In some situations, a company may offer certain fringe benefits available to employees to independent contractors and temporary labor as well.
A thorough discussion of each fringe benefit which can be either excluded or deferred from an employee's income and exempt from employment taxes is beyond the scope of this article. However, the following are examples of fringe benefits that manufacturers might consider offering to employees:
- No additional-cost services
- Working condition fringe benefits
- De minimis fringe benefits
- Qualified transportation expenses
- Qualified retirement planning services
- Meals or lodging for employer's convenience
- Cafeteria plans
- Educational assistance programs.
Let’s take a closer look at one of the beneficial opportunities—cafeteria plans. A cafeteria plan allows participating employees to forego taxable compensation, (e.g., cash) and choose among certain fringe benefits. Employees participating in the plan basically purchase taxable and non-taxable benefits by allocating benefit dollars or by reducing their salary through a salary reduction agreement. It enables the employees to choose the benefit package that is best suited for their needs. In many respects, most benefits offered as part of a cafeteria plan are not subject to employment taxes. Generally, cafeteria plans are limited to group-term life insurance, dependent care, and certain accident and health benefits.
It is recommended that you reach out to your tax advisor prior to the implementation of a fringe benefits program to review the potential limitations and exceptions that can apply to your company.
Expense Reimbursement Plans
Most companies take steps to establish an expense reimbursement plan. However, many of these plans do not meet the IRC requirements to be classified as an “accountable” plan. You may wonder: Why is it so important to have an accountable plan? The most significant reason relates to exclusion from the employee’s gross income and employment taxes. Tax legislation provides that reimbursements under accountable plans, to the extent of substantiated expenses, are excluded from gross income, are not reported as wages, and are not subject to income tax withholding and employment taxes. This provision does not apply to non-accountable plans.
Requirements of an Accountable Plan
An accountable plan is a reimbursement plan or arrangement that satisfies three conditions:
- Under the business connection condition, advances, allowances, or reimbursements may be made only for business expenses than are allowable as deductions and incurred by the employee in performance of services as an employee of the employer.
- Under the substantiation condition, the employee must substantiate, within a reasonable period of time, the expenses covered by the arrangement to the person providing the reimbursement.
- Under the excess non-retention condition, the employee must not retain any amount in excess of the substantiated expenses covered under the arrangement and must return the amount within a reasonable period of time.
In relation to the substantiation condition, each business expense for travel, entertainment, meals, or gifts covered under the arrangement must be substantiated by the employer under the provisions of the tax legislation, which require the employee to submit to the employer adequate records, consisting of necessary receipts or other documentary evidence establishing the elements of each expenditure that must be corroborated. Other types of expenses must be substantiated in a manner that enables the company to identify the specific nature of the expense and to conclude that it is attributable to the company's business activities.
“Reasonable time period” is mentioned within two of the three conditions. One should have an understanding as to the parameters of a reasonable time period. The period can be based on the facts and circumstances of the situation; however, tax legislation provides two safe harbors as to a reasonable time period: fixed-date and periodic statement methods.
The fixed-date method provides that an advance made within 30 days of when an expense is paid or incurred, an expense substantiated to the employee within 60 days after it is paid or incurred, or an amount returned to the company within 120 days after an expense is paid or incurred is treated as having occurred within a reasonable period of time.
A company utilizing the periodic-statement method provides the employees with statements, on at least a quarterly basis, listing any amounts paid in excess of those satisfying the substantiation condition. If the employees provide additional substantiation or return of the excess within 120 days of the statement, it is treated as substantiated or returned within a reasonable period of time.
If any of the three conditions of an accountable plan are not met, the advances or expense reimbursements are characterized as received under a non-accountable plan, and are included in gross income, reported as wages, and subject to income tax withholding and employment taxes. Note that a company may have both an accountable and non-accountable plan. Thus, the unsubstantiated portions of the expense reimbursement or excess amounts not returned within a reasonable time period are treated as though it were paid under a non-accountable plan.
Independent Contractors and Temporary Labor
Consider the following scenario: Your company recently received an order which will generate a big boost to the bottom line. Your facility has the capacity to fill the order, but your workforce is already maxed out. In this situation, the use of independent contractors and temporary labor can help you not only to meet the demands of your customers, but potentially to reduce your employment costs. By hiring independent contractors and temporary labor, certain fringe benefits (e.g., health insurance and payroll taxes) are not the responsibility of your company.
A company needs to evaluate if independent contractors or temporary labor are the best strategy for its operations. If orders are trending upward and the company does not foresee a downturn, the company should review the cost differential for an employee compared to one of these classifications. Though the company’s payroll tax burden is less for independent contractors and temporary labor, the costs could be greater because these two classifications indirectly shift its burden to the company. In many cases, these classifications request a higher rate per hour to cover their own taxes and fringe benefits.
Besides the potential for higher rates per hour for independent contractors and temporary labor, a company needs to be cautious in that the Internal Revenue Service can claim that the company misclassified a member of its workforce. Misclassification from independent contractor to employee status can lead to payroll tax assessments, interest and penalties.
There are many other ways to reduce your employment costs; therefore, you should reach out to your tax advisor to discuss these opportunities. Employments costs will never go away, but planning can go a long way to help minimize the hit to the bottom line.
Rick Rosell, CPA, is a principal at Bennett Thrasher PC in Atlanta, Ga., with more than 15 years of experience in providing tax advisory and compliance services. He has broad experience with corporate taxation specializing in tax compliance, ASC 740 (accounting for income taxes) preparation and review, and multistate issues.