Business regulations and tax laws are seemingly always in flux. Leelyn Smith’s tax team, led by director of tax Zach Gordon, tracks these changes closely to ensure we understand how they affect our clients.
In the 2022-23 tax season, our team is paying particular attention to two key issues: new guidelines for determining whether a worker is an independent contractor or an employee, and new rules for inherited IRAs.
While final guidance hasn’t been issued on either of these matters, both of them have advanced far enough that we think it is important to share what we know and help you prepare.
Independent contractor or employee?
If you own a business, you may work with independent contractors outside your base of full-time and part-time employees. If you depend on contractors, you should know that the U.S. Department of Labor (DOL) recently proposed significant changes to the tests used to determine a worker’s status as an employee versus a contractor.
The new guidelines would rescind a Trump-era rule that gave greater weight to how much control workers have over their job duties and their opportunities for profit or loss when determining whether a worker is an employee or independent contractor. The Biden administration’s DOL said the previous test was inconsistent with federal court decisions and would result in many more workers being wrongly classified as independent contractors when they should be considered employees.
According to the DOL’s proposal released in October 2022, the following six-factor test will be used to determine if a worker is an independent contractor or an employee going forward:
- Opportunity for profit or loss depending on managerial skill: Does the worker exercise managerial skill that affects the worker’s economic success or failure in performing the work?
- Investment by the worker and the employer: Is the worker’s investment capital or entrepreneurial in nature?
- Degree of performance of work relationship: Is the work relationship indefinite in duration or continuous?
- Nature and degree of control: Does the employer set the worker’s schedule, supervise the performance of the work, or explicitly limit the worker’s ability to work for others?
- Work performed is “integral” to employer’s business: Are the tasks performed by a worker critical, necessary, or central to the employer’s principal business?
- Skill and initiative of the worker: Does the worker use specialized skills to perform the work?
Overall, this new framework will make it much harder to lawfully classify workers as independent contractors. Furthermore, individual states can set their own requirements. For example, Illinois uses even more rigorous standards than the DOL in evaluating whether workers are independent contractors or employers.
Under the Illinois Wage Claim Act, all workers are presumed to be employees unless these three factors are proven in a proceeding:
- The worker is free from control over the performance of the worker’s services.
- The service provided by the worker is outside the employer’s usual course of business or is performed outside all the employer’s places of business.
- The worker engages in an independently established trade, occupation, profession, or business.
Ultimately, decisions categorizing workers as independent contractors or employees can have a significant impact on many areas of your business, including compensation, Social Security and Medicare taxes, and unemployment insurance. The new rule will also affect unionization—if contractors are reclassified as employees, they can join a union more easily.
While the Department of Labor’s rules regarding independent contractors aren’t final, it seems likely they will be adopted. We will continue to monitor the situation, and we would encourage all clients who are business owners to speak with your advisor as soon as possible.
Inherited IRAs and required distributions
Individuals must start taking withdrawals—technically called required minimum distributions (RMDs)—from traditional IRA and 401(k) accounts once they reach age 73 (recently updated from age 72 by the SECURE Act 2.0, which was signed into law on December 29, 2022). These RMDs are based on the individual’s life expectancy and account balance. However, if you inherit an IRA, you may need to consider RMDs regardless of your age.
The SECURE Act brought about a rule change that said non-spouse beneficiaries who inherit IRAs must withdraw the money from that inherited account within 10 years. (Exceptions were made for minor children, disabled people, and those who were within 10 years of the age of the deceased.)
Tax professionals previously interpreted the SECURE Act’s changes to mean that the 10-year rule did not require annual RMDs on inherited IRAs, and that IRA beneficiaries could take distributions at any point in the 10-year period. This thinking gave tax professionals some flexibility in helping recipients of inherited IRAs manage their taxes.
However, in February 2022, the IRS issued guidelines saying IRA beneficiaries must take RMDs each year throughout the ten-year period. Then, in October 2022, the IRS announced its updated rules on inherited IRAs won’t apply until 2023—a move that essentially sets aside RMDs for 2021 and 2022 for inherited IRAs. Consequently, the IRS won’t apply the potential 50% penalty for a failure to take RMDs in 2021 and 2022, and taxpayers that paid a penalty can request a refund.
If you have recently inherited an IRA, please speak with your advisor to discuss required distributions and how they will affect your tax situation.
Circle up with your tax advisor in early 2023
While these regulations aren’t final, we have every reason to believe they will become official in the coming months. These new rules may have a significant impact on your financial plan, especially if you are a business owner or have recently inherited an IRA. We encourage you to speak with your advisor to examine what these changes mean for you.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
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