IRS Issues HIRE Act Guidance on Self-Employed Individuals and More

August 6, 2010

The IRS has updated the HIRE Act frequently asked questions section (FAQs) on its webpage to address additional issues relating to the HIRE Act’s payroll tax exemption. It also has added new FAQs relating to the new hire retention credit (a business credit of up to $1,000 for retaining certain employees hired in 2010). The FAQs address a number of topics, the more significant of which are discussed below.

Self-Employed Individuals

One of the requirements for an individual to be a “qualified employee” for purposes of the HIRE Act is that he or she must not have been employed for more than 40 hours during the 60-day period ending on the date he or she is hired. The IRS guidance clarifies that a self-employed individual is not “employed” for purposes of this requirement. Accordingly, an employer will be eligible for the payroll tax exemption under the HIRE Act, if it hires a self-employed individual, assuming the other requirements are met (e.g., the individual has not been employed (i.e., worked for an employer) for more than 40 hours during the 60-day period ending on the hire date).

Under this guidance, an employer who retains the services of an individual as an independent contractor could qualify for the payroll tax exemption by hiring the independent contractor as an employee, assuming the individual meets the requirements of a qualified employee. Before hiring such an individual, however, the employer should review whether it correctly classified the individual as an independent contractor. The IRS might take the position that the individual should have been classified as an employee, and not an independent contractor, when he or she first began providing services.

To be a qualified employee, an individual must be hired after Feb. 3, 2010, and before Jan. 1, 2011. If the independent contractor rendered services to the employer before Feb. 4, 2010, and the IRS classifies the independent contractor as an employee, the individual will not be a qualified employee because he or she would have begun employment with the employer before Feb. 4, 2010.

When Employment Begins

The date an individual “begins employment” is relevant under the HIRE Act for purposes of determining whether the individual meets the hiring date requirement of a qualified employee (i.e., hired after Feb. 3, 2010, and before Jan. 1, 2011) and whether the employer is eligible for the new hire retention credit. The HIRE Act does not address when employment begins. The IRS’ updated guidance provides that general principals relating to employment apply. Under general principals, an individual begins employment on the date when, based on the facts and circumstances of the particular situation, the employer-employee relationship is first established.

In most cases, the date on which the employer-employee relationship is first established is clear. There are cases, however, when it is not clear. For example, an individual may have been previously employed by the employer, or the employee may be on furlough, standby status, or on temporary layoff. In these cases, the issue is whether the employer-employee relationship was terminated and later reestablished. The IRS guidance provides no bright-line test. Rather, it provides that whether the employment relationship has terminated is based on facts and circumstances.

Factors indicating that an employer-employee relationship has terminated may include:

  • Issuance of a termination notice or letter
  • Cancelation of access to office (surrender of building pass)
  • Cancelation of access to computer system
  • Cancelation of benefits
  • Eligibility for COBRA continuation of health insurance benefits
  • Termination under retirement plans
  • Severance payment
  • Coded as terminated in payroll records
  • Payment of unemployment compensation
  • Intervening employment with another employer

An individual who was previously employed and terminated may meet the requirements of a qualified employee, if the employment relationship is reestablished after Feb. 3, 2010. An individual who is on furlough, standby status, or temporary layoff on Feb. 3, 2010, and later brought back to active status may not have been terminated before Feb. 4, 2010, and therefore, would not begin employment after Feb. 3, 2010.

An individual who begins employment on March 1, 2010, and meets the requirements of a qualified employee might be furloughed for a month during 2010. If the employment relationship never terminates, the employer may be eligible for the new hire retention credit, if the employee is still employed on March 1, 2011. These are difficult issues that employers will have to answer after examining all the facts and circumstances.

Replacing Employees

Generally, an employee does not meet the requirements of a qualified employee if he or she is hired to replace an existing employee. The updated IRS guidance clarifies, however, that an employee can be a qualified employee even if he or she is hired to replace an employee who:

  • Voluntarily terminated employment
  • Was terminated due to gross negligence
  • Was terminated for poor performance
  • Was terminated in a reduction in force due to lack of work

Minors Signing Form W-11

The updated IRS guidance clarifies that a minor can sign an employee affidavit, such as the Form W-11, which is required to be signed under penalties of perjury.

Reporting Agents

The guidance also clarifies that employers using reporting agents are not required to provide copies of the Form W-11 to the reporting agents.

Retention Credit & WOTC Credit

An employer cannot claim both the HIRE Act’s payroll tax exemption and the Work Opportunity Tax Credit (WOTC) on wages paid to the same individual. An employer can elect, on an employee-by-employee basis, whether to claim the payroll tax exemption or the WOTC for the wages paid an employee. This is not the case, however, for the new hire retention credit. The new FAQs for the new hire retention credit make clear that an employer may claim the retention credit for a qualified employee, even if the employer also claimed the WOTC for the same employee.

Retention Credit & AMT

The new IRS guidance clarifies that the retention credit cannot offset the business Alternative Minimum Tax.

Compensation Deductions

The WOTC specifically provides that employers must reduce their business deduction for compensation by the amount of the WOTC credit. This is not the case with the retention credit. The new guidance clarifies that the business deduction for compensation is not reduced or affected by the retention credit.

Prior HIRE Act Articles

For prior articles on the HIRE Act, see:

  • HIRE Act Provides Tax Breaks for Hiring Unemployed Workers
  • IRS Issues Draft Form to Certify Qualified Employees Under HIRE Act
  • IRS to Issue Hire Act Final Form W-11 Week of April 5
  • IRS Issues HIRE Act Final Form W-11 and New Q&As
  • IRS Issues Revised Forms W-2 and W-3 for HIRE Act Changes
  • IRS Issues Additional FAQs for HIRE Act
  • IRS Notes Errors on Payroll Tax Returns Seeking HIRE Act Benefits.
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