If you work on taxpayer funded jobs or you provide services to a government agency, you’re probably subject to the Davis Bacon Act, Service Contract Act, state prevailing wage laws, or local living wage laws. Small compliance mistakes quickly add up to large costs. On average, a 12-man company that works 25% on public jobs will spend 15 hours a week on compliance and waste $67,184 annually on overpaid wages and taxes.
Three reasons contractors overpay on government projects:
Most prevailing jobs require that you pay a specific amount of fringe benefits to employees. For example, in San Diego, you pay $19.60/hr in benefits on all prevailing hours worked by carpenters. After deducting the credit for existing benefits (e.g. $4.53/hr), you pay the difference ($15.07/hr) in “cash” by adding it as taxable income. This leads to four common mistakes that can cost tens or even hundreds of thousands of dollars:
- Not taking all available credits — effectively double paying your employees.
- Calculating time-and-a-half on the overtime fringe. You must pay fringe on all overtime prevailing hours, but not at time-and-a-half.
- Paying the difference in “cash”. This costs an average of 20% in payroll taxes, workers’ compensation (WC), and general liability (GL) insurance — plus 30% in taxes for your employees.
- Assigning prevailing work to employees with low benefits. If you use employees that are higher paid (or have greater benefits), you’ll spend less to satisfy the prevailing wage requirements.
Take credit for these benefits:
You can’t take credit for:
To calculate each credit, divide your annual cost (e.g. employer health = $400/month or $5,000/year) by annual hours worked (typically 2,080 —$5,000/2,080 = $2.40/hr).
Any amount you pay in “cash” will cost you and your employees a lot in taxes and insurance. If you pay $15.07/hr in cash, you pay another $3/hr in employer costs and employees pay an average of $4.50/hr in taxes. That adds up to $3,750 for an employee working just 500 prevailing hours a year. You’re better off depositing the $15.07/hr into a third-party “fringe trust”. A properly structured fringe trust can save these costs and still give employees access to cash and desired benefits. A poorly designed fringe trust can block employees from their money and expose you to thousands in taxes or compliance penalties.
You may try to satisfy the fringe by offering more generous benefits — but that will cost more than you expect. Most benefits are subject to “annualization”, which means that the credit is reduced based on a percentage of prevailing hours each employee works. For example, if you pay a $5,000/year medical benefit for an employee that works 25% (520/2080 hours) on prevailing jobs, you can only take $1,250 of credit. If you increased the contribution to $10,000/year, you would just increase the disallowed credit from $3,750 to $7,500.
Alternatively, you can provide certain benefits that are exempt from annualization and take 100% credit on your costs. While annualization-exempt benefits vary by state, they typically include:
- “Cash” payments (but you pay taxes, WC and GL)
- “Cash” payments with a Section 125 cafeteria plan (exempt from taxes and sometimes WC)
- Hourly fringe HSA contributions (limited to $7,000/yr for employees with a family HDHP medical plan)
- Hourly fringe 401(k) contributions
There are a lot of flavors of fringe trusts in the market, but be careful when reviewing options. As an example, the Department of Labor (DOL) determined in 2015 that Supplemental Unemployment Plans (SUPs) were no longer exempt from annualization. Health trusts are also subject to annualization and some even keep leftover funds when an employee’s hours are more than needed to cover insurance costs.
Depending on a client’s needs, we typically set them up with a multi-purpose trust with Section 125, cash fund, and 401(k) components. This provides the largest company tax savings while giving each employee a configurable mix of retirement, tax-reduced spending, and available cash as they need it.
If you do set up a trust, you may consider reducing some general benefits that would be subject to annualization. For example, an employer contributing 100% to employees’ insurance may want to reduce to the state’s minimum requirement (usually 50%).
Lack of Compliance
Penalties can be significant — fines, debarment from government contracts, and even criminal prosecution. On a federal level, the DOL has issued 480,179 violations to 16,278 companies, resulting in fines and back payment orders totaling $600 million. State and local enforcement can be more aggressive, and private lawyers are constantly trying to generate class action lawsuits.
Here are some easy steps to help you stay out of trouble:
- File all certified, non-performance, and EEO reports on time and accurately
- Make sure employees are classified correctly
- Calculate your fringe credits for each employee. Averages are not allowed.
- Keep all reports and make sure they match (e.g. timecards, daily reports, 5500s, fringe statements, etc.)
- Pay weekly on federal jobs (and some state) jobs
- Get employees to sign off on all deductions and don’t use any disallowed deductions on certified payrolls (e.g. uniform, damage, or unreturned items)
- Manage your subcontractors’ certified work. You are responsible for their compliance issues and employee payments. California and Massachusetts extend this to private jobs too.
On the other hand, if you understand the laws, you can make them work for you:
- Track non-productive hours – Drivetime, shop-time, and offsite hours are generally exempt from prevailing wage and fringe
- Go negative on fringes – On federal and many state jobs, you can take credit for benefits in excess of the required hourly fringe rate to reduce the base prevailing wage.
- Understand California wage determinations – Since 1996, California has allowed employers to take credit against the aggregate fringe requirement without needing to cap against the published individual sub-benefit amounts (health, pension, vacation, training, other).
Government contracts can be very profitable, but come with compliance and other costs. Review your requirements with your awarding agency, GC, and attorneys. Automate where possible and look into a fringe trust to increase profitability and outbid your competitors.
Contact an eBacon representative today to find out how we can help set up your employee benefits more favorably for your business.
The material presented here is educational in nature and is not intended to be, nor should be relied upon, as legal or financial advice. Please consult with an attorney or financial professional for advice.