HUBZone Program: SBA’s Proposed Rule Clears Up Some Common Misconceptions

Last week, the SBA released a proposal to overhaul the HUBZone Program.  The proposed rule will make major changes to almost all aspects of the HUBZone Program, and my colleague Ian Patterson is covering those changes in a series of two posts on SmallGovCon.

But while the proposed HUBZone Program rule changes will garner most of the headlines, the SBA also has used the proposed rule as an opportunity to clear up a few very common HUBZone Program misconceptions–such as the notion that so-called “jobsite employees” don’t count toward the 35% HUBZone residency requirement.

Here are three of the most important clarifications SBA offered in the proposed HUBZone rule.

Independent Contractors

HUBZone applicants often believe that bona fide 1099 independent contractors can be used to satisfy HUBZone eligibility requirements.  But that’s never been the case.  In the proposed rule, SBA says that “independent contractors who receive compensation through Internal Revenue Service (IRS) Form 1099 generally are not considered employees, as long as such individuals are not considered to be employees for size purposes under SBA’s Size Policy Statement No. 1.”

The SBA explains:

SBA believes that it would not make sense to find an individual to be an employee of a firm when determining the concern’s size, but to then not consider that same individual to be an employee when determining compliance with HUBZone eligibility rules.  If an independent contractor meets the employee test under SBA Size Policy Statement No. 1, such individual should be considered an employee for HUBZone eligibility purposes.  If someone is truly acting as an independent contractor, that individual is acting as a subcontractor, not an employee.  Such an individual does not receive the same benefits as an employee, but is also not under the same control as an employee.

The SBA’s guidance is consistent with its statement from May 2016, in which SBA stated that 1099 contractors are not employees for purposes of meeting the limitations on subcontracting.  In short, regardless of whether it is size, subcontracting limits, or HUBZone status at issue, the SBA’s message is that government contractors probably cannot have it both ways by counting an individual as a 1099 for purposes of taxes and benefits, but counting the same person as an employee for SBA’s size and socioeconomic programs.

Employees of Affiliates

If a HUBZone applicant or participant has an affiliate under the SBA’s size rules, do the employees of the affiliate count toward the HUBZone Program’s 35% and principal office requirements?  The SBA has long used a “totality of the circumstances” test in such cases–but that test was nowhere to be found in the regulations.  Now, the SBA offers some concrete guidance, saying that it will count the employees of an affiliate “if the totality of the circumstances demonstrates that there is no clear line of fracture between the concerns.”

The SBA continues:

When looking at totality of the circumstances, SBA will review all information, including criteria used by the [IRS] for Federal income tax purposes and those set forth in SBA’s Size Policy Statement No. 1.  This means that SBA will consider the employees of an affiliate firm as employees of the HUBZone small business if there is no clear line of fracture between the business concerns in question, the employees are in fact shared, or there is evidence of intentional subterfuge.

When it comes to a “clear line of fracture,” the SBA says it will review, “among other criteria,” whether the companies:

Operate in the same or similar line of business; operate in the same geographic location; share office space or equipment; share any employees; share payroll or other administrative or support services; share or have similar websites or email addresses; share telephone lines or facsimile machines; have entered into agreements together (e.g., subcontracting, teaming, joint venture, or leasing agreements) or otherwise use each other’s services; share customers; have similar names; have key employees participating in each other’s business decisions; or have hired each other’s former employees.

That’s a lot to consider, but it’s very helpful for SBA to clearly set out the “clear fracture” test and a list of criteria that may be considered in the analysis.  Of course, I hope we can all agree that in late 2018, almost no one should still be using that abomination of 1980s-era technology, the fax machine.  If you’re still using one, may I recommend you consider this handy fax machine disposal demonstration from Office Space.

Job Site Employees and the 35% Residency Rule

When it comes to the 35% rule, there’s a lot of confusion out there.  It’s a very common misconception that employees who work on employee job sites aren’t included in the 35% count.  In fact, they are included in the 35% calculation; they’re exempt, instead, from consideration when it comes to determining the company’s principal office.

In the new rule, “SBA proposes to clarify that all employees are counted when determining a firm’s compliance with this requirement, regardless of where the employee performs his or her work.”  The SBA continues:

This has always been SBA’s policy, but it appears that some applicants have misinterpreted SBA’s rules.  SBA has received several comments indicating that some in the community mistakenly believe that SBA would look only at those employees performing work in the principal office, and not any employees performing work at job site locations, in determining whether the firm meets the 35% HUBZone residency requirement.  This has never been the case.  SBA counts all individuals considered “employees” under the HUBZone definition of the term toward the 35% HUBZone residency requirement.

The Road Ahead

It’s important to remember that the sweeping changes the SBA has proposed to the HUBZone program are just that: proposed changes.  The SBA is accepting public comments until December 31, 2018, and will then publish a final rule, likely at some point in mid-to late-2019.  Only with the publication of the final rule will the underlying HUBZone regulations change.

That said, for HUBZone applicants and participants, these three items I’ve discussed are worth noting right now.  With respect to independent contractors, employees of affiliates, and job site employees, the new rules effectively clarify and codify what the SBA is already doing (and has been doing for years).