SBA Proposes Big Changes to the HUBZone Program (Continued)

Big changes could be coming to the HUBZone program. On October 31, the SBA published a proposed rule that, if adopted, would bring clarity to the HUBZone regulations. Yesterday, we posted about proposed changes to the HUBZone certification, compliance, and protest processes.

In this post, we wanted to bring you up to speed on some of the more substantive revisions to the way HUBZone employees are defined and counted under the proposed rule.

Continuing Eligibility of HUBZone Employees

Another substantial proposed change is the way in which the SBA will treat HUBZone employees. Under the previous HUBZone regulations, employees were required to maintain residence within a HUBZone in order to qualify as HUBZone employees. As soon as the employee moved to another area, however, that employee would immediately cease to count toward the 35 percent residency requirement of the HUBZone small business.

The SBA’s proposed rule dramatically revises the employee eligibility requirements. As the proposed rule explains, “[the] SBA is also proposing that an employee that resides in a HUBZone at the time of a HUBZone small business concern’s certification or recertification shall continue to count as a HUBZone employee as long as the individual remains an employee of the firm, even if the employee moves to a location that is not in a qualified HUBZone area or the area where the employee’s residence is located is redesignated and no longer qualifies as a HUBZone.”

The justification to this change makes sense: “[s]omeone who is hired by a HUBZone small business concern and who is then able to better the lives of his or her family by moving to a different location outside a HUBZone area (due to that newly created job) should not face losing his or her job because the HUBZone small business concern cannot maintain its HUBZone eligibility with that individual on the payroll.”

Shifting to a grandfathering system for employees is a positive step. As many HUBZone concerns are likely aware, trying to account for the movements of employees—particularly HUBZone employees—can be particularly taxing. By allowing HUBZone small businesses to continue counting employees that formerly resided in a HUBZone toward the required totals, the SBA is substantially increasing the possibility for HUBZone concerns to meet and maintain HUBZone eligibility.

Changes to 1099 Contractors and Affiliate Employees

One common question we get about HUBZone compliance is whether 1099 contractors count as an employee. The answer, up to now, is usually some variation of “it depends.”

The proposed rule tries to clarify the treatment of 1099 contractors through commonality with its size regulations. That is, if a 1099 contractor is an “employee” for size purposes (according to SBA’s Size Policy Statement No. 1), they will also be considered an “employee” for HUBZone purposes:

[The] 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 also be considered an employee for HUBZone eligibility purposes.

As such, the SBA’s proposed rule seeks to bring greater commonality between the HUBZone and size regulations.

Additionally, the proposed rulemaking also clarifies that affiliate employees will be counted as HUBZone employees if “the totality of circumstances demonstrates that there is no clear line of fracture between the concerns.” According to the proposed rule, “[t]his has always been SBA’s policy and this amendment is intended to eliminate ambiguities in the regulation.” Given that the SBA’s policy has always been to include affiliate employees in the calculation, this change may not be as substantial as the change to the treatment of 1099 employees. That being said, the additional clarity provided by the SBA is nevertheless welcome.

Owners as Employees

Another area the proposed rule clarifies is the treatment of owners as employees. This has been an area of considerable confusion under the SBA’s current rules. Under the current HUBZone regulations, an owner would be deemed an employee if such owner worked 40 hours a month for the HUBZone business, regardless of whether such owner received compensation for his or her efforts. Despite this, there was still some ambiguity as to whether sole owners working less than 40 hours each month count as employees in firms with just a few employees.

The SBA’s proposed rule retains the presumption that an owner working 40 or more hours a month is an employee for HUBZone purposes. The proposed rule, however, also clarifies the treatment of sole owners in small firms. As the SBA explains, “the proposed definition adds that if the sole owner of a firm works less than 40 hours during the four-week period immediately prior to the relevant date of review, but has not hired another individual to direct the actions of the concern’s employees, then that owner will be considered an employee as well.” Accordingly, under a proposed rule, a small business that has not hired some type of manager will have its owner considered an employee regardless of the number of hours worked.

Businesses with a small number of employees will likely bear the brunt of this rule change. Notably, when a concern only has a few employees, the change in HUBZone eligibility of one employee can substantially impact the HUBZone eligibility of the firm. Consequently, counting owners to be an employee may have a number of adverse impacts on potential HUBZone start-ups.

Residency Definitions

The SBA has also proposed revising the definition of “reside.” Under the current regulations, an employee being claimed for compliance with the 35 percent residency requirement must demonstrate their principal residence is located within a HUBZone and that the employee intends to live at the location indefinitely. The SBA acknowledges, however, that the term “principal residence” may not accurately describe the SBA’s expectations, and that it has developed no effective means for policing the indefinite residency requirement. As such, the SBA is proposing to remove both of these requirements.

Moreover, employees who are performing work overseas in connection with a contract, but maintain a residence within the United States will also be considered employees. According to the SBA, “as long as that employee can provide documents showing he or she is paying rent or owns a home in a HUBZone, then the employee should be counted as a HUBZone resident in determining whether the small business meets the 35 percent HUBZone residency requirement.”

In all, the SBA’s changes to the employee eligibility requirements are likely to have a positive impact on HUBZone participation and continued compliance.

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As we mentioned yesterday, these proposed changes are just that—proposed. The SBA has invited public comments on these rules, which are due December 31, 2018. We’ll keep you posted on whether—and when—any of these revisions are adopted.