Affordable Care Act Employer Penalties – Another Reason to Make Sure Workers are Properly Classified as Employees or Independent Contractors
Beginning next year, an applicable large employer that does not offer affordable minimum value group health coverage to its fulltime employees (and their children up to age 26) will be vulnerable to employer shared responsibility penalties under Internal Revenue Code §4980H. Whether an employer is an “applicable large employer” depends on its number of fulltime (and fulltime equivalent) employees in 2014. The amount of penalties to which an applicable large employer is vulnerable also depends substantially on the number of fulltime employees it has and how many of those employees obtain subsidized Exchange coverage. Thus, an employer cannot begin to consider its penalty vulnerability, much less strategize on how to avoid or minimize that penalty vulnerability, without knowing how many employees it has and who they are.
That an employer should know how many employees it has, and who they are, may seem obvious. But what’s not so obvious, in many cases, is whether a worker is properly identified as an employee. Many employers have workers who perform services under individual or third party contract arrangements (written or otherwise). Employers frequently refer to these workers as contract workers, temporaries, independent contractors, consultants, contingent workers, and the like. They may or may not be on the employer’s payroll. They may or may not receive a Form W-2 from the employer. They may or may not be offered coverage under the employer’s benefit plans. And they may or may not be employees.
A serious problem arises when the Internal Revenue Service (“IRS”) disagrees with the employer’s classification of a worker as an independent contractor rather than an employee. An employee, for employer shared responsibility penalty purposes (as for other purposes considered by the IRS), means a “common law employee” of the employer as explained under Treasury Regulation § 31.3401(c)-1(b). A common law employment relationship exists “when the person [entity] for whom services are performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work but also as to the details and means by which that result is accomplished.” Whether a common law employment relationship exists obviously turns on a subjective “facts and circumstances” test and the IRS gets to decide whether the relationship passes or fails that test. The IRS considers whether the employer has behavioral and financial control as well as the nature of the relationship. Important among the facts and circumstances the IRS considers is whether the employer has the right to hire and fire the worker. The IRS also considers things like whether the employer gives the worker the tools, equipment and place to work, among other facts and circumstances. The IRS does not consider as relevant how the employer refers to the worker (e.g., independent contractor, consultant, etc.). For employers that have misclassified workers as independent contractors who should have been treated as employees, the IRS’ Voluntary Worker Classification Settlement Program remains open, enabling those employers to reclassify workers as employees who’ve been misclassified as independent contractors in prior years for a fraction of the cost (in penalties) that otherwise could be incurred.
An individual paid by a staffing firm, but working under the direction and control of another entity is the common law employee of the entity for whom the individual performs the work. Thus, using a staffing firm to hire workers will not reduce the number of employees an employer has. However, for purposes of avoiding employer shared responsibility penalties, the employer will be treated as offering affordable minimum value coverage to those workers if the staffing firm offers such coverage to the workers and the employer pays a higher fee for those workers who enroll in coverage than for those who don’t.
For an employer that has not already done so, it is imperative that the employer make sure it has properly identified all of its common law employees as employees (using the IRS’ Voluntary Classification Settlement Program, if appropriate). And, an applicable large employer that uses a staffing firm should determine whether the staffing firm will offer affordable minimum value group health coverage to fulltime employees and charge the employer a higher fee for those who enroll.