The ACA & The Perils of Engaging Independent Contractors

Feb 17

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Employers who engage a significant number of 1099 employees run a tremendous risk of incurring the no insurance penalty, even when they offer coverage to all of the employees they categorize as full-time.

Why? Because the regulators may disagree with the independent contractor classification used by the employer and deem all of the 1099 employees to be “common law employees” of the employer. If the number of 1099 employees who are reclassified as common law employees exceeds 30% in 2015 or 5% in 2016 and beyond of the employer’s full-time workforce, the no insurance penalty may be tripped.

As noted, in the Final Regulations, the IRS has provided a bit of a breather (perhaps) on this issue for 2015. In 2015, only a large number of percentage (i.e., 30% or more) of the workforce being misclassified will trip the penalty. However, employers with a significant number of 1099 employees should check the percentages for 2015 and start to implement appropriate steps in 2015 if it looks like the concentration of 1099 employees will be greater than 5% starting in 2016 (and begin now to make changes for 2015 if the concentration is greater than 30%).

Consider this example: in 2016, a hospital employs 3,000 full-time employees. It offers self-insured insurance coverage to 100% of these 3,000 employees and their families. It subsidizes a significant portion of the premium cost and its group health care spend is in the tens of millions of dollars per year. The insurance is also “affordable” for ACA purposes, so the hospital believes that it has no exposure to the ACA’s so-called “pay or play penalties.”

To meet the demands or needs of about 200 clinical staff, the hospital has created a pool of 1099 employees. These are individuals who work full-time but for personal, financial or other reasons, have agreed with the hospital to be treated as “independent contractors” and to forego eligibility for benefits, including health insurance, perhaps in exchange for a higher hourly rate of pay.

Let’s say up front that the IRS (and other regulators) takes a very dim view of these relationships and the agreement described above is generally disfavored by the IRS and other regulators because of tax, withholding and potential wage and hour abuses. The IRS, in general, determines whether an individual is a common law employee based on a host of factors, including:

  • The amount of control exercised by the employer over when, where and how the individual works;

  • The worker’s opportunity (or lack thereof) to incur profit or loss;

  • Whether the employer can fire the individual;

  • Whether the work is part of the employer’s regular business; and

  • The permanency of the relationship.

Note that this is a short list—other factors may be used to determine “employee” status. Also, note the hospital setting is used as an example. There are many industries that have similar arrangements. For example, it is not uncommon in education to find that part-time teachers and coaches are classified as 1099 employees. It is often the case that these individuals would be treated as common law employees by the IRS.

In the hospital example described above, it might be difficult to avoid these 1099 employees being reclassified as common law employees. If that happens, the results rival any of the perils that the heroine in Perils of Pauline may have encountered.

If the 200 1099 employees the employer treated as non-eligible are determined to be common law employees, and any full-time employee obtained subsidized coverage on an ACA exchange, then the penalty assessed against the hospital would be a whopping $6,340,000 per year!

Why? Because the hospital would be deemed to have had 3,200 full-time employees, 200 of whom were not eligible for insurance. 200 is 6.25% of 3200—so the hospital would have offered coverage to about 94% of the full-time workforce and therefore the no insurance penalty would be assessed under the ACA. This would be the case even though the hospital had been spending tens of millions of dollars per year to offer good insurance to those who wanted insurance.

Employers who engage 1099 employees may want to review whether these workers are appropriately classified before they find themselves on the wrong side of the guys in black hats when the pay or play requirements go into effect in 2015. And even if they are well below the 30% range with 1099 employees for 2015, they clearly have to check to see whether they will be below 5% of 2016 and beyond. If not, they should look carefully and with a keen eye to determine whether these individuals aren’t really common law employees.

The author of this blog is Peter J. Marathas, Jr., Esq. Mr. Marathas is a partner at Proskauer Rose LLP and chairs the firm’s Health Care Reform Task Force. Mr. Marathas speaks and writes frequently on the requirements of the Affordable Care Act. He provides counsel and assists Prosential agencies with compliance support. Mr. Marathas can be reached at [email protected] or (617) 526-9704. © 2014 Proskauer Rose LLP. All Rights Reserved. Used by permission.

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