Several comments filed by various industry groups on proposed regulations issued in January by the Internal Revenue Service have focused on worker classification ambiguities that are embedded in the “common law” standard for distinguishing between “common law employees” and bona fide non-employee service providers. The IRS had issued proposed regulations under the excise tax provisions of the Affordable Care Act (i.e., “Health Care Reform” or “Obamacare”), found in section 4980H of the Internal Revenue Code, on January 2, 2013. The comment period for the proposed regulations ended March 18, 2013. A hearing on the proposed regulations is currently scheduled for April 23, 2013.
The employment status of service providers is a critical factor in determining whether an employer is large enough (generally, 50 or more full-time equivalent employees) to be required to provide health care. Employment status is also relevant to determining whether a “large employer” is subject to the excise tax when a particular worker receives subsidized health insurance coverage offered through a state or federal exchange. The Affordable Care Act extends the range of potential collateral consequences of independent contractor (IC) misclassification and retroactive re-classification of service providers in addition to direct payroll tax withholding requirements.
Other benefits-related collateral consequences include potential retroactive exposure for employee benefits under retirement and health and welfare plans and qualified employee stock purchase plans. Under the Affordable Care Act, the reclassification of service providers initially characterized by an employer as independent contractors or treated as the common law employees of third party staffing agencies could push an employer into “large employer” status. In addition, reclassification of service providers who are not eligible to participate in an employer’s health insurance plan because of their classification as non-employees could result in significant excise tax exposure from the employer’s failure to offer them a minimum level of coverage.
Comments from business industry groups have requested that the definition of the term “employee” be clarified to incorporate the principles of other employee classification safe harbor and clarification rules that apply in different contexts. One comment offered by the ERISA Industry Committee, for example, urges the IRS to incorporate the “section 530” classification relief rules that apply generally to payroll tax withholding situations where an employer has consistently and in good faith classified workers as non-employees. With respect to the status of service providers supplied by third party staffing businesses, comments take conflicting provisions. A University of California labor research center has urged that workers supplied through a third party staffing organization be treated as the employees of the service recipient, whereas other comments seek exclusion from the service recipient’s headcount for agency workers and a safe harbor where the worker has access to affordable minimum coverage through the agency.
The comments reconfirm that the resolution of worker classification issues can have significant financial consequences, and that classification strategies that may be effective for one purpose may have limited effectiveness for other purposes. Given the Obama Administration’s crackdown on misclassification of employees as ICs, it is unlikely that the final regulations will include significant classification relief or clarification.
The Affordable Care Act represents another significant category of IC misclassification exposure, which could result in excise tax penalties of up to $3,000 per reclassified worker beginning in 2014. As employers consider their health care coverage alternatives in the ramp-up to the full effective date of the Affordable Care Act, the scale of non-employee service provider utilization may be an important risk factor.
Most companies with business models that are IC-dependent or simply make use of multiple ICs are aware that they are at risk of IC misclassification liability if they have not properly classified these workers. Recognizing which tests will be applied to the workers in question by the most relevant federal agencies and the applicable state agencies is one of the first steps, using the 48 Factors-Plus™ analysis, in determining where a business falls on the IC Compliance Scale™.
Once a company’s level of compliance is so measured, it can then enhance its IC compliance by restructuring, re-documenting, reclassifying, or redistributing contingent workers, using a process such as IC Diagnostics™ as described in my “White Paper” on minimizing IC misclassification liability.
Most companies understand that it is wise to enhance their level of IC compliance, but oftentimes lack the impetus to do so. If the potential for substantial IC misclassification liability was not enough reason in the past, perhaps the worker classification issues presented by the Affordable Care Act will give companies an additional reason to move this subject from the back burner to the front.
Written by Richard Reibstein.