The Employer Mandate under the Affordable Care Act subjects Applicable Large Employers (ALEs) to penalties for failing to offer their full time employees healthcare coverage. Moreover, the ALE is subject to penalties for failing to report about such coverage through the 1094/1095 forms, which must be both furnished to the applicable employees and filed with the IRS.
To determine whether an employer is an ALE and, if so, which of its workers for whom the employer must offer coverage can get problematic if the employer has misclassified workers as something other than employees, e.g., “independent contractors.”
Employers have no Employer Mandate obligations for their independent contractors and such workers are not counted towards the measure of whether the employer is an ALE. An ALE is generally determined by the number of full time and full time equivalent employees in the prior year. If an employer has 50 of such employees, the employer will be deemed an ALE.
So, what would happen if a business purports to have 40 employees and 10 independent contractors, all of whom are working an average of 30 hours per week? If the business misclassified those 10 “independent contractors,” who should have be deemed employees, then the business would have reached the 50 full time employee threshold and thus deemed an ALE. This triggers two issues.
First, that means the business is required to report on IRS 1094/1095 forms about the healthcare coverage offered to each of the 50 workers. Failure to do so may result in penalties that could reach $260 per form, and double for willful failure.
Second, that means the business is required to offer coverage to at least 95% of the 50 workers. Failure to do so may result in penalties of around $2,000 per worker per year. Even if businesses offer coverage to their employees, they typically do not offer health benefits to their “independent contractors.” In such a case, the net result would be that such businesses would not have offered coverage to at least 95% of their 50 workers.
To avoid this problem, businesses must take care in distinguishing which workers are employees and which are “independent contractors.” The IRS has published guidelines on the distinction. See IRS Topic 762; see also; see also 26 C.F.R. Section 31.3121(d)-(1)(c)(2) (defining “employee” using substantially the same factors) and 31.3401(c)-1(b) (in the context of collection of income taxes, defining “employee” using substantially the same factors).
These guidelines recognize that not all enumerated factors may be relevant, that there is no “magic” or set number of factors that makes a worker an “employee,” and that no one factor stands alone in making this determination. Instead, the key is to view the relationship as a whole and consider the degree or extent of the right to direct and control, which can be segregated in into three categories:
Behavioral Control covers facts that show if the business has a right to direct and control what work is accomplished and how the work is done, through instructions, training, or other means.
Financial Control covers facts that show if the business has a right to direct or control the financial and business aspects of the worker’s job. This includes:
The extent to which the worker has unreimbursed business expenses;
The extent of the worker’s investment in the facilities or tools used in performing services;
The extent to which the worker makes his or her services available to the relevant market;
How the business pays the worker, and
The extent to which the worker can realize a profit or incur a loss.
Relationship of the Parties covers facts that show the type of relationship the parties had. This includes:
Written contracts describing the relationship the parties intended to create;
Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay, or sick pay;
The permanency of the relationship, and
The extent to which services performed by the worker are a key aspect of the regular business of the company.
As should be evident, the distinction between employee and independent contractor can often be unclear. The safe bet is to conservatively assume such workers are employees if they fall into the grey area.
