Another Reason Not to Misclassify Employees

A colleague of mine, Nancy Campbell, drafted yet another article that is a must-read. It serves as a great reminder as to why it is essential to properly classify employees. While the IRS announced a one-year extension last week for the large employer penalties, this issue is something companies might want to consider as they have the additional time to evaluate compliance.

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By: Nancy Campbell

As reported in prior Snell & Wilmer publications (See September 2011 Workplace Word, October 2011 Workplace Word and January 9, 2013 Legal Alert), there are numerous reasons why employers need to ensure that they do not treat common law employees as independent contractors. Now, there is another risk for employers who misclassify employees.

As reported in our recent Navigating Health Care Reform Alert, employer shared responsibility penalties (commonly referred to as the “large employer play or pay penalties”) take effect on January 1, 2014 for employers with 50 or more full-time plus full-time equivalent employees. Under those rules, misclassifying employees puts employers at risk of having to pay an Internal Revenue Code Section 4980H subsection (a) or subsection (b) penalty, with respect to its group health plan, and the penalties can be quite significant.

Example:  Employer A has 100 full-time common law employees, but misclassifies 10 of them as independent contractors. Employer A offers minimum essential health coverage that provides minimum value and is affordable to the 90 employees. Employer A believes it has designed its group health plan to avoid both the subsection (a) and (b) penalties. Unfortunately, it has not. By only offering coverage to 90% of its full-time common law employees, it is subject to a subsection (a) penalty if even one of the employees it misclassified as an independent contractor receives subsidized coverage through a Health Benefit Exchange. The potential subsection (a) annual penalty for failing to offer coverage to at least 95% of its full-time employees is $2,000 x (100 full-time employees – 30) = $140,000.[1] Unfortunately, the subsection (a) penalty applies to all full-time employees, not just the 10 misclassified full-time employees who were not offered group health plan coverage.

The first step in complying with the employer shared responsibility penalties is to make sure that all common law employees are being treated as such as required by IRS rules. Employers should carefully consider whether 1099 independent contractors, temporary workers and other similar workers are really common law employees. If they are, they must be counted in determining whether the employer is “large” (i.e., meets the 50 employee threshold to be subject to the penalties) and, if they work on a full-time basis, they must be offered group health plan coverage meeting certain requirements in order to avoid the Code Section 4980H subsection (a) and (b) penalties.

Complying with the large employer play or pay penalties is very complicated and misclassifying workers is just one of many traps for the unwary.

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Notes

[1] The proposed regulations include a 95% coverage rule, the purpose of which is to provide employers with a margin of error in the event they fail to provide coverage (inadvertently or intentionally) to a small group of full-time employees.

About Ashley Kasarjian

Attorney at Snell and Wilmer in Phoenix, Arizona, and publisher of the blog, Employment and the Law.
This entry was posted in Other Things... and tagged , . Bookmark the permalink.

2 Responses to Another Reason Not to Misclassify Employees

  1. Blake says:

    I enjoyed reading this post! Often times there is a gray area when determining whether a worker is an independent contractor or an employee. What would you recommend to employer’s who have workers who fall somewhere within this gray area? In other words, when applying the balancing test, some factors point towards the worker being an employee while others point towards being an independent contractor.

    • Well, aside from the obvious point that employers need to be consulting with their legal counsel and weigh the various factors from the applicable tests (e.g., IRS factors, economic realities, etc), a lot of the determination is made based on experience. If a worker falls in a gray area, that suggests to me they should likely be classified as an employee. However, each situation is so fact specific, there unfortunately is no clear cut answer.

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