As previously reported, on February 10, 2014, the IRS issued final regulations on the Affordable Care Act’s (ACA) employer shared responsibility requirements—the so-called “pay-or-play” mandate. In the regulations, the IRS provides new and additional guidance on a wide range of issues relating to the implementation of the pay-or-play rules. Among them, the IRS has restated its position and introduced some new rules relating to the engagement by employers of “contingent workers,” including temporary employees, individuals hired through temporary staffing firms and independent contractors (“1099 employees”). Not surprisingly, in its proposed regulations released about a year ago, the IRS had flagged contingent workers as presenting challenging issues for compliance with the pay-or-play requirements.
Key provisions of the final regulations’ rules for contingent workers are summarized below.
Definition of Employee. In the final regulations the IRS reaffirms its position that it will use a common law definition of employee to determine employer-employee status. Generally, an individual is the common law employee of an entity if that entity has the right to control the individual’s performance of services. The final regulations continue to exclude leased employees, sole proprietors, partners in a partnership, 2-percent S corporation shareholders, and certain direct sellers and real estate agents from the definition of employee.
Common Law Employees of the Client Employer. For purposes of the pay-or-play mandate, when the client is the common law employer, an offer of coverage made by the temporary staffing firm “on behalf of” the client employer will be considered to be an offer of coverage by the client employer. In order for an offer of coverage to be “on behalf of” the client employer, the client employer must pay a higher fee to the temporary staffing firm for those employees who enroll in the temporary staffing firm’s plan. In other words, if the contract provides for a flat fee per employee placement irrespective of whether the employee enrolls in the staffing company’s coverage, the employer will not be considered to have made an offer of coverage. This could lead to exposure under the pay-or-play mandate’s $2,000 per full-time employee “no coverage offered” penalty if more than 5% of its full-time employees (30% in 2015) are employed through the staffing agency.
Contingent Worker Misclassification Issues. Employers are not required to offer coverage to independent contractors; however, because the final regulations use a common law definition of employee, an IRS examination finding that common law employees have been misclassified as independent contractors could result in significant penalty exposure to the employer. Employers that engage a significant number of “1099 employees” run a tremendous risk of incurring the pay-or-play mandate’s $2,000 per full-time employee “no coverage offered” penalty, even when they offer coverage to all of the employees they categorize as full-time. If the number of 1099 employees who are reclassified as common law employees exceeds 5% of the employer’s full-time workforce (30% in 2015), the “no coverage offered” penalty may be tripped.
Another important issue for employers that hire independent contractors is whether they could rely on the IRS so-called “Section 530” relief for identifying common law employees. In short, this relief is based on Section 530 of the Internal Revenue Code of 1978 and provides that no penalties or interest will be incurred as the result of worker misclassification if the employer (i) consistently treated the workers in question as independent contractors, (ii) complied with the Form 1099 tax reporting requirements for the independent contractors and (iii) had a reasonable basis for treating the workers as independent contractors.
The ACA regulations specifically reject the availability of Section 530 relief for purposes of the pay-or-play requirements. Despite the requirement for a reasonable basis as a condition for Section 530 relief, the IRS based its decision on the concern that allowing Section 530 relief would incentivize worker misclassification. Given the lack of available relief, employers should carefully review their contractual arrangements with service providers to ensure that they have been properly classified as independent contractors as opposed to common law employees under the more traditional common law tests.
Short-Term Employees. The final regulations confirm the IRS’s position that short-term employees (other than seasonal employees) who are reasonably expected to work full-time (30 hours or more per week) at date of hire must generally be offered coverage within 90 days. There is no blanket exemption for short-term employees—if employment extends beyond the end of the third full calendar month of employment, the employer must offer coverage regardless of the projected termination date (the offer of coverage will generally be within 90 days from date of hire due to the ACA’s waiting period rules).
Employees of Temporary Staffing Firms. There are special rules for determining whether a variable hour employee is a full-time employee. Variable hour employees are employees with no set schedule or seasonal employees (generally those working 6 months or less on a seasonal basis). Under these rules, the employer (staffing company) can use a determination period of from 3 to 6 to 12 months to determine an individual’s full-time status for a following so-called “stability period” of 6 or 12 months. Because of the nature of the business—where employees may work for several client employers during a certain period of time—commenters observed that it would be difficult to determine when a staffing company employee was a variable hour employee. Some commenters asked that a presumption—either for or against variable hour status—be developed. Noting the varying nature of the industry, the regulators rejected the idea of a presumption. Instead, the final regulations provide criteria that a staffing company may consider to determine whether a new employee is “variable hour.” This assessment is done at the time of hire based on the staffing company’s reasonable expectations. Considerations may include whether other similar employees of the staffing company: retain the right to reject assignments; have periods during which no assignments are available; are offered assignments of differing lengths; and are typically offered assignments that do not extend more than thirteen weeks. No one factor is dispositive.
These are just a few of the significant issues employers need to consider as they identify their worker classification arrangements in light of the ACA rules. Of course, employers also need to consider their contractual agreements with any temporary staffing agencies and all of the other possible legal requirements that could apply in this context (such as ERISA section 510 liability for intentional interference with attainment of benefits and the ACA whistleblower protections).