Open enrollment sounds alarm for ACA worker classification

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If you’re an employer whose company uses independent contractors or workers from staffing agencies, you’ll need to make sure you’ve correctly identified whether they’re common law employees based on the IRS definition. Both types of workers may be considered common law employees, and if any of them are, you’ll need to add them to your total employee count in your Affordable Care Act (ACA) calculation or risk incurring a hefty excise tax.

How hefty, you may ask? Here’s a quick refresher on the calculation. To figure whether your company has offered health care coverage to 70% of your full-time employees (those working an average of 30 or more hours per week) in 2015 and 95% thereafter, divide the number of full-time employees who are offered coverage by the total number of full-time employees, including common law employees who work full-time and may currently be classified as leased employees or independent contractors. If you miss the threshold, you’ll owe a tax of $2,000 per year times the total number of full-time employees minus the first 80 employees in 2015, and 30 employees thereafter. (New hires must be on board for three months to be counted.) The penalty adds up: A company with 250 full-time employees would pay an annual penalty of $340,000 in 2015 and $440,000 after 2015 .

To identify common law employees, you’ll need to evaluate how your company’s full-time independent contractors and workers from staffing agencies line up with the IRS’s definition of common law employees and the factors the agency considers in making determinations. Generally, the IRS considers individuals to be common law employees if you’re authorized to direct and control the way they perform their services. (Actual control isn’t required.) But there are many other factors to consider.

The agency has long viewed worker classification as a major contributor to the tax gap and as a result has actively audited employment classification — a trend that will likely intensify under the ACA. The IRS perspective is that when workers are treated as employees, the employer acts as an IRS collection agent by withholding income taxes and FICA taxes. With workers who aren’t employees, payment to the IRS is less certain because not everyone who should file and pay does so. That widens the tax gap, so the IRS prefers to count everyone as an employee who could possibly be considered one.  

Why you need consistent procedures
Employers should consistently use and communicate procedures for determining and documenting worker classification because otherwise lapses can occur. A manager who is hundreds of miles away from headquarters may be bringing independent contractors on board, but people at headquarters may not know. An HR department is aware of employees but not necessarily of independent contractors, because the latter are paid through accounts payable, not payroll.   

So, it’s essential to notify everyone in a position of authority that they can’t bring in workers and automatically consider them independent contractors. Instead, they should follow an established process to figure out whether each person is an independent contractor or an employee.

Keep in mind that under the ACA, each legal entity within a group of related companies must be considered separately in figuring the total number of employees, and whether the 70% and 95% thresholds described previously are satisfied.

Staffing agencies
Companies may be surprised to learn that they must evaluate workers from staffing agencies to decide if they’re common law employees of the companies rather than of the staffing agencies. This analysis is needed even if a staffing agency has those workers on its payroll or considers them independent contractors. You’ll need to look at each individual according to the 20-factor analysis described below and ask: Whose common law employee is he or she? You may find that even though workers are coming from a staffing agency and on the agency’s payroll, they’re still your common law employees.   

If a staffing firm is offering health coverage to a worker at your company and you determine the worker is your common law employee, you can count that worker as if you’ve offered him or her coverage and add the person into the numerator of the formula described previously. If the worker accepts coverage the agency offers, you must pay a higher fee to the agency than you would have paid if the coverage hadn't been accepted by the worker. That means you’ll need to allow time before open enrollment to negotiate with the staffing agency if this is the route you want to take.

The 20-factor analysis
The IRS’s Rev. Rul. 87-41 lists 20 factors that should be used in identifying common law employees. The IRS developed this list based on court cases. Courts continue to use some or all of the factors when faced with the question of whether an individual is a common law employee. In the IRS’s Internal Revenue Manual, which provides instructions to IRS auditors, the IRS groups the factors into three broad categories. Many of the factors have additional related considerations listed in the Internal Revenue Manual  that aren’t in Rev. Rul. 87-41.  

Behavioral control — whether the business has a right to direct or control how the worker performs specific tasks for which he or she is engaged, including instructions and training.

  • Instructions — The worker is required to comply with other people’s instructions about when, where and how to work (indicates an employee).
  • Set hours of work — The company establishes set hours of work for the worker (indicates an employee).
  • Doing work on the employer’s premises — The work is performed on the company’s premises, especially if the work could be done elsewhere. For example, the company has the right to compel the worker to travel a designated route, canvass a territory within a certain time or work at specific places (indicates an employee).
  • Training — An experienced employee is required to work with the worker by corresponding with him or her, requiring him or her to attend meetings or using other methods (indicates an employee).
  • Hiring, supervising and paying assistants — The company, rather than the worker, hires, supervises and pays the worker’s assistants (indicates an employee).
  • Order of sequence set — The worker must perform services in the order or sequence set by the company (indicates an employee).
  • Furnishing of tools and materials — The company furnishes significant tools, materials and other equipment (indicates an employee).
  • Integration — The success or continuation of the business depends to an appreciable degree upon the performance of the worker’s services (indicates an employee).
  • Services rendered personally — The worker’s services must be rendered personally (indicates an employee).
  • Full time required — The worker must devote substantially full time to the work (indicates an employee).
  • Oral or written reports — The worker must submit regular or written reports to the company (indicates an employee).

Additional factors noted in the Internal Revenue Manual:
  • The company controls what tools or equipment to use (indicates an employee).
  • The company controls what work must be performed by a specified individual (indicates an employee).
  • The company controls what workers to hire or to assist with the work (indicates an employee).
  • The company controls where to purchase supplies and services (indicates an employee).

Financial control — whether the business has a right to direct and control the financial and business aspects of the worker’s activities, including the extent to which the worker has a significant investment or unreimbursed business expenses, or may realize a profit or loss, and the extent to which the worker makes his or her services available to the market.

  • Payment of business and/or traveling expenses — The company ordinarily pays the worker’s business and/or traveling expenses (indicates an employee).
  • Payment by hour, week or month — Payment to the worker is made by the hour, week or month (unless this method of payment is not just a convenient way of paying a lump sum) (indicates an employee). Payment made by the job or on a straight commission generally indicates that the worker is an independent contractor.
  • Significant investment — The company, rather than the worker, invests in facilities that are used by the worker in performing services (indicates an employee).
  • Realization of profit or loss — The worker cannot realize a profit or suffer a loss as a result of the worker’s services (over and above the profit or loss ordinarily realized by employees) (indicates an employee). If the worker is subject to a real risk of economic loss due to significant investments or a bona fide liability for expenses, such as salary payments to unrelated employees, that factor indicates that the worker is an independent contractor.
  • Working for more than one firm at a time — The worker performs more than de minimis services for a multitude of unrelated people or firms at the same time (indicates an independent contractor).
  • Making services available to the general public — The worker makes his or her services available to the general public on a regular and consistent basis (indicates an independent contractor).

Additional factors noted in the Internal Revenue Manual:
  • The worker gets paid whether the work is done or not (indicates an employee).
  • The worker gets paid only if the worker finishes the job (indicates an independent contractor).
  • There are unreimbursed expenses that the worker has to bear himself/herself (indicates an independent contractor).
  • The worker has a significant investment in assets or tools (indicates an independent contractor).
  • The worker can make business decisions that affect his or her bottom line (indicates an independent contractor).

Relationship of the parties — how the parties perceive their relationship (for example, the intent of the parties in establishing the relationship and written contracts, and the permanence of the relationship).

  • Continuing relationship — There is a continuing relationship, including work performed at frequently recurring intervals, even if the intervals are irregular (indicates an employee).
  • Right to discharge — The company has the right to discharge the worker (indicates an employee). In contrast, an independent contractor cannot be fired so long as the independent contractor produces a result that meets the contract specifications.
  • Right to terminate — The worker has the right to end his or her relationship with the company at any time he or she wishes without incurring liability (indicates an employee).

Additional factors noted in the Internal Revenue Manual:  
  • If there is a contract between the parties, how is it worded?
  • The relationship is only for a specific project or period (indicates an independent contractor).
  • The worker receives benefits from the company (for example, vacation and sick pay, pension plan, health or life insurance) The worker has his or her own business, which he/she markets to others (indicates an independent contractor).

You can use the following form to list and analyze each of the factors listed previously for each contractor, and identify any pattern. If there’s a written agreement, you’ll review it, and if you think a factor points to the worker’s being an employee or an independent contractor, you’ll enter a note in the appropriate column. If the agreement says one thing, but something else is actually being done, you’ll note that in the “Observations” column. After you’ve entered information for each factor, you’ll look at all the factors and see if you have more entries in the employee column or in the independent contractor column. The following form provides an example for one factor.

Worker classification: factor analysis form

Keep in mind that the process is something of an art. You have to look at all the factors together and understand that they aren’t equally weighted, because this is a facts-and-circumstance test. A factor such as whether the company has the right to control or direct how the individual performs the work would be weighted more heavily, for example.

The process is manageable with enough time and resources, so the key is to start your analysis now so that you know how many employees must be offered coverage in 2014 to meet the 70% threshold for 2015. In addition, establishing and using consistent processes and communicating them throughout your organization will position you well for 2016 and beyond, when the coverage threshold becomes the much more stringent 95%.

Eddie Adkins
+1 202 521 1565

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