The Affordable Care Act requires applicable large employers to offer minimum essential coverage to their full-time employees. A penalty is imposed if at least one full-time employee gets coverage from an exchange and coverage isn’t offered to at least 95% of an employer’s full-time employees. In an employer-employee relationship with two parties, classifying an individual as an employee can be relatively straightforward. It gets more complicated with a three-party employment arrangement. This relationship generates questions: Is the individual an employee of the staffing agency or the client of the agency? Can the IRS reclassify who is the individual’s employer, and what happens in this case?
The IRS released final regulations in February 2014 that differentiated temporary staffing firms from professional employer organizations and other staffing firms. Because of the variability in employment arrangements, the IRS was unable to establish a rule with clear demarcation lines to identify the employer. Instead, the agency relies on the common law employee definition.
The ACA defines an employee as an individual who meets the definition of a common law employee. An employee “includes every individual performing services if the relationship between him and the person for whom he performs such services is the legal relationship of employer and employee.” The employer- employee relationship exists when the employer has the right to control and direct the individual who performs the services — not only the results but also the details and means by which the results are to be accomplished. Furthermore, the IRS identified 20 factors to determine whether an individual is a common law employee. The Supreme Court later reduced those to 13. The IRS has since described the factors according to three general standards: behavioral control, financial control and legal control.
Temporary staffing agencies recruit, screen and hire workers from a general labor pool. These hired workers are usually assigned to a client temporarily. The staffing agency, not the client, decides whether to terminate employment with the employee. The staffing agency is responsible for paying wages and withholding and remitting employment taxes. It’s reasonable that the staffing agency would be the employer based on the level of control if the worker is truly temporary. The issue becomes murky when an employer “leases” a “temporary” employee for an extended length of time.
What you need to know
The final regulations for Internal Revenue Code (IRC) Section 4980H provide a safe harbor for employers and allow a staffing agency to offer minimum essential coverage to the employees leased from a staffing agency if the amount charged by the staffing agency is greater for employees who accept minimum essential coverage from the staffing agency than for employees who don’t. Such a differential shouldn’t be confused with an “ACA fee,” which some staffing agencies have charged for all employees — a fee that doesn’t meet the safe harbor requirements.
Whether the staffing agency or client is the employer depends on the level of control each asserts over the individual. Since the common law employee test is a facts-and-circumstances analysis, entities must be well advised about their potential liability under the ACA.
The IRC allows for tax returns to be audited for a period of time, depending on certain characteristics. During this time, the IRS may reclassify an individual as an employee of the agency or the client. Therefore, the client should plan to reduce the possibility of an unfavorable tax liability. Contractual terms can help lessen this risk.
The client could mitigate the risk of having an employee reclassified as its employee by complying with the safe harbor in the regulations. The client can have the agency offer insurance to the employee on its behalf, provided the client pays a higher fee to the agency for the employees who actually enroll in health coverage.
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