The Patient Protection and Affordable Care Act (ACA) has brought sweeping changes throughout our country since its inception, affecting individuals and businesses alike with countless mandates, and imposing penalties and taxes for noncompliance. In 2014, individuals must secure health care coverage or face taxation. The counterpart to this provision requires employers that employ at least 50 full-time employees (including full-time equivalent employees) (Applicable Large Employers)[i] to offer affordable coverage to their full-time employees or, as with the individual mandate, face a penalty.[ii] Although the employer shared responsibility mandate, found in section 4980H and its related proposed regulations (Pay or Play Mandate), has been delayed until 2015, Applicable Large Employers should waste no time and take this opportunity to carefully strategize their approach toward compliance, including (1) analyzing their employee population, (2) ensuring that coverage is affordable and provides minimum value, and (3) contemplating how and when to calculate full-time employee status, either on a monthly basis or by using the safe harbor look-back provisions (found in the proposed regulations) in which they need to set measurement periods and subsequent stability periods, and decide whether to use administrative periods.[iii] Additionally, many employers must substantially revise their eligibility criteria, amend plan documents, and update policies, procedures, handbooks and other materials to reflect the new standard for full-time eligibility and, if applicable, continuation of coverage during a subsequent stability period. With these mountainous tasks loaded upon employers, one simple question may be forgotten: “Who are my employees?”
What Employees Are Considered?
The Pay or Play Mandate requires Applicable Large Employers to offer minimum essential coverage (MEC)[iv] that provides minimum value (MV)[v] and is affordable to the employer’s full-time employees.[vi] The “employees” at hand are an employer’s common law employees. Not only are part-time and full-time employees considered in determining common law status, but so are other categories of workers, including but not limited to, seasonal, variable hour, casual, per diem, temporary, and student intern workers. The latter categories cannot be ignored. Whether or not an employer provides a Form W-2 to a worker is not necessarily controlling. The common law employer-employee relationship is paramount.
Temporary Staffing Agencies
Employers that use third party entities, such as temporary staffing agencies, to handle their workforce needs have special considerations when determining their compliance obligations under the Pay or Play Mandate. The Pay or Play Mandate generally requires an Applicable Large Employer to offer its full-time employees (and their dependents) the opportunity to enroll in MEC under an eligible employer-sponsored plan that is affordable and provides MV, or pay a penalty.[vii] When analyzing their obligations and risks under the Pay or Play Mandate, many employers likely have failed to consider the need to provide benefits to workers who perform services for the employer, but are paid by a temporary or other employment or staffing agency, assuming that such workers are employees of the staffing agency. However, under the common law employee standard, which is applicable for purposes of determining employee status under the Pay or Play Mandate, depending on the amount of direction and control provided by the employer, these workers could be employees of the employer (and not the staffing agency) under the Pay or Play Mandate. Although the effective date for the Pay or Play Mandate has been delayed until January 1, 2015, employers with temporary workers provided through third party entities need to start determining such workers’ “employee” status in order to avoid substantial unforeseen penalties for failure to comply with the Pay or Play Mandate. The pages that follow walk through an overview of the Pay or Play Mandate penalty provisions, the importance of proper employee designations, and the risks and penalties associated with mistaken classifications.
General Overview Of Penalty Provisions
Under the Pay or Play Mandate, Applicable Large Employers are required to offer affordable health plan coverage to at least 95% of their full-time employees (and their dependents) or pay a penalty.[viii] Specifically, an Applicable Large Employer generally will be subject to a penalty under the Pay or Play Mandate if either (1) the employer fails to offer its full-time employees (and dependents) the opportunity to enroll in MEC under an eligible employer-sponsored plan and any full-time employee is certified as having received an applicable premium tax credit or cost-sharing reduction (the No Coverage Penalty);[ix] or (2) the employer offers its full-time employees (and dependents) the opportunity to enroll in MEC under an eligible employer-sponsored plan and one or more full-time employee is certified as having received an applicable premium tax credit or cost-sharing reduction (the Insufficient Coverage Penalty).[x] The employer can be liable for the No Coverage Penalty or the Insufficient Coverage Penalty, but not both.[xi]
The No Coverage Penalty will generally be imposed if the employer fails to offer MEC to at least 95% of its full-time employees (and dependents) for any calendar month (and the employer receives certification that an applicable premium tax credit or cost sharing reduction was obtained by at least one full-time employee). The penalty amount generally applies at a rate of $2,000 per year (adjusted yearly for inflation) multiplied by the number of full-time employees (minus the first 30 full-time employees).[xii]
The Insufficient Coverage Penalty generally applies if the employer offers MEC to at least 95% of its full-time employees (and their dependents) and the employer receives certification that at least one full-time employee received an applicable premium tax credit or cost sharing reduction. The Insufficient Coverage Penalty generally applies at a rate of $3,000 per year (adjusted for inflation) multiplied by the number of full-time employees who received the premium tax credit or cost sharing reduction because either: (1) the employer’s coverage was not affordable, (2) the employer’s coverage did not provide MV, or (3) the full-time employee was not one of the 95% who were offered coverage. The Insufficient Coverage Penalty cannot exceed the penalty that would have applied to the employer had it not offered coverage (i.e., the No Coverage Penalty).[xiii]
Thus, in determining their obligations under the Pay or Play Mandate and any penalties that may apply, it is essential for employers to determine which of their workers are full-time employees. The full-time determination cannot be made without first determining which workers are “employees.”
Determining a Worker’s Employee Status
A threshold issue for all employers in determining their obligations under the Pay or Play Mandate is to determine which of their workers are “employees.” The Pay or Play Mandate generally defines “employee” as an individual who is a common law employee.[xiv] However, a leased employee (as defined in section 414(n)(2)), a partner in a partnership, a sole proprietor, or a 2-percent S corporation is not an “employee.”[xv] Thus, an employer’s analysis of its obligations under the Pay or Play Mandate is dependent upon determining its common law employees. Accordingly, in order to avoid unexpected penalties for noncompliance with the Pay or Play Mandate, it is imperative for each employer to correctly identify all of its common law employees, when determining (1) whether it is subject to the Pay or Play Mandate, (2) whether it should offer coverage or pay the applicable penalties, and (3) to which employees (and dependents) it should offer coverage.
The Pay or Play Mandate requires an employer to determine its common law employees based on the standard set forth in Regulation section 31.3401(c)-1(b), which provides:
“(b) Generally the relationship of employer and employee exists when the person for whom services are performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work but also as to the details and means by which that result is accomplished. That is, an employee is subject to the will and control of the employer not only as to what shall be done but how it shall be done. In this connection, it is not necessary that the employer actually direct or control the manner in which the services are performed; it is sufficient if he has the right to do so. The right to discharge is also an important factor indicating that the person possessing that right is an employer. Other factors characteristic of an employer, but not necessarily present in every case, are the furnishing of tools and the furnishing of a place to work to the individual who performs the services. In general, if an individual is subject to the control or direction of another merely as to the result to be accomplished by the work and not as to the means and methods for accomplishing the result, he is not an employee.” [xvi]
While some workers will clearly fall within this common law definition, even the Treasury Department and the Service recognize that confusion exists with respect to whether temporary workers that an employer obtains through a staffing agency constitute common law employees of the employer.[xvii]
As noted above, under the applicable Regulation, the determination of whether a common law employee relationship exists is generally based on whether the employer has the right to control and direct the individual who performs the services (not only as to the results of the work, but also by how such result shall be accomplished).[xviii] Thus, if an employer is providing daily direction to a temporary worker obtained through a staffing agency with respect to such worker’s activities, duties, manner of work, and end results, then the employer may be the common law employer for that temporary worker.
Ultimately, the determination of common law status is a facts and circumstances type analysis. The preamble to the Pay or Play Mandate’s proposed regulations references Revenue Ruling 70-630 as an example of facts and circumstances under which a temporary staffing agency (rather than the employer-client) was the worker’s common law employer.[xix] In that particular ruling, the Service found that a salesclerk that was trained by a staffing agency and furnished to a retail store to perform temporary services for the store was the common law employee of the staffing agency (and not the retail store) under circumstances where (1) the temporary staffing agency had trained the salesclerk to perform sales services in conformity with the established procedures of the store; (2) the agency placed a supervisor in the store who had control over the clerk, and determined (a) whether the clerk had been properly assigned to the department for which he or she was requested, (b) whether the clerk was complying with the store’s regulations, and (c) the number of hours worked and number of sales made by the clerk; (3) the store was required to accept the clerk assigned to it; (4) the clerk was subject to discharge by the temporary staffing agency (not the store); and (5) the agency carried insurance on the salesclerk.[xx] While the facts and circumstances found in Revenue Ruling 70-630 made it fairly easy for the Service to determine who the common law employer of the salesclerk was, in many cases, the determination will not be so simple.
Over the last several decades, the Service and courts have developed a subjective multi-factor test to distinguish independent contractors from employees, which includes analysis related to behavioral control, financial control, and the general relationship of the parties. Given the subjective nature of the test, the government and the courts can come to inconsistent conclusions with respect to who the common law employer is for a particular worker based on varying facts and circumstances. Indeed, the preamble to the Pay or Play Mandate proposed regulations relevantly notes:
“In considering any requests for special consideration for temporary staffing agencies or other staffing agencies, the Treasury Department and the IRS will take into account the factual nature of the common law analysis in determining who is the common law employer of the workers providing the services and the potential implications for other Code sections, including employment tax liability provisions, for which the determination of common law employer status is necessary.”[xxi]
Thus, it is imperative for an employer with temporary workers provided through a staffing agency or another third party entity to carefully analyze the status of each temporary worker (including how any employment breaks or separation of service may impact the worker’s employment status) with its legal counsel.
Potential Impact of Failure to Properly Classify All Common Law Employees
Employers need to include all workers who are likely to be classified as common law employees in their analysis of whether they are offering coverage to at least 95% of their full-time employees. Mistakes as to whether a temporary worker is an employer’s common law employee could leave the employer subject to unforeseen substantial penalties under the Pay or Play Mandate. For example, a particular employer does not offer coverage under the Pay or Play Mandate because it does not believe it is an Applicable Large Employer; however, it mistakenly excluded certain temporary workers in its analysis. When including these misclassified common law employees, it is determined that the employer actually is an Applicable Large Employer, and the employer becomes subject to the No Coverage Penalty. Likewise, if this employer had offered coverage to its full-time employees (not including the misclassified temporary workers) and these temporary workers accounted for at least five percent of the employer’s full-time workforce, then the employer would again face the No Coverage Penalty due to not providing coverage to 95% of its full-time employees. Alternatively, if the temporary workers accounted for less than five percent of the full-time workforce so that the employer meets the 95% coverage rule, it could be subject to the Insufficient Coverage Penalty for failure to offer coverage to those few temporary workers who are common law employees if they (or any other full-time employees) do in fact receive the tax credit or cost-sharing reduction. Thus, proper classification of temporary workers plays a pivotal role in the employer’s compliance endeavors with the Pay or Play Mandate. As such, employers that obtain (or are contemplating obtaining) temporary workers from third party entities should carefully analyze the workers’ employee classification and determine ways to mitigate compliance risks associated with such relationships.
Mitigating Risks Associated with Temporary Workers
Due to the numerous risks associated with employee misclassification, employers working with temporary staffing agencies should consult with legal counsel to develop an action plan to reduce the risk of unanticipated penalties for failure to comply with the Pay or Play Mandate. Non-compliance concerns associated with temporary workers would be alleviated through proper classification as a common law employee or otherwise. However, as discussed above, given the subjective nature of the common law test, this can be a particularly daunting task.
Nonetheless, certain other action plans may help mitigate the risk of non-compliance with the Pay or Play Mandate. For example, some employers may consider offering benefits to all full-time workers, regardless of their temporary nature. This approach would ensure that all common law full-time employees are being offered coverage. However, prior to adopting this approach an employer needs to carefully analyze its plan documents and policies to ensure consistency therewith. Additionally, employers would still need to ensure that the workers are in fact common law employees in or to avoid possible multiple employer welfare arrangement (MEWA) situations for the plan. Another approach could be to ensure that an employer’s contract with a staffing agency requires the staffing agency to provide MEC which is affordable and provides MV from the temporary staffing agency. If the temporary staffing agency is required to provide coverage, then the temporary workers would likely be unable to receive the premium tax credit or cost sharing reduction from the exchange, and the risk of a penalty being imposed on the employer for failing to provide coverage for such worker may be substantially reduced. Please note the compliance risks are not eliminated, however, especially if not providing coverage to temporary workers results in the employer not providing coverage to 95% of its full-time employees. Other strategies regarding hours worked, length of employment and cost of coverage are available as well. However, when determining action plans for use of temporary workers, employers need to be aware that the government is anticipating putting anti-abuse rules in place to prevent employers from using temporary staffing agencies to evade applicability of the Pay or Play Mandate.[xxii] Thus, prior to implementing any approach with respect to temporary workers, all options should be carefully analyzed with the employer’s legal counsel.
Article written by Elizabeth H. Latchana. Originally published in “Michigan Tax Lawyer” Volume XXXIX, Issue 3, Fall 2013.
Elizabeth H. Latchana is a shareholder attorney specializing in health and welfare employee benefits law at the law firm of Fraser Trebilcock Davis & Dunlap, P.C. in Lansing, Michigan. She received her J.D. from the University of Notre Dame. Ms. Latchana can be reached at firstname.lastname@example.org or (517) 377-0826.
IRS Circular 230 Disclosure
Unless expressly stated otherwise, this memorandum is not intended or written to function as a covered opinion under Department of Treasury regulations. Any federal tax advice within this memorandum is not intended or written to be used, and cannot be used, for the purpose of: (1) avoiding penalties that may be imposed, or (2) promoting, marketing or recommending to another party any transaction or matter addressed herein.
[i] The term “applicable large employer” is more completely defined at Prop. Reg. §§54.4980H-1(a)(4), -2, 78 Fed. Reg. 240-43 (2013).
[iii] The proposed regulations are located at 78 Fed. Reg. 218-53 (2013). See Prop. Reg. §54.4980H-3, 78 Fed. Reg. 243-50 (2013) for further information related to the look-back measurement method.
[iv] The term “minimum essential coverage” is defined at Prop. Reg. §54.4980H-1(a)(23), 78 Fed. Reg. 241 (2013).