When we think of the Affordable Care Act (“ACA”), we invariably think of health insurance. The ACA mandates that any employer with 50 or more full time equivalent employees may face penalties unless it offers affordable health insurance to its full-time employees. This ACA requirement applies to employers with 50 or more full time employees, including full-time equivalents (referred to in ACA as “applicable large employers”). The ACA defines full time employees as those who average 30 or more hours of service per week.
What about the implications of the ACA on independent contractors? Many public entities use independent contractors for services such as maintenance, security, building inspection, planning, engineering, janitorial and pest control. Under the ACA, independent contractors do not count as employees when determining whether an employer meets the minimum threshold as a large employer. Also, an independent contractor is not counted as a full-time employee who could trigger a potential penalty or impact the penalty calculation. The ACA’s “individual mandate” requires that all individuals, as of January 1, 2014, have health insurance or face penalties (unless exempt due to low income or religious beliefs). However, an employer will not be penalized for failing to offer coverage to its independent contractors.
Has your agency correctly classified its independent contractors? When you strip down the title, are they really just employees in disguise? The IRS recently issued a final audit report estimating that employers misclassify millions of workers as independent contractors instead of employees, thus avoiding the payment of employment taxes. However, correctly determining who is an employee and who is an independent contractor can often be a cumbersome task. Simply because a worker has been labeled as an independent contractor is not sufficient proof of independent contractor status. Indeed, the IRS and other governmental agencies are not bound by any agreement between the worker and the agency classifying the worker as an employee or an independent contractor. Similarly, the fact that a worker is issued a 1099 form rather than a W-2 form is also not determinative. (See S. G. Borello & Sons, Inc. v. Department of Industrial Relations (1989) 48 Cal.3d 341; see also Toyota Motor Sales U.S.A., Inc. v. Superior Court (1990) 220 Cal.App.3d 864.)
The ACA incorporates the ERISA definition of an “employee” as “any individual employed by an employer.” (29 U.S.C. § 1002(6)). However, this doesn’t clearly define the term “employee” for compliance purposes. Final regulations refer to the common law “employee” definition of “right to control.” (26 C.F.R. § 54.4980H-1(a)(7).) The common law “employee” definition determines whether a worker is an “employee” or “independent contractor” based on whether the agency has the “right to control and direct the worker in the way of when, where, how and what work is performed.”
To help determine whether a worker is an employee under the common law rules, the IRS has identified 20 factors that may indicate whether the employer can exercise enough control to establish an employer-employee relationship. These factors, set forth in Revenue Ruling 87-41, were based on the circumstances that courts have identified and relied upon to assess whether an employment relationship exists. Not all of the factors must be present to find an employment relationship, but the factors are guidelines used to assess whether an individual is an employee or an independent contractor. An employer must weigh the following:
- Is the worker required to comply with instructions on where, how and when the work is to be done?
- Is the worker provided training to perform the job in a particular manner?
- Are the services performed an integral part of the organization’s operations?
- Must the services be rendered personally?
- Does the business hire, supervise and pay assistants to help the worker on the job?
- Is there a continuing relationship between the worker and the business?
- Does the organization set the work schedule?
- Is the worker required to devote his/her full time to the organization?
- Is the work performed at the company’s place of business or at specific places designated by the company?
- Does the organization direct the sequence in which work is performed?
- Are oral or written reports required to be submitted?
- Are payments to the worker made by the hour, week or month?
- Are travel and lodging expenses reimbursed?
- Does the organization furnish tools and materials?
- Does the worker have an investment in the equipment or facilities?
- Does the worker stand to realize a profit or loss as a result of the work?
- Does the worker work exclusively for the organization?
- Does the worker work predominantly for the organization or are services available to the general public?
- Can the worker be discharged for reason other than nonperformance of contract provision?
- Can the worker terminate the relationship without liability?
There are significant consequences which could follow if agencies misclassify a worker as an independent contractor who, in fact, is an employee. If an independent contractor is misclassified, the agency must, among other things, withhold state and federal income taxes, enroll him or her as a CalPERS member when the worker meets eligibility requirements and provide workers’ compensation insurance coverage. It would also be responsible for offering the employee (and his or her dependents) health insurance to avoid penalties if the employee is considered full-time under the ACA.
Moreover, if an IRS audit reveals that an employer has misclassified its independent contractors and reclassifies those workers as W-2 employees, the employer could be subject to penalties for failing to offer healthcare coverage. That penalty is $2,000 per year multiplied by the number of full-time employees (less 30, or less 80 during 2015 only) if the large employer is not offering coverage to substantially all (95%, or 70% during 2015 only) of its full-time employees and their dependents. If the large employer does offer coverage, but the coverage does not meet ACA standards for minimum value and affordability, the employer could be required to pay a fine of $3,000 for each full-time employee who receives coverage through Covered California and obtains a government subsidy. On the other hand, if the worker is truly an independent contractor, the worker will not trigger a potential penalty and will not be considered full-time for any IRS penalty determination. Independent contractors are obligated to make arrangements to pay their own taxes and to provide their own benefits.
The ACA also provides strong whistleblower protection for employees or independent contractors who reasonably believe they are misclassified. (29 U.S.C. § 218c). That section defines protected activity quite broadly. Protected activity includes providing (causing to be provided or about to provide) to the employer, information relating to certain violations of the ACA. In sum, employees may be engaged in protected activity even if they do not actually complain and even if they are not ultimately correct about whether their employer violated the ACA.
As a result of the strong whistleblower protections, employers must be vigilant about properly classifying their employees. If an independent contractor is found be an employee, then the employer must determine whether that employee is full or part time. Under the ACA, an employee can only be classified as part-time if he is reasonably expected to have less than thirty hours of service per week.
In order to reduce potential exposure to liability, large employers should implement procedures for auditing employee classifications and ensure they have properly classified any independent contractor. Accordingly, if you have independent contractors, you should review your written agreement(s) and conduct a legal analysis of their functions to determine whether the independent contractor has been properly classified.