Companies that use third parties to handle some or all of their
staffing needs have special considerations in determining how to
address the new Affordable Care Act's "play or pay"
regime that requires employers to offer health coverage to
full-time employees or risk paying a tax penalty. Although the
government has delayed the effective date for the new employer
penalty, if a company uses a staffing agency, leasing company,
professional employer organization (PEO), or other third party to
secure workers, these concerns may result in questions for the
company as early as this fall when workers begin exploring coverage
through the new state insurance marketplaces. These concerns apply
to all "contingent workers," including temporary workers,
long-term regular workers, and rehired retirees.
"Play or Pay"
Beginning in 2015 (following the one-year delay of implementation
that the federal government announced on July 2), "large
employers" will risk paying a tax penalty if they do not offer
health coverage to their full-time employees and those
employees' children. This "play or pay" regime is
briefly summarized below and discussed in more detail in the
Jones Day Commentary "Deciding Whether to Play or Pay Under the
Affordable Care Act." Under "play or pay," an
employer can be subject to one of two penalties: the no coverage
penalty and the insufficient coverage penalty.
The no coverage penalty applies if an employer does not offer
health coverage to "substantially all" of its full-time
employees and their children and any one of the employer's
full-time employees receives a premium tax credit to buy coverage
through a state insurance marketplace. "Substantially
all" is generally defined as at least 95 percent. The penalty
can be significant for an employer that does not offer coverage, as
it generally applies at the rate of $2,000 per full-time employee
for the year. The first 30 employees are not included in the
penalty calculation. For example, if an employer had 1,000
full-time employees in each month of the year and did not offer
them health coverage or offered health coverage to fewer than 950
of them, the employer would owe a penalty of $1,940,000 for the
year ($2,000 x 970 full-time employees).
The insufficient coverage penalty applies if an employer offers
coverage to "substantially all" full-time employees and
their children and one or more of the employer's full-time
employees receives a premium tax credit to buy coverage through a
state insurance marketplace. The insufficient coverage penalty
applies at the rate of $3,000 for the year, but only for those
full-time employees who were able to receive a premium tax credit
because that employee's coverage was not affordable or did not
provide minimum value or because that full-time employee was not
one of the "substantially all" who were offered
coverage.
Definition of "Employee"
Because "play or pay" penalties can be incurred if an
employer does not offer coverage to its full-time employees, it is
important for an employer to identify who its employees are for
these purposes. The statute is silent in this regard. However, the
proposed regulations implementing the penalty provide that the term
"employee" means a common law employee.1
Generally speaking, an individual who provides services to an
employer is a common law employee if the employer has the authority
to direct and control the manner in which services will be
performed. An employer need not actually direct and control the
work; the mere right to do so creates the employment relationship.
Moreover, state laws, such as laws that establish the
employer/employee relationship when a professional employer
organization provides workers to a service recipient company, do
not control who is the common law employer for purposes of
"play or pay."
In determining which workers are common law employees, the IRS has
taken the position that "[a] correct determination can only be
made by examining the relationship of the worker and the
business."2The IRS looks to three aspects of the
relationship in making this determination: behavioral control,
financial control, and the relationship of the parties.
Behavioral Control. A company has behavioral
control over a worker when it has authority over where to do the
work, what tools or equipment to use, what work must be performed
by a specified individual, what routines are to be used, and what
order or sequence is to be followed. The determination of whether a
company has behavioral control also depends on the degree of
instruction, the extent to which the company retains the right to
control the worker's compliance with the instructions, and the
effect on the worker in the event of noncompliance. Generally, the
more detailed the instructions are for the worker, and the more
control the company exercises over the worker, the more likely it
is that the company retains the right to control the methods by
which the worker performs the work.
Financial Control. Whether a company has
financial control over the relationship with the worker, i.e., the
economic aspects of the relationship, depends upon whether the
worker makes a significant financial investment in performing the
work, the extent to which the worker incurs expenses that the
company does not reimburse, the extent to which the worker makes
his or her services available on the open market, and the
worker's opportunity for profit or loss. The IRS has taken the
position that the ability to realize a profit or incur a loss is
the strongest evidence that the worker controls the business
aspects of services rendered. But this, by no means, is the only
relevant factor.
Relationship of the Parties. This factor reflects
how the worker and the company perceive their relationship to each
other. The relationship of the parties is important because it
reflects the parties' intent concerning control of work. Intent
can often be found in the written contract, although a contractual
designation, in and of itself, is not sufficient evidence for
determining whether a worker is an employee. Similarly, providing a
worker with employee benefits has traditionally been associated
with employee status. Courts have also considered the existence of
an ongoing relationship between the worker and the company as
relevant in determining whether there is an employer-employee
relationship. Therefore, if a company engages a worker with the
expectation that the relationship will continue indefinitely,
rather than for the duration of a specific project or period, the
indefinite duration is evidence of an intent to create an
employment relationship. The IRS takes the position that a
relationship that is long-term, but not indefinite, is a neutral
factor in determining employee status.
It is entirely possible, and in fact likely in some circumstances,
that a company that uses a third party for some of its staffing
needs is actually the common law employer of these workers, even
though the third party handles payroll and benefits, and may have
initially hired the worker.3 Furthermore, it is
extremely rare for a joint or co-employment relationship to exist
under the IRS's common law test. Under these rules, contingent
workers of all types, including temporary workers, long-term
regular workers, and retired employees who have been rehired, can
all potentially be common law employees of the company that is
receiving their services and not of the third party that hired them
and sent them to the worksite.
For 35 years, companies facing potential worker reclassification
by the IRS have been able to rely on section 530 of the Revenue Act
of 1978 ("section 530") to protect them from significant
prior tax liabilities. A company can invoke relief under section
530 when it did not treat a person as an employee for any period,
it filed all federal tax returns (including information returns) it
was required to file with respect to that person, and had some
reasonable basis for the non-employee treatment. A company gets
this relief even if the IRS would otherwise conclude that the
workers are common law employees. By its terms, section 530
provides relief only with respect to employment taxes. The IRS has
not yet indicated whether it would still pursue a "play or
pay" penalty against a company based on the consequences of
reclassifying workers where the company was otherwise protected by
section 530.
Considerations for "Play or Pay"
Compliance
In light of the definition of "employee" set forth in
the proposed regulations for the employer "play or pay"
requirement, the treatment of contingent workers will merit special
attention. Some issues to consider are:
How Are the Contingent Workers Likely To Be
Classified? In determining who is the employer for
purposes of "play or pay," you would look to the same
behavioral control, financial control, and relationship of the
parties factors that the IRS will use to assess which contingent
workers would likely be classified as common law employees of the
client company versus the third party. Any workers who are likely
to be classified as common law employees need to be included when
determining whether the employer is offering health coverage to at
least 95 percent of its full-time employees. Making this assessment
of potential common law employee status is particularly important
where contingent workers are more than 5 percent of an
employer's full-time work force, because failure to offer them
coverage could result in the substantial no coverage penalty even
if all the workers otherwise recognized as common law full-time
employees are offered coverage.
Terms of the Contingent Worker Agreement. The
service recipient and the third party will want to consider the
"play or pay" requirement in negotiating the terms of the
contingent worker agreement, both to minimize potential exposure
and to assign clear responsibility for obligations the employer
must meet. Simply stating in the agreement that the third party is
the employer of the workers it is supplying will not be sufficient
to make the third party the "employer." Similarly,
stating in the agreement that the service recipient is the employer
for purposes of the employer "play or pay" requirement
will not make the service recipient the employer. Whoever has the
right to direct and control the workers is the employer.
It is common for the agreement to make the third party responsible
for paying the workers, paying their employment taxes, and
providing any benefits that may be made available. The parties may
wish to have the third party offer affordable, minimum value health
coverage to the workers it is supplying. If the third party is the
common law employer, doing so will protect the third party from the
penalty. If, instead, the client company is the common law
employer, having the third party offer this coverage may reduce the
risk of the client company incurring a penalty. Although it is not
clear under current guidance that coverage offered by a third
party—and not by the employer itself—meets the
technical requirements of "play or pay," ensuring that
the workers are offered affordable, minimum value coverage can
mitigate exposure. First, workers who take the affordable, minimum
value coverage will not receive premium tax credits and cannot, by
themselves, trigger a "play or pay" penalty. Second,
although the proposed regulations do not give the employer credit
for offering coverage when it contracts with a third party, the
contractual agreement still achieves the policy goal of ensuring
that employers provide access to affordable coverage. Given the
difficulties in knowing exactly how the IRS will classify workers,
a contractual provision of this type will at least give the
employer an argument for contesting a penalty and may decrease the
IRS's interest in pursuing strict enforcement. Furthermore, as
the IRS reviews comments on its proposed regulations, it may make
changes to take account of these third party arrangements.
Full-Time Employee Reporting Requirement.
Beginning in January 2015 (again following the one-year delay
announced by the federal government), large employers will be
required to report to the IRS regarding who their full-time
employees were in the prior calendar year and whether they were
offered affordable, minimum value coverage. The first reports will
be due in January of 2016. Consideration should be given regarding
how to handle workers acquired through a third party who work
enough hours to be considered full-time. Will the client company
report these workers as their full-time employees, or will the
third party vendor handle the reporting? How will the questions
regarding the offer of coverage be answered, particularly if the
coverage is offered through the third party, but the common law
employer is the client? Because this filing will be a tax filing
made under penalties of perjury, it is important that the agreement
between the company and the third party reflect a clear
understanding of the employment relationship and the associated
reporting requirement. Consideration should also be given to
reconciling between who is the common law employer for purposes of
full-time employee reporting and who is the employer for purposes
of ERISA requirements, such as reporting on the Form 5500.
Providing Information to Workers Required under the FLSA
and Needed for Premium Tax Credit Eligibility. The
Affordable Care Act added a new section to the Fair Labor Standards
Act that requires every employer subject to the FLSA to provide
their employees with a notice informing them about the new state
insurance marketplaces and providing certain information about any
health coverage the employer may offer. This FLSA notice
requirement is discussed in more detail in the Jones Day
Commentary "New Affordable Care Act Notice to Employees Must
Be Provided by October 1, 2013." Contingent workers who
wish to explore their eligibility for financial assistance through
one of the new state insurance marketplaces will need to complete
an application that asks for information about any health coverage
they are offered by their employer. The FLSA notice can be used as
a vehicle for providing that information, at the employer's
election. To ensure that the required FLSA notice is provided on a
timely basis, the company and the third party should agree to the
contents of a notice and specify who will provide the notice, both
for purposes of the initial distribution later this year and the
ongoing distribution required for workers hired after September 30
of this year. In the absence of clear guidance on who will be
considered the employer, this approach should be a practical way to
address the legal requirement. Regardless of who is considered the
employer for purposes of the "play or pay" requirement,
the guidance to date on the FLSA notice appears to leave room for
the notice to be provided, directly or through an agent.
Rehired Retirees. Occasionally, a company's
retirees are rehired through a third party process. If the retiree
becomes a common law employee of the client company and is offered
coverage through a retiree plan, the employer will be given credit
for making an offer of coverage for purposes of "play or
pay." There is no requirement that employees be offered
coverage in the active employee plan. However, if the retiree plan
is exempt from certain coverage mandates on the basis that it is a
retiree-only plan (e.g., covering preventive care with no cost
sharing, prohibition on annual and lifetime dollar limits), and the
retiree rehired through the third party is actually the common law
employee of the client, offering coverage to this retiree through
the retiree health plan may destroy the "retiree-only
plan" status. Without the "retiree-only plan"
status, the retiree plan must comply with the coverage mandates.
Thus, special care must be taken if there is a possibility that a
third party will hire a company's retirees and assign them to
do work at the company. Doing so could force the company to make
changes to its retiree health plan.
Footnotes
1.Under the proposed regulations, a leased employee, a sole proprietor, a partner in a partnership, or a 2-percent S corporation shareholder is not considered an employee. Prop. Reg. § 54.4980H-1(a)(13).
2.See Department of the Treasury Internal Revenue Service, "Independent Contractor Or Employee?: Training Materials," at p. 2-5, available athttp://www.irs.gov/pub/irs-utl/emporind.pdf (last accessed July 17, 2013).
3.Although the proposed regulations do include a special rule regarding leased employees, it provides that even if the leased employee must be treated as an employee of the service recipient for purposes of qualified retirement plans, this treatment has no bearing on whether or not the worker is a common law employee for purposes of "play or pay."
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.