Affordable Care Act Amplifies Risk of Misclassifying Employees

Affordable Care Act Amplifies Risk of Misclassifying Employees
From left: Chris Doolittle of BKD LLP, Missy McJunkins Duke and Amber Bagley of Cross Gunter Witherspoon & Galchus.

Health care reform is increasing the importance of the correct classification of employees, employment lawyers and others say.

That’s because the “employer mandate” of the Patient Protection & Affordable Care Act requires businesses with 50 or more full-time employees (or their equivalent) to offer those workers health insurance. If employers misclassify their employees — as independent contractors, for example — they could find themselves not only facing sanctions under wage and hour laws, but costly penalties under the ACA of from $2,000 to $3,000 per misclassified employee.

Heightening the risk is an IRS crackdown, now in its third year, on worker misclassification, particularly in the area of independent contractors.

The temptation to classify an employee as an independent contractor instead of a traditional employee is always present. Independent contractors don’t cost their employers payroll taxes, unemployment insurance or worker’s compensation insurance. Under the Affordable Care Act, the temptation to under-report full-time or “traditional” employees is even greater.

Employment lawyers, accountants and human resource professionals are warning businesses to resist that temptation.

Chris Doolittle, a senior manager at BKD LLP in Little Rock, said he’s particularly worried about businesses on the cusp of the 50-employee ACA requirement. “If a few independent contractors get reclassified into full-time employees, it could pull [such businesses] under the law and subject them to penalties. That’s my concern.”

He gave the example of a business with 45 full-time workers. “They think that they’re not under the definition of a large employer and then all of a sudden they’re surprised when an IRS exam comes along and several independent contractors are reclassified as full-time employees,” he said.

“Let’s just say the years under audit were ’17, ’16 and ’15 — and all those years the health care law was in effect. Well, you could have multiple years all of a sudden where you’re surprised by the health care penalty.”

Doolittle cited the Kiplinger Tax Letter of Aug. 2, published by the financial media company. “The stakes on worker classification will get higher, thanks to health reform,” it said. “After 2014, firms with at least 50 full-time employees must offer a reasonable level of affordable health insurance or large penalties will be due. If the reclassified workers push the company over 49 employees, that triggers the employer insurance mandate.”

(To view a PDF chart breaking down the national workforce by traditional, self-employed and independent status, click here.)

The IRS isn’t the only government agency cracking down on businesses that try to skirt laws protecting full-time traditional employees. The U.S. Department of Labor, as part of the Middle Class Task Force led by Vice President Joe Biden, also has employee misclassification in its sights.

The laws about independent contractors can be confusing, said Missy McJunkins Duke, a lawyer with Cross Gunter Witherspoon & Galchus of Little Rock. “There’s an IRS test, there’s a test under the Fair Labor Standards Act (the wage and hour law), there’s a test for unemployment purposes under Arkansas law (Workforce Services), there’s an ERISA test and there’s an Arkansas workers’ compensation test,” Duke said. “So there may be somebody who for workers’ comp purposes or unemployment under Arkansas law might be an independent contractor but under another test, they may not be.”

“Unfortunately, the fact is that most of the time when I encounter employers who have people classified as independent contractors, they really are inappropriately classified,” Duke said.

Some business sectors tend to use more independent contractors than others, fields like construction, information technology, transportation and health care. Those sectors need to be particularly careful.

In addition, the recession and the sluggish recovery led some employers “to classify people as independent contractors because it was less expensive,” Duke said.

Amber Bagley, also with Cross Gunter, said that she had noticed the Arkansas Department of Workforce Services becoming more aggressive about classification. A triggering event for a state audit is a worker labeled by his employer as an independent contractor filing for unemployment benefits.

“The majority of misclassified workers are discovered through the Unemployment Insurance claim filing process,” Ronald Calkins, assistant director of the state Department of Workforce Services, said in an emailed response to questions from Arkansas Business.

“DWS also performs random audits of employers throughout the year and misclassified workers are sometimes discovered during this process,” he said.

And though Duke and others have seen increases in employees classified as independent contractors, Calkins said his agency had not noted such a trend.

In determining whether an employee should be classified, Bagley said, “Ultimately, a person’s free will and their ability to make employment decisions for themselves really factors into the outcome. For instance, if you have an independent contractor agreement that is exclusive of that person’s time, and pretty much forbids them from working for any other group, then you can almost come to the quick conclusion that that person isn’t able to go and contract with someone else. But again, it’s a very gray area.”

“Companies are not defenseless,” Doolittle said. Businesses can submit a form SS-8 to the IRS asking that agency to determine worker status, whether an individual is an employee or independent contractor.

“You have to go with what the law requires,” Duke said. “It’s not a business decision; it’s a legal decision.”

Employment Relationship and the Fair Labor Standards Act

The Wage & Hour Division of the U.S. Department of Labor has provided a fact sheet on the meaning of the “employment relationship.” It says:

The U.S. Supreme Court has on a number of occasions indicated that there is no single rule or test for determining whether an individual is an independent contractor or an employee for purposes of the FLSA. The Court has held that it is the total activity or situation which controls. Among the factors that the Court has considered significant are:

  • The extent to which the services rendered are an integral part of the principal’s business.
  • The permanency of the relationship.
  • The amount of the alleged contractor’s investment in facilities and equipment.
  • The nature and degree of control by the principal.
  • The alleged contractor’s opportunities for profit and loss.
  • The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor.
  • The degree of independent business organization and operation.

Source: U.S. Department of Labor