If you have 50 full-time employees, including full-time equivalent employees, you must offer full-time employees affordable health insurance that covers a set menu of benefits (called minimum essential coverage) and that provides minimum value, or pay a free-rider penalty. Independent contractors, on the other hand, aren’t covered under the Affordable Care Act’s (ACA) employer play-or-pay provisions. The incentive to misclassify employees as independent contractors to get under the 50-employee cap, therefore, may seem tempting. The real incentive is to ensure that your workforce is properly classified in the first place.
Who are employees? The final ACA employer-play-or-pay regs adopt the payroll definition of employees: workers are employees if they’re common law employees. Under long-standing IRS rules, a common law employee is a worker whom you have the right to control; actual control isn’t necessary.
If, after a payroll audit, the IRS determines that you’ve misclassified employees as independent contractors, you may qualify for relief under Section 530 of the Revenue Act of 1978. If you do, you won’t have to put these newly reclassified employees on the payroll. To qualify for Section 530 relief you must meet these criteria:
- You filed Forms 1099-MISC for your independent contractors on time.
- You treated all similar independent contractors similarly.
- You have a reasonable basis for your actions. A reasonable basis can be shown by your reliance on judicial precedent, published IRS rulings or private IRS rulings; a past payroll audit that resulted in no penalties for misclassified workers; or a long-standing industry practice treats workers as independent contractors.
NO SECTION 530 RELIEF UNDER THE ACA: The IRS stressed in the final play-or-pay regs that Section 530 relief is not available to employers that misclassify their employees. Domino effect: If the IRS reclassifies independent contractors as employees, you may find yourself above the 50-employee cap. You might then be liable for a free-rider penalty if you didn’t offer at least 95% of your full-time employees affordable health insurance (70% for certain employers during 2015) and one full-time employee bought insurance on the individual exchange and obtained a premium tax credit.
What can you do? Conduct an objective internal audit to ensure that your workforce is classified properly. Need help? You can use the items on the IRS’ Form SS-8 to structure your internal audit. If you determine that some or all of your independent contractors should be reclassified as employees, you can take advantage of the IRS’ Voluntary Classification Settlement Program (VCSP). VCSP allows you to reclassify employees prospectively, without paying penalties.