Worker Misclassification May Lead to ACA Penalties

Employers trying to duck out of the employer mandate of the Affordable Care Act should think twice before re-classifying their employees as independent contractors.

Under the Affordable Care Act, employers with 50 or more full-time employees (or equivalent) will have to either provide health care by the deadline or pay a penalty.

Some businesses may try to finagle the number of eligible employees by reducing work hours or hiring only part-time employees. Businesses also may be tempted to remove their W-2 employees from their payroll and pay them as 1099 independent contractors, in hopes that these workers will not "count" toward the total number of eligible employees.

But that can be a bad move, says Debbie Fledderjohann of Top Echelon Contracting, who has served as the employer of record for contractors since 1992.

"Calling a worker an independent contractor doesn’t make it so," she said.

"One of the red flags that can trigger an IRS audit is a W-2 employee who is suddenly being paid as a 1099 contractor," she explained. "Employers abruptly changing the status of their employees may prompt the IRS to further scrutinize the business.”

Who is an independent contractor?

The IRS has created strict rules about who can be considered an independent contractor. They have created a three-part test based on behavioral control, financial control, and the type of relationship that exists between the business and the individual. The more control that a business exerts over a person’s actions, the more likely that a person should be considered an employee rather than a contractor.

If there is a question about whether a worker is an employee or a bona fide contractor, an individual or business can request a Determination of Worker Status (SS-8) Report from the IRS. However, in most SS-8 cases, the IRS does, in fact, determine that a worker should be an employee.

Why is worker misclassification such a big deal?

The IRS and U.S. Dept. of Labor had started cracking down on 1099 misclassification even before the Affordable Care Act began to impact employers. Misclassification costs the U.S. an estimated $54 billion in underpaid employment taxes and $15 billion in uncollected Social Security, Medicare, and unemployment taxes.

The Miami Herald reports that workers who file their own income taxes under-report their wages by 56%. Plus, workers paid as contractors are not covered by workers’ compensation or unemployment, so they are on their own if they are injured or laid off from the job.

In the case of a worker classification audit, the IRS will examine the relationship between the business and the individual. If the IRS finds that the individual should be considered an employee, the results can be costly for employers in terms of back taxes and penalties, and may include possible penalties associated with the health-care law, according to the Wall Street Journal.

If an IRS audit discovers employee misclassification, and if correctly classifying the workers as W-2 employees puts the employer over the 50-employee mark, the employer may be fined $2,000 for failing to offer healthcare coverage. This $2,000 fine applies per full-time employee, even if one employee buys insurance through the Marketplace. If the employer’s plan doesn’t measure up to the ACA’s minimum coverage and affordability standards, employers could owe as much as $3,000 for each employee who buys Marketplace insurance and receives a subsidy.

What can employers do?

Employers who have misclassified workers can request amnesty from the IRS through the Voluntary Classification Settlement Program (VCSP), which can reduce the amount of interest and penalties owed if the business owner agrees to classify workers correctly going forward.

A safer alternative to misclassifying workers as independent contractors is to utilize workers who are legally employed by a staffing firm or contracting back-office. The contractors will be counted as W-2 employees of the staffing firm, sparing employers the worry of complying with the Affordable Care Act or the threat of an IRS misclassification audit, Fledderjohann explained.

My advice to small business owners? Don't try to get out of it. Put your employees on your payroll, pay them as W-2 employees, and get health insurance for your group. Lastly, have your accountant and attorney look over your shoulder and make sure you're doing it all correctly.

The Affordable Care Act has small business owners everywhere asking questions. Here are some answers, courtesy of Top Echelon Contracting.

Q. When is the deadline for the employer mandate, exactly?

A. The deadline has been a moving target, but here’s the latest. Employers with 50-99 employees are not subject to the employer mandate until 2016 if they certify that they did not specifically reduce their numbers under 99 just to qualify for the delay. Employers with 100+ employees must provide 70% of their staff with health insurance in 2015. By 2016, they must cover 95% of their employees.

Q. I have part-time and full-time employees. How do I calculate the number of employees eligible for health insurance?

A. You can average the number of full-time and full-time equivalent employees from the last six months of 2014. Under the law, full-time means an average of 30 hours per week.

Q. What’s the penalty for not complying and when does that take effect?

A. In 2015, the penalty will be $2,000 per employee, minus the first 80 employees (even if just one employee receives a federal premium credit to buy insurance through the marketplace.) In 2016, only 30 employees will be excluded from the calculations.

For more information on the requirements for small business owners, visit HealthCare.gov/small-businesses.