4 Benefits Issues That May Trip Up Worker Reclassification

By Kellie Mejdrich

Law360 (January 12, 2024, 6:02 PM EST) — The U.S. Department of Labor’s recently finalized rule toughening the test for determining whether someone qualifies as an independent contractor or an employee under federal wage and hour law may make businesses rethink deeming workers contractors.

The DOL’s final rule, published in the Federal Register on Wednesday, sets out a six-factor, nonexhaustive test for assessing employee versus independent contractor status, a potentially costly distinction since contractors aren’t covered by the minimum wage and overtime requirements of the Fair Labor Standards Act.

Employee status also comes with benefits that companies don’t have to provide contractors, like healthcare coverage and retirement plan participation. Employers also have to pay taxes on things like Medicare and Social Security for employees but not for contractors, along with having to potentially pay into a state workers’ compensation fund and purchase workers’ compensation insurance.

“Independent contractors don’t have any of those benefits and employees do. So it can come at a big cost to employers, as they shift independent contractors into an employee category,” said Leonard K. Samuels, an employer-side partner at Berger Singerman LLP.

Here are four benefits concerns that employers who opt for reclassification should be aware of.

ACA’s 50-Employee Threshold

A major takeaway for employer-side benefits attorneys is that a shift in the number of workers classified as employees could significantly affect small businesses’ healthcare compliance requirements, given that employers with more than 50 employees must offer health coverage that meets certain minimum standards under the Affordable Care Act.

Under the ACA, businesses that have 50 or more full-time equivalent employees, called applicable large employers, or ALEs, can face tax penalties if they don’t offer affordable healthcare that includes so-called minimum essential coverage. That term refers to certain essential health benefits provided under ACA-compliant plans, such as emergency services, preventive care and prescription drugs. ALE health plans must also cover 60% of expected benefit costs, which is an attribute called minimum value according to IRS rules on health plan requirements for ALEs. Employers face tax penalties if they fail to offer affordable minimum essential coverage that provides minimum value to their full- time employees.

“I think there are a lot of employers across the U.S. that teeter on that Affordable Care Act compliance requirement — becoming an applicable large employer for purposes of the Affordable Care Act,” said Anne Tyler Hall, managing partner at Hall Benefits Law.

Hall said “once you’re an ALE, then all sorts of ACA compliance requirements kick in” at the 50-employer mark, with “some significant new benefits compliance requirements” involved including additional reporting to the IRS.

Attorneys said in the case of a misclassification, health insurance costs are a major potential source of liability.

“I think benefits really drive the concern for a lot of companies” on misclassification, said Aaron Goldstein, an employment-side partner at Dorsey & Whitney LLP.

“Because even if you don’t have employees who are working enough to get overtime, that’s one source of liability. … If you’ve misclassified them, you owe them the 401(k) match, you owe them the value of the health insurance. And that can be very expensive,” Goldstein said.

Retroactive Claims

The rule’s finalization is also a good opportunity for employers to review contractor-related language in their employee benefit plans, attorneys said, particularly to guard against retroactive claims for benefits in the case of a misclassification.

Chelsea M. Deppert, an employer-side attorney and associate at Morris Manning & Martin LLP, said as employers look to potentially add more participants to their retirement or health plans in the event of a misclassification, it’s important for attorneys to check plan language regarding retroactive claims from employees who previously were classified as contractors.

Deppert said attorneys should be “making sure that plan sponsors have that Microsoft language,” referring to a 1997 Ninth Circuit decision called Vizcaino v. Microsoft Corp. that established case law related to retroactive retirement plan claims against the software giant from a group of misclassified freelancers.

Deppert said that language, added to most plans after the Microsoft case, limits employee claims from workers to future benefits in the case of a misclassification. But Deppert cautioned that the language isn’t always included.

“So checking plans, to make sure that it has that sort of safeguard language, is going to be important, if there are employers that are going to experience a lot of reclassifications as a result of these changes,” Deppert said.

Still, worker-side attorneys were broadly skeptical that the final rule would force employers to reclassify a large number of employees.

“The rule is really just a restoration of the same framework that’s been applied by the Supreme

Court, and appellate courts and the DOL for decades. So, you know, it doesn’t change the law, and no one should be surprised by it,” said Sally Dworak-Fisher, a senior attorney with the National Employment Law Project.

“The only businesses that have something to worry about are those that have been misclassifying,” she said.

Retirement Plan Impacts

Another issue highlighted by employer-side attorney Hall has to do with how a company’s employee headcount might change certain retirement plan reporting and auditing obligations.

“If you have at least 100 employees with account balances, then you have got to go and get an auditor for your plan,” she said.

Hall said beyond the potential for additional retirement plan participants, the independent contractor rule’s finalization comes after both Congress and the DOL have already implemented policy significantly expanding worker access to retirement plans. She gave the example of how Congress in 2019 passed the Secure Act, lowering the threshold for participation in a 401(k) plan to employees who worked 500 hours a year over the last three years. The threshold was again lowered, to two years with 500 hours of work annually, in 2022 with the passage of Secure 2.0.

“Basically, if you work 500 hours a year in two consecutive years, you have to be allowed to participate in the 401(k) plan,” Hall said.

Executive Recruiting

Management-side attorneys noted that some businesses may also have to adjust their recruiting practices, particularly in the tech industry where sometimes executives are first brought on as independent contractors before becoming employees, given the additional factors in the final rule’s test.

Attorneys said while hiring tech executives on a contracting basis isn’t very common, it has gained popularity as a way of recruiting in some industries, with the practice being more common with tech startups, for example.

“It’s going to be far more difficult to bring people in, executive-level, on an independent contractor basis than it was previously, to the extent companies have been doing that,” said Samuels, at Berger Singerman.

Samuels said in his experience “most employers recognize that it’s difficult to classify a C-suite executive or a higher-up as an independent contractor, but it does happen, particularly with startups.”

–Editing by Bruce Goldman and Nick Petruncio.

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Hall Benefits Law, LLC

HBL offers employers comprehensive legal guidance on benefits in mergers and acquisitions, Employee Stock Ownership Plans (ESOPs), executive compensation, health and welfare benefits, healthcare reform, and retirement plans. We counsel a wide spectrum of clients including small, mid-sized, and large companies, 401(k) investment advisors, health insurance brokers, accountants, attorneys, and HR consultants, just to name a few. HBL is passionate about advising clients, and we are dedicated to our mission: to provide comprehensive, personalized, and practical ERISA and benefits legal solutions that exceed client expectations.

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