Misclassifying Employees Can Have Unintended Consequences
The Internal Revenue Service (IRS) has announced a new, voluntary correction program that allows employers to reclassify employees who are currently misclassified as 1099 “independent contractors” when they should actually be reported as “W-2 paid” employees. Known as the Voluntary Classification Settlement Program (VCSP), employers who are not currently being examined by the IRS are allowed to eliminate years of past employment tax liabilities for “pennies on the dollar,” an amount equaling just greater than one percent of the wages paid to the reclassified workers for the past year.
The first question an employer may ask is, “What determination is used to classify an employee?” Unfortunately, that is not an easy one to answer. Multiple factors are used to determine worker classification and may require the involvement of an employment attorney. And, while this relief program spells out many good reasons for an employer to take advantage — most of which are financially-driven — those who find any errors in classification should also consider how that could impact other areas of their business.
Some examples of where the VCSP does not shield employers include:
- Potential state tax liability
- Retesting of retirement plans to ensure nondiscrimination
- Liability from other applicable federal laws
Health & Welfare Benefit Plan Considerations
As for how this new program interacts with employee health and welfare benefits, employers will want to consider the compliance and contractual impacts to their plan. From a compliance perspective, it all starts with control groups and eligible employees. This impacts traditional regulatory issues such as COBRA, HIPAA, ERISA, FMLA and discrimination testing. When you add in the additional impact of healthcare reform, employers will need to consider the implications on provisions that apply to varying sizes of groups, such as “Pay or Play,” tax credits and medical loss ratios.
Of course, there is also the issue of repercussions that might be felt from employees that were previously misclassified and, as a result, were denied benefits.
From a contractual perspective, employers should be aware of the requirements the insurers or reinsurers impose. This might mean a re-rating of coverage if there are material adjustments to the covered population. With clearer definitions of employees and control groups, employers may want to tighten up their eligibility monitoring to prohibit unreported carve outs. As can be seen, all of this impacts more than just tax withholdings.
HCW Viewpoint
HCW perceives there will be a lot of future motion around defining employer groups and employees. Clearly, the Federal Government has more at stake from a taxation standpoint, but this also extends into many other issues. Currently the control group regulations and employee status are difficult to interpret. There are resources available to help you define or clarify your current employee population. It is anticipated that the government will continue to tighten up these guidelines, which will continue to remove the loopholes that currently exist for non-compliance and healthcare reform provisions.
Employers should be cautious when relying upon their carriers to define or determine eligible employees. The carrier’s definition and monitoring of an eligible employee is very ambiguous. As you reclassify with insurers (or as definitions and requirements get more precise) you may find some of these specific situations arise:
1. Will your group size change? Many carriers define a small employer as one that has 50 or fewer employees. Starting in 2014, healthcare reform will redefine the employee count of a small employer to those who employ 100 or fewer employees. However, states can elect to keep small group defined as 1 - 50 employees until January 1, 2016. Knowing how your state and insurance carrier define an employer group is important in understanding how they determine your premiums and which state mandates may apply.
Insurance carriers have already started asking employers to verify the number of eligible employees they cover. If your employment count increases enough to push you into the next rating category, you may be eligible to receive valuable claims data, but that also means the insurer will be using that data in determining your rating increase.
2. If I reclassify will my group be re-rated? Another underwriting practice an insurer may exercise is a re-rating of the plan should a group’s enrollment change by more than 10 percent. If that is the case, the insurer will look at the new population of employees and compare it to the rest of the group. They will also ask for proof of prior coverage. Carriers may impose “unknown risk charges” if they are not comfortable with the new risk coming onto the plan.
3. Will pre-existing conditions apply? The answer is that they may; the elimination of pre-existing conditions provision for those 19 and older is not applicable until 2014. If a reclassified employee has a pre-existing condition, you may have more issues on your plate:
Does that employee have any right to a financial claim for covering any premiums they were paying on their own prior to becoming a W-2 employee?
What if they developed a pre-existing condition this past year and now know that they should have been covered under your plan?
Will the employer inherit that risk directly since the insurance carrier is not going to allow those claims?
We believe now is the time to clean up your employee roster and validate that you have a clear definition of your control group.
