Written by Alden J. Bianchi
Distinguishing employees who are full-time from those who are not takes up a good deal of real estate in final regulations published in the Federal Register on February 12 implementing the Act’s employer shared responsibility rules (the “final regulations”). When determining whether an employee is a full-time employee, it is also necessary to determine who employs the full-time employee. To identify the proper employer, the final regulations look to the “common law employer/employee” standard. (For a detailed explanation of these standards, please see Bianchi and Lenz, The Common Law Employer Test and the Affordable Care Act — Will Businesses Be Responsible for Temporary Employees Assigned by Staffing Firms? Bloomberg/BNA Tax Management Memorandum (Feb. 14, 2014), available here (note: This article was submitted before the issuance of the final Code § 4980H regulations. The authors are planning to produce an updated version that takes the final regulations into account.)). In two-party employment arrangements, i.e., where the employer hires the employee directly without an intermediary, identifying the common law employer and the common law employee is a simple matter. This determination gets exponentially more complicated, however, when the employee is instead hired through a staffing firm or Professional Employer Organization (PEO).
The question of who is the common law employer/employee is not new. For purposes of the Federal tax code and ERISA, employers have historically been required to distinguish between workers who are their common law employees and workers who are not. This distinction is important, for example, when complying with payroll tax and withholding at the source provisions. It also affects the design and maintenance of tax qualified retirement plans and welfare plans. The Affordable Care Act’s employer shared responsibility rules (which are codified at Internal Revenue Code § 4980H) add another, compelling reason to properly determine a worker’s status as a common law employee: if at least one of an (applicable large) employer’s full-time (common law) employees qualifies for a premium tax credit from a public insurance exchange, then the employer may have liability under the Act’s employer shared responsibility requirements if the employer fails to make an offer of group health plan coverage to at least 95% (or 70% in 2015 under a transition rule) of its full-time (common law) employees. What’s at stake here is best illustrated with an example.
Employer A has 300 employees, all of whom are full-time. Of these, 250 are direct hires, and 50 are hired through Staffing Firm B. For all months during calendar year 2017, Employer A determines that the 250 direct hires are its common law employees. Employer A makes an offer of coverage under its group health plan to all of these employees. Staffing Firm B also makes an offer of coverage to all of its full-time employees, including the 50 workers placed with Employer A (whom Staffing Firm B has determined are full-time for Code § 4980H purposes). On audit, it is determined that the 50 workers placed through Staffing Firm B are the common law employees of Employer A and not Staffing Firm B. Absent the relief described below, Employer A would be deemed to make an offer of coverage during 2017 not to 100% of its full-time (common law) employees as it anticipated, but rather to only 83%. As a consequence, if at least one of Employer A’s employees qualified for a premium tax credit from a public insurance exchange, Employer A would incur a non-deductible excise tax for 2017 of over a half of a million dollars.
Comments submitted in response to the proposed Code § 4980H regulations urged the Treasury Department and the IRS to adopt a special rule under which an offer of coverage would be counted for Code § 4980H purposes if made by another, unrelated entity—e.g., under the circumstances outlined in the above example or in the case of a multiemployer or single employer Taft-Hartley plan. In response, the final regulations clarify that for purposes of Code § 4980H, an offer of coverage includes an offer of coverage made on behalf of an employer by an unrelated entity. However, where the employer is a client of a “professional employer organization or other staffing firm,” there is a further requirement:
“the fee the client employer would pay to the staffing firm for an employee enrolled in health coverage under the plan [must be] higher than the fee the client employer would pay to the staffing firm for the same employee if the employee did not enroll in health coverage under the plan.”
The combined reference to “professional employer organization or other staffing firm” is troublesome, in our view. In their informal comments, representatives of the Treasury Department and the IRS, expressing their own, non-binding views, assert (rightly) that these terms have no independent significance. That is, common law employer status does not depend on whether the third-party is a PEO or a staffing firm. But as a practical matter, PEOs and staffing firms are different. At least since 2002 (as a consequence of IRS guidance dealing with 401(k) plans maintained by professional employer organizations), it has been widely if not universally presumed that a PEO is not a common law employer, while the opposite is generally true in the case of mainstream staffing firms. Historically, contract and temporary workers placed by staffing firms have been treated as common law employees of the staffing firm and not the client organization. These conclusions are, to be sure, broad oversimplifications. But they have endured presumably because the multi-factor tests for establishing common law employee status are complex and difficult to administer.
Fortunately, there is nothing to prevent a staffing firm from taking advantage of the special rules relating to “offers of coverage on behalf of other entities,” but it will require some modifications to each firm’s administrative systems. The rule says nothing about how much higher the fee must be in cases where the worker placed by the staffing firm elects coverage. A nominal amount appears sufficient. What’s less clear is whether the increased fee must appear as a higher amount in the bill rate, participant-by-participant, or whether the incremental charge could simply be included in the aggregate bill rate (but with appropriate record-keeping back-up).
Separately, there is a lingering issue not addressed in the final regulation (since it is outside the jurisdiction of the Treasury Department and the IRS): where a staffing firm that makes an offer of coverage to a worker is determined not to be the common law employer, the plan under which the offer is made is most likely a multiple employer welfare arrangement. Such a plan would be required to file a Form M-1 annually with the Department of Labor. If the plan was self-funded, then it might be treated as an unlicensed insurance company for state insurance law purposes. If the plan is fully-insured, in most states it could not cover small groups (many state insurance codes do not permit combining a number of small group plans to make a large group plan). While many of the PEOs that offer group health plan coverage have claimed (and duly report their) MEWA status, to our knowledge no staffing firm has done so to date.
On balance, the provisions of the final regulations governing offers of coverage on behalf of other entities should be welcome. It will take some time, however, for standards and best practices to emerge. The relationship to other Federal laws and state insurance codes will also have to be sorted out.