Independent Contractors & Other Non-Employees

Organizations enter into a variety of different staffing arrangements to handle special projects, meet varying capacity needs, and fill temporary employment gaps. When entering into such arrangements, it’s important for organizations to properly categorize such individuals as independent contractors/non- employees or employees and to ensure that benefits are handled accordingly. Determining employment status is critical for several purposes beyond that of handling benefits, but this summary focuses specifically on benefit considerations.

Employment Status

Not everyone who provides services to an organization for pay is an employee. “Employee” has a specific legal meaning and applies only to workers who meet the common-law definition of an employer-employee relationship. Others such as independent contractors, board members, or volunteers are not employees.

It’s important to use the term employee correctly. For example, “1099 employee” is a contradiction: independent contractors receive a Form 1099, while employees receive a Form W-2. Only workers who meet the legal definition should be called employees; others should be referred to by their proper classification.

Independent Contractors & Other Non-Employees

Employers must take care when classifying workers as employees or independent contractors, as misclassification can result in liability for back wages, taxes, penalties, and fines under laws such as the FLSA, the tax code, and state workers’ compensation statutes. Both federal and state laws define who may be treated as an independent contractor, using multi-factor tests that consider the totality of the circumstances and share many common elements. If a worker does not meet the applicable independent contractor test(s), the worker is an employee by default. Because these determinations are often complex and carry significant legal risk, employers should consult an employment law attorney whenever a worker’s classification is unclear.

Employers need to be careful with labels for other individuals as well. For example, members of a board of directors are not employees; they may be an employee in addition to being a board member, but they are not employees simply by being on the board. Certain trainees and unpaid interns may be non-employees under FLSA rules. In addition, individuals who perform volunteer work for a non-profit are not employees.

Benefit Considerations

Organizations are generally not required to offer benefits to independent contractors or other non- employees, and these workers are typically ineligible for employee benefits. However, because benefits can be an effective talent-attraction tool, some organizations may consider extending benefits to non- employees. Before doing so, employers should carefully evaluate the legal and practical implications of offering benefits to these workers.

Independent Contractor Status

Offering benefits is one factor considered in determining whether a worker is an employee or an independent contractor—employees are typically offered benefits, while independent contractors are not. Because the independent contractor test is multifactor, offering benefits is not automatically determinative, but it can tip the scale if the classification is already borderline. Given the potentially significant consequences of misclassification, organizations should carefully evaluate whether extending benefits to independent contractors could affect their classification before doing so.

Eligibility

Most often the organization’s existing benefit plan eligibility rules only extend coverage to employees. So before extending coverage to independent contractors and other non-employees, the organization must first obtain permission from any insurance carriers and stop-loss vendors to include independent contractors and/or non-employees. In addition, plan documents should be amended accordingly.

Taxation

Tax-free benefits are only available to employees; any benefits provided to independent contractors and other non-employees will be taxable. Non-employees are not eligible to participate in the organization’s cafeteria plan and any amounts they are required to pay to enroll in benefits are paid after-tax. Further, contributions made by the organization for an independent contractor or other non-employee’s benefits are additional compensation and must be included on the individual’s Form 1099.

Because independent contractors and other non-employees cannot be provided tax-free benefits, independent contractors and other non-employees cannot participate in HRAs, health FSAs, or DCAPs. While an independent contractor or non-employee can contribute to an HSA, they must do so on an after-tax basis and claim a deduction on their tax return at the end of the year. Likewise, any HSA contributions made by the organization are taxable income that must be reported on Form 1099, for which the worker can then claim a deduction on their tax return.

MEWA

Covering a non-employee under an organization’s benefit plan creates a multiple employer welfare arrangement (MEWA), which can raise significant compliance concerns—particularly for self-funded plans. While fully insured MEWAs are generally permissible if the insurance carrier agrees, self-funded MEWAs are subject to extensive state licensing, financing, and reporting requirements and are prohibited in some states. Once a MEWA is created, ERISA plan documents must be updated, and the plan sponsor may be required to file Form M-1 annually in addition to Form 5500. An exception to the Form M-1 filing requirement may apply if independent contractors make up less than 1% of the employees and former employees covered by the plan.

Compliance Considerations

If the organization decides to extend benefits to independent contractors and other non-employees, they must recognize that many of the compliance rules that normally apply may not extend to those non-employees. Below are some of the more common compliance considerations.

• HIPAA Special Enrollment. Independent contractors and other non-employees and their dependents are not entitled to HIPAA special enrollment rights unless specifically provided for in the plan documents.
• ERISA. Independent contractors and other non-employees are included in the participant counts reported on Form 5500. Independent contractors and other non-employees are not entitled to automatic distribution of summary plan descriptions (SPDs) but can make an ERISA document request for the SPD and other plan documents.
• COBRA. Independent contractors and other non-employees and their dependents are entitled to federal COBRA continuation rights. State continuation may or may not apply to independent contractors and other non-employees – check the state law and insurance certificate for details.
• ACA / Employer Shared Responsibility Penalties (ESRP).
  • Independent contractors and other non-employees do not have to be counted when determining applicable large employer (ALE) status.
  • ALEs are only required to offer coverage to full-time employees, so ALEs are not required to offer medical coverage to independent contractors and other non-employees; and if choosing to do so, they are not required to make an affordable offer of coverage.
  • ALEs do not need to report §6056 offer of coverage information in Part II of the Form 1095- C for independent contractors and other non-employee, however, independent contractors and other non-employees enrolled in a level-funded or self-funded plan are subject to §6055 coverage reporting on Form 1095-B or Part III of Form 1095-C.
• PCORI Fees. Independent contractors and other non-employees are included when counting covered lives to determine the amount of PCORI fees owed by a self-funded plan.
• §105(h) Nondiscrimination. Independent contractors and other non-employees are not included when performing §105(h) nondiscrimination testing on a self-funded plan.
• Medicare Secondary Payer (MSP). Actively working independent contractors and other non- employees are generally subject to Medicare Secondary Payer (MSP) rules if they are “associated with the employer through a business relationship”, including Medicare coordination rules and prohibitions on incentives or discrimination based on Medicare eligibility or entitlement (enrollment). However, group health plan coverage may not prevent Medicare Part B late enrollment penalties, so non-employees should confirm with Medicare before relying on employer coverage and delaying Part B enrollment.

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