The ACA’s pay or play rules (aka employer mandate, employer shared responsibility) require applicable large employers or “ALEs” (generally 50 or more full-time employees plus equivalents) to offer medical coverage meeting certain ACA standards to full-time employees in order to avoid potential penalties under §4980H. The ACA defines “full-time employees” to include all common law employees who average at least 30 hours of service per week. The pay or play rules do not apply to workers who are properly classified as independent contractors.
On Wednesday, the California Labor Commissioner ruled that an Uber driver was acting as a common law employee—not an independent contractor as previously classified—in the performance of her duties as a driver. This decision is limited to the one worker at issue, and it will almost certainly be appealed and further litigated for a long time to come. However, it provides insight into a major potential liability and shift in business practices for the rising shared economy freelance workforce model largely pioneered by Uber.
The ACA pay or play rules include a large and small penalty. The large “sledgehammer” penalty is contained in Internal Revenue Code §4980H(a). It imposes an annualized penalty of $2,000 multiplied by all full-time employees (reduced by the first 80 in 2015, the first 30 in 2016) for an ALE’s failure to offer coverage to substantially all full-time employees. In 2015, this standard requires an offer of coverage to at least 70% of the company’s full-time employees. Next year, this standard rises to at least 95% of the company’s full-time employees.
Where purported independent contractors are subsequently retroactively reclassified as common law employees, there are a number of significant consequences. The employee benefit plan consequences were first tested on a grand scale at Microsoft in the mid-1990s. A large group of temporary workers at Microsoft initially classified as independent contractors were determined to be common law employees retroactively. Microsoft’s ERISA employee benefit plan document provided that all common law employees were eligible to participate. The reclassified workers were therefore determined to be retroactively eligible for the Microsoft employee benefit plans—at a major expense to Microsoft. Since this landmark case, ERISA plan documents typically include a provision to clarify that any worker classified as an independent contractor who is subsequently reclassified as a common law employee is not eligible to participate in the plan on a retroactive basis. This is commonly referred to as “Microsoft language” in the plan document.
The lurking liability companies in the shared economy face stems from the fact that there is no “Uber language” equivalent to address potential ACA penalties under §4980H. The preamble to the pay or play regulations confirms that there is no ability for employers to avoid retroactive penalties where workers are retroactively reclassified. In explaining its refusal to add such protection, the IRS stated that “the relief requested would serve to increase the potential for worker misclassification by significantly increasing the benefit of having an employee treated as an independent contractor. Accordingly, the final regulations do not adopt this suggestion.”
Example: Assume that in 2016 an employer like Uber, which relies primarily on purported independent contractor drivers, suffers a major class action reclassification of its workforce to common law employees on a retroactive basis to the beginning of 2015. Further assume that after the reclassification, Uber had 10,000 full-time employees (averaging at least 30 hours of service per week, as defined under the ACA) for each month in 2015. As a result of the reclassification, Uber failed to offer medical coverage to at least 70% of its full-time employees for every month in 2015. Uber would be subject to a pay or play penalty under §4980H(a) of $2,000 x 9,920 (10,000 full-time employees, reduced by the first 80) =$19,840,000.
This type of brand new $20 million ACA pay or play liability places an enormous new pressure on employers to properly classify its workers—particularly in the shared economy that relies so heavily on purported independent contractors. One likely result is that employers such as Uber may begin to err on the side of caution by a) classifying more workers as common law employees, and b) offering medical benefits to all such full-time workers classified as employees to avoid potential pay or play penalties.
If you have any questions about how this ruling may impact your company, please contact our lead benefits counsel Brian Gilmore.