It’s reporting 101: when tax season rolls around, independent contractors get form 1099, and permanent employees get a W-2. They get different forms because they are different: different benefits, different working structures, different pay structures. However, the process of defining each employee and distributing these forms to the correct person can get tricky. And, many forms often end up in the wrong hands.
Now, thanks to the Affordable Care Act and its long list of reporting mandates, the IRS is monitoring—closer than ever—how employers define their employees and what that means for benefits coverage of the workforce.
State-level studies found that between 10% and 20% of employers misclassify at least one worker as an independent contractor. It’s tempting to categorize employees more often as independent contractors because, in short, it’s cheaper. They don’t receive overtime pay, unemployment benefits, or workers’ compensation. Plus, the employer doesn’t have to pay payroll taxes such as Social Security and Medicare. But, full-time employees misclassified as independent contractors miss out on the benefits they deserve.
Not only does misclassification leave the employee at a disadvantage, but it also puts the employer at risk of being hit with penalties—stricter penalties now that the ACA is kicking in. For an employer with at least 50 full-time employees, not providing coverage to at least 95% of its full-time employees results in a fine. Sometimes, the failure to reach 95% happens due to employees being reclassified by the IRS.
The Department of Labor is cracking down on misclassifications and fighting for the rights of these employees through their own investigations. In 2015, the department’s investigations found $246 million in back wages for more than 240,000 workers—a 29% increase from 2008 in back wages for low-wage workers.
On top of the DOL’s increased monitoring, the ACA’s new reporting structure makes getting by with misclassified employees less likely. As of 2015, each employer with 50 or more full-time employees, including full-time equivalent employees, must file forms 1094-C and 1095-C. These are the employers who, under the ACA, are required to provide employees with health insurance coverage.
The employer sends form 1095-C to both the employee and the IRS. It outlines the offered coverage, the lowest-cost premium available to the employee, and the months of the year when the coverage was available. The 1094-C form only goes to the IRS, with the 1095-C forms attached. The 1094-C form provides information about the employer, including how many 1095-C forms were sent. These forms allow the IRS to see what kind of coverage employers are providing and will ensure that employers correctly classify—and correctly cover—all of their employees.
The higher risk of penalties means employers need to double, even triple, check how they are classifying their employees. Guidelines to classify an employee examine the degree of control and independence in three categories: behavioral, financial, and type of relationship. More specific rules can be found via the IRS here, and with more info on the Namely Blog here.
Although there are a number of determinants and tests for deciding the label of an individual employee, there is no exact checklist to find the final answer. But not to worry: If an employer is unsure of how to classify an employee, he or she can file an SS-8 form with the IRS. The IRS will review the information and respond with an official decision.
The Affordable Care Act is changing the way employers handle employee reporting. And, with the increase in penalties, getting classification right has become a top priority for both employers and the DOL. Staying on top of employee definitions will keep your business in the clear and the IRS far away.