Employee Benefit Considerations In Light of the DOL Independent Contractor Final Rule

Now that the Department of Labor (DOL) released the final independent contractor rule on January 9, 2024, this is a good opportunity to remind employers of the intersection of independent contractors and health & welfare benefits, and the related implications.

Read on for more information.

Independent Contractor Final Rule Background

This final rule, effective March 11, 2024, revises the DOL’s standard for determining who is an employee or independent contractor under the Fair Labor Standards Act (FLSA). Generally, the FLSA establishes minimum wage, overtime pay, and benefit standards for qualified employees, but not for independent contractors. The final rule replaces the current independent contractor rule from January 2021, which was implemented by the Trump Administration’s DOL leadership, and mirrors the proposed rule released by the Biden Administration’s DOL one year later.

The final rule reverts to the multifactor, totality-of-the-circumstances standard to assess whether a worker is an employee or an independent contractor under the FLSA, applying the following six factors:

1. opportunity for profit or loss depending on managerial skill;
2. investments by the worker and the potential employer;
3. degree of permanence of the work relationship;
4. nature and degree of control;
5. extent to which the work performed is an integral part of the potential employer’s business; and
6. skill and initiative.

No factor or set of factors listed above has a predetermined weight, and additional factors may be relevant if such factors reflect whether the worker is in business for themself (i.e., an independent contractor), as opposed to being economically dependent on the putative employer for work (i.e., an employee under the FLSA).

In contrast, the 2021 FLSA independent contractor rule, elevated two out of five “core” factors in the independent contractor evaluation as outlined below:

1. the nature and degree of the worker’s control over the work; and
2. the worker’s opportunity for profit and loss based on initiative and/or investment.

These two factors carried more weight in determining the status of workers as independent contractors rather than employees. This brighter-line test, which identified two factors as most important, was generally regarded as more business-friendly, resulting in clearer cases for workers to be classified as independent contractors, and therefore not covered by the FLSA’s minimum wage and overtime requirements.

According to the DOL, the new rule "is more consistent with the FLSA as interpreted by longstanding judicial precedent" and will "reduce the risk of employees being misclassified as independent contractors while providing a consistent approach for businesses that engage with individuals who are in business for themselves."

The DOL issued new FAQs and additional compliance guidance to assist employers with understanding and complying with the final rule. Since the independent contractor determination is nuanced and requires careful analysis, employers are advised to consult with their employment and labor law counsel for worker classification purposes.

Health & Welfare Benefits and Independent Contractors

The DOL confirmed that this final rule only revises FLSA standards for worker classification and does not impact the classification of workers under other laws, such as IRS rules on worker classification or even ERISA, both of which generally govern employee benefit plans.

Nonetheless, this development presents a good opportunity for employers to consider the implications of worker misclassification on their health and welfare plans as well as offering health & welfare benefits to independent contractors. For purposes of this article, we focus strictly on health & welfare plans, but employers should be aware of the adjacent pitfalls for retirement plans and other nonqualified employee benefit plans in the context of worker misclassification.

What happens when an independent contractor is deemed misclassified by the DOL or IRS, or by a judge or arbitrator under employment/tax laws?

Worker misclassification issues can occur when workers themselves challenge their classification through a lawsuit^[1] or may be identified by an agency investigation or audit, either at the federal level (DOL or IRS) or even at a state or local agency level. Since the DOL and IRS share information,^[2] an investigation by one agency, such as the DOL in the context of assessing worker classification for FLSA purposes, may lead to an audit from the IRS.

If a DOL or IRS audit determines that independent contractors must be reclassified as employees, employers could face stiff consequences. Under the FLSA, those workers may be entitled to back wages (whether minimum wages, overtime wages, or both) over a three-year period, liquidated damages equal to back wages, and, if they retain counsel, attorneys’ fees. On the tax side, businesses likewise face a range of potential penalties for worker misclassification. And, of course, businesses facing these claims could be forced to determine whether the impacted workers are eligible for health & welfare benefits, even retroactively.

A potent reminder of this consideration is the notable Vizcaino v Microsoft Corp. lawsuit from 1999, stemming from an IRS investigation resulting in the reclassification of many Microsoft workers for tax purposes. Those reclassified workers sued for benefits. Although the reclassified employees in the Vizcaino case did not ultimately prevail on their claim for health and welfare benefits, the legal conclusions established here apply with equal force for health & welfare plans as they do for retirement and certain equity plans. A key takeaway from the Microsoft decision is that employers should ensure their ERISA plans exclude non-employees based on the employer’s label of those workers, notwithstanding a later reclassification of those workers as employees by a court or agency.

Worker reclassification could also affect the Affordable Care Act (ACA) offer of coverage and reporting requirements. The ACA requires an applicable large employer (ALE) to provide full-time employees with an offer of affordable, minimum value health plan coverage and also report that offer of coverage to the IRS, or face potential penalties.

If independent contractors are reclassified as employees as a result of an audit (either by a government agency or an employer self-audit), investigation, or even a lawsuit, employers might be faced with ACA offer of coverage and/or reporting penalties, even retroactively (notwithstanding any Microsoft language the employer may have included in the plan’s eligibility terms). For example, an employer might become an ALE if headcount increases to over 50 full-time employees due to worker reclassification, or if even one of the reclassified workers (determined to be full-time) enrolls in Exchange coverage with a premium tax credit. Click here for a refresher on the ACA employer shared responsibility penalties.

Can employers offer health & welfare benefits to independent contractors?

Finally, this final rule might spur questions from employers wondering if they can offer health & welfare benefits to their independent contractors. Some employers consider this for recruitment and retention purposes or even upon an individual request for coverage.

While employers are neither required nor prohibited from offering health & welfare benefits to independent contractors, they are advised to tread very carefully here and consider the compliance “traps” in doing so outlined below:

• Inadvertent MEWAs: Employers should be mindful of the risk of inadvertently creating a multiple employer welfare arrangement (MEWA) by offering coverage to individuals who are not employees, such as independent contractors. Generally, MEWAs may be subject to state insurance law regulations and are subject to additional ERISA reporting rules.
• Tax issues:
  1. Employer-provided coverage is generally excludible from employees’ taxable income under Internal Revenue Code §106(a). This exclusion does not apply if the coverage is provided to a worker who is not a common-law employee of the employer, such as an independent contractor.^[3] The chain reaction of these tax issues can lead to tax collection headaches on a federal and state level not only for the employer but also for impacted independent contractors.
  2. IRS rules require that Section 125 cafeteria plans may only permit participation by current and former employees of the employer.^[4] Allowing independent contractors to participate in a Section 125 cafeteria plan could potentially disqualify the entire plan.
  3. Similar to Section 125 cafeteria plan concerns noted directly above, eligibility for Health Reimbursement Arrangements (HRAs) is generally limited to employees and former employees, and making independent contractors eligible runs the risk of potentially disqualifying the entire plan.^[5]

Employer Action

In light of this new final FLSA rule from the DOL and the pending March 11, 2024 effective date, employers should consider working with their human resource professional team members and employment & labor counsel to conduct a worker classification self-audit.

Additionally, employers should be aware that health & welfare benefits (along with retirement plan benefits) might be impacted due to increased scrutiny of worker classification and any resulting changes to plan eligibility.

Taking extra care to draft clear and unambiguous ERISA plan eligibility language addressing non-employees, such as independent contractors, is a proactive prudent measure.

Risk Strategies is here to help. Contact us directly at benefits@risk-strategies.com.

[1] Several high-profile worker misclassification lawsuits impacting employee plan benefits, including both health & welfare plans and retirement plans, and the resulting court decisions have been inconsistent and dependent on the complex facts of each particular case. Due to this, this article does not delve into a longer discussion of these lawsuits.

[2] Information shared in accordance with a Memorandum of Understanding between the DOL and IRS.

[3] Rev. Rul. 56-400.

[4] Prop. Treas. Reg. §1.125-1(g)(1).

[5] Generally, Internal Revenue Code §105 and 106.