A Service of OnQue Technologies, Inc.
Are you sure you know the difference between independent
contractors and employees?
A worker's right to COBRA and other benefits may
depend on it
and it's not as obvious as you might think.
March 13, 2003
Santa Rosa, CA
The use of alternative workers has increased in recent years, giving
employers more flexibility when making staffing decisions. Temporary
and part-time workers, along with independent contractors and consultants,
increasingly are taking the place of traditional full-time employees.
Generally, such workers do not receive the full range of employee benefits
such as group health plan coverage, retirement benefits, income tax
withholding, or social security and Medicare tax payments.
When classifying a worker
as an independent contractor or temporary worker, rather than an employee,
employers must be careful to get it right. Failing to properly classify
personnel and then denying benefits based on that erroneous classification
can be a costly mistake, as Microsoft discovered when it was successfully
sued by more than 8,000 employees who claimed they'd been wrongfully
classified as temporary workers and denied the valuable benefits given
to permanent employees, particularly stock options. Some of these so-called
"permatemp" employees had worked for Microsoft for as long as 14 years.
Microsoft settled this lawsuit for $97 million.
What does all this have to do with COBRA administration?
For purposes of administrating COBRA benefits, it is important to know
the distinction between an employee and a contract worker for two reasons:
The small employer exception to COBRA
1. Only employees may be counted for the small-employer COBRA exemption, and
2. COBRA benefits are available only to covered employees who lose coverage
under the employer's group health plan.
An employer with fewer than 20 full-time employees in the preceding
calendar year is not subject to COBRA regulations. When counting workers
to determine whether a business is exempt from COBRA administration,
only employees are counted; a full-time employee is counted as one employee
and a part-time employee is counted as a fraction of an employee. At one
time, independent contractors and self-employed workers could be counted
when determining if an employer had 20 or more employees, but this is no
longer the case; under final IRS regulations, only employees may be counted
when determining whether a business is exempt from COBRA regulation.
When is a worker entitled to COBRA and other ERISA benefits?
Only covered employees are entitled to COBRA coverage. A "covered employee"
is defined under ERISA regulations as an individual who is, or was, provided
coverage under a group health plan. Note that independent contractors may
be considered "covered employees" if they are covered under the group health
plan. But so long as a worker is not a participant of the employer's health
plan, COBRA benefits need not be offered.
But what if a worker had been denied participation in a group health plan as
the result of being misclassified? This was precisely the argument made in
a recent case before the New York federal district court brought by Ioana
Baraschi, who was terminated after she entered into a written employment
contract with Silverwear, a New York City company. Under the terms of her
contract, Baraschi was to be paid an annual salary of $135,000, an
incentive bonus, three weeks' annual vacation, half-days off on Friday
afternoons during the summer, and three months' severance in case of
termination. A line in the contract providing "medical insurance for
my daughter and I" was crossed out. Ms. Baraschi alleged that Silverwear
denied her request for enrollment for herself and her family in the group
health plan and violated ERISA rules by not providing the required COBRA
election notice or COBRA coverage.
Was she or wasn't she an employee?
Silverwear asked the court to dismiss Ms. Baraschi's suit, saying
that it was clear from the parties' contract that she was not a
common-law employee, but an independent contractor and not entitled
to ERISA benefits. Silverwear maintained that because the contract
stipulated that Ms. Baraschi was to be paid on IRS tax form 1099 and
contained limits on the time and content of her work, it indicated
the parties' intention to enter into an independent contractor relationship.
Nevertheless, the federal court refused to dismiss Ms. Baraschi's
lawsuit stating that, for ERISA purposes, all relevant factors must be
weighed in determining employment status. Thus, Ms. Baraschi will have
a chance to prove at trial that she was, in fact, an employee who
should have been allowed to participate in Silverwear's health plan.
Obviously, if she had been a participant of that plan, she would have
been entitled to COBRA benefits upon termination. Stay tuned!
What's in a name?
Simply because an employer calls a worker an "independent contractor"
or "temporary" doesn't necessarily make it so. According to the
Internal Revenue Service (IRS), it is the substance of the employer-employee
relationship, not the label that governs the worker's status. And it
doesn't matter if the worker is employed full time or part time - it
is the actual relationship between the worker and the business that
must be examined.
According to the IRS, a general rule for determining the true status of
a worker is: An individual is an independent contractor if the person
for whom the services are performed has the right to control or direct
only the result of the work and not the means and methods of
accomplishing the result. To help in determining a worker's status,
the IRS has issued Revenue Ruling 87-41, which contains a list of
twenty factors to consider when classifying a worker and, more recently,
IRS Publication 1779, which condenses those factors into these three
categories: Behavioral Control, Financial Control and Relationship
of the Parties.
If a worker receives extensive instructions on how work is to be done, it
suggests that the worker may be an employee. Instructions include:
If the business provides training about required procedures and methods,
it indicates that it wants the work done in a certain way, which suggests
that the worker may be an employee.
- how, when, or where to do the work;
- what tools or equipment to use;
- what assistants to hire to help with the work; and
- where to purchase supplies and services.
Significant investment. If a worker has a significant investment
in his or her work, it suggests that the worker may be an independent
contractor. There is no precise dollar test for determining whether an
investment is "significant."
If a worker is not reimbursed for some or all business expenses, it
suggests he or she may be an independent contractor, especially if the
expenses are high.
Opportunity for profit or loss.
If a profit may be realized, or a loss incurred, it suggests that
the worker may be an independent contractor.
Relationship of the Parties
If a worker receives benefits such as insurance, pension or
paid leave, it suggests that he or she may be an employee.
But even if no benefits are received, the worker still could
be either an employee or an independent contractor.
A written contract may be a good indication of the type of relationship
intended by the parties. The terms of an employment contract may determine
the status of a worker, particularly when other factors are not clear.
For example, does the contract set out a specific time period in which
the work is to be performed, or is it meant to continue indefinitely?
A specified time period suggests the worker is an independent contractor.
For IRS information relating to the classification of workers, see:
IRS Publication 15-A Employer's Supplemental Tax Guide
IRS Publication 1779 Independent Contractor or Employee
IRS Revenue Ruling 87-41 Factors for Determining Employment Status
| This information is provided by
OnQue Technologies, Inc. for educational purposes only and does not constitute
legal advice. If legal advice or other professional assistance is required, the
services of a competent professional should be sought.
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