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See how easy COBRA administration can be...

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:
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.

The small employer exception to COBRA
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.

Behavioral Control
Instructions. If a worker receives extensive instructions on how work is to be done, it suggests that the worker may be an employee. Instructions include:
  • 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.
Training. 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.
Financial Control
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."

Expenses. 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
Employee benefits. 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.

Written contracts. 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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