Strategy No. 3: Leased Employees
The leased employee strategy is similar to the independent contractor strategy. A leased employee is someone employed by a third-party leasing company, but who actually performs services on behalf of the leasing company’s client. Under the PPACA, if a leased employee is actually a common-law employee of the leasing company, and not a common-law employee of the client, then the leased employee does not count toward determining whether the client is a “large” employer—and would not be considered a full-time employee of the client for purposes of the PPACA penalty.
Of course, even when employee leasing is successful—when the worker is actually an employee of the leasing company rather than the client—the PPACA obligations and penalties would apply to the leasing company. The leasing company is likely to pass the cost of healthcare coverage for the workers to its clients.
How the Leased Employee Strategy Could Go Awry
The leased employee strategy has the same inherent weakness as the independent contractor strategy—misclassification. It is difficult to be certain that the workers should be classified as employees of the leasing company, rather than its client; the leasing company and the client might also be joint employers.
A client that depends on the leasing company to provide healthcare coverage to the leased employees should verify that the coverage is actually being provided. If the leasing company fails to deliver on its promise to provide coverage, the client may be liable for the PPACA penalties.
Strategy No. 4: Separate Entities
A business is permitted to exclude up to 5 percent of its full-time employees from healthcare coverage without being subject to the 4980H(a) penalty. But what if an employer wants to exclude a group that accounts for more than 5 percent? One strategy is to have a separate entity act as the employer for the uncovered group.
The separate entity strategy could reduce, but not eliminate, the penalty. For example, assume that a business has 100 full-time employees. Eighty are employed by a subsidiary that has employer-provided coverage; the other 20 are employed by a subsidiary that does not have coverage. Both subsidiaries are at least 80 percent owned by a common parent. As a result of the common ownership, both subsidiaries are treated as a large employer. Since the first subsidiary has employer-provided coverage for its employees, it is not subject to the 4980H(a) penalty. The second subsidiary, however, is subject to a penalty of $28,000. (The 30-employee exemption from the penalty is pro-rated between the two subsidiaries. Since the second subsidiary has 20 percent of the employees of the business, it has six exemptions. Thus, the penalty is $2,000 multiplied by 14 employees.)
By contrast, if all 100 employees were employed by the same entity, the penalty for failing to cover at least 95 percent of them would be $140,000.
How the Separate Entity Strategy Could Go Awry
It is unclear how much freedom employers will have to allocate employees to separate entities. The IRS could conceivably require the separate entity to have a business purpose beyond just the avoidance of penalties. The IRS might also seek to treat separate entities as joint employers.
In sum, a carefully constructed and executed contingent worker strategy could help an employer avoid or reduce healthcare costs and PPACA penalties. Businesses must bear in mind, however, that common-law principles will determine whether such strategies are successful. Application of these principles depends on the specific facts involved, rather than the intent of the parties. As legal responses and pitfalls to these contingent worker plans continue to evolve, it’s prudent for all employers to check with legal counsel before enacting a strategy.
Wayne Jacobsen is a partner in O'Melveny & Myers LLP’s Newport Beach office and a member of the executive compensation and employee benefits practice. His practice is exclusively in the employee benefits and executive compensation field, including pension and profit sharing plans, employee stock ownership plans, deferred compensation plans, stock option plans, welfare plans, employment agreements, severance arrangements, and change of control arrangements. The opinions expressed in this article do not necessarily reflect the views of O'Melveny or its clients, and should not be relied upon as legal advice.
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