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Addressing Employee Health Plan Exception Requests: Part IV

By Brian Gilmore | Published July 1, 2022

Question: What are the main employer considerations when responding to worker classification exception requests to enroll independent contractors (not Form W-2 common law employees) in the health plan?

Short Answer: The main concern is that offering coverage to an independent contractor likely creates a multiple employer welfare arrangement (MEWA). MEWA status is generally infeasible for reasons related to additional compliance burdens, insurance carrier limitations, and state law restrictions that are not preempted by ERISA.

Note: This is the fourth in a multi-part series addressing employee health plan exception requests.

Eligibility Exceptions

Worker Classification (Independent Contractor) Exception Requests

There are three main issues for employers to consider upon receiving a request to enroll an independent contractor in the health plan.

The three main issues are:

1. Multiple Employer Welfare Arrangement (MEWA) Status;
2. State Insurance Law Restrictions; and
3. Section 125 Cafeteria Plan Exclusion.

Issue #1: Multiple Employer Welfare Arrangement (MEWA) Status

A multiple employer welfare arrangement (MEWA) is an arrangement used to provide employee welfare benefits to the employees of two or more employers that are not part of the same controlled group.

Requests to enroll a properly classified non-employee worker typically arise from situations where the employer has a significant independent contractor population (e.g., gig workers) or the employer wants to offer coverage to its non-employee members of the board of directors. Offering coverage under the health plan to any properly classified non-employee (i.e., not a Form W-2 common law employee), including any independent contractor reported via Form 1099, generally is not a realistic option because it will likely create a MEWA.

The general rule is that covering any non-employees creates a MEWA by providing coverage to two or more employers that are not part of the same §414 controlled group. The DOL has stated that where an employer-sponsored group health plan covers both its employees and independent contractors, the plan is treated as a MEWA. In this case, the independent contractors are treated as self-employed individuals that are part of unrelated employers.

Allowing outside, non-employee directors to participate in the health plan also likely creates a MEWA. The DOL has refused to definitively opine on this issue. However, because non-employee directors are generally considered self-employed individuals, including them in a health plan likely creates a MEWA in the same manner that offering coverage to a standard independent contractor creates a MEWA.

Multiple untenable situations arise from inadvertently creating a MEWA by offering coverage to non-employees. One is that the insurance carrier generally would not permit employers to create a MEWA to cover non-employees outside of arrangements specifically designed for that purpose (e.g., health plans sponsored by a bona fide association).

Failure to obtain carrier approval could result in the carrier refusing to pay claims for the independent contractors, with the employer ultimately likely responsible for self-funding all claims for the non-employee. This is the worst-case scenario of potentially unlimited liability that employers must avoid.

Employers that inadvertently created a MEWA by offering coverage to independent contractors would in many cases also be subject to the Form M-1 filing requirement with the DOL. Plans that fail to file the M-1 may be subject to penalties of up to $1,746 per day.

One item to note here is that there is an exception from the M-1 filing requirement for a plan that provides coverage to non-employee directors where the number of such non-employees covered is less than 1% of the total number of employees or former employees covered by the MEWA. Although this exception could prove helpful in potentially avoiding the Form M-1 filing requirement, it also strongly suggests that offering coverage to a non-employee director creates a MEWA—otherwise there would be no need for the exception.

Issue #2: State Insurance Law Restrictions

In general, a self-insured employer-sponsored group health plan is not subject to state insurance law because of ERISA preemption.

However, one important consequence of providing benefits through a MEWA is that you lose much of the ERISA preemption of state law. An exception in the ERISA preemption rules provides that state insurance law can regulate a self-insured MEWA. In other words, unlike standard single employer plans, MEWAs do not enjoy ERISA preemption from state insurance mandates even if they are self-insured.

In California, state insurance law has prohibited the creation of any new self-funded MEWA since 1995. A handful of other states have taken a similar approach to essentially ban new self-funded MEWAs to address a sordid history of criminal actors fraudulently promoting the arrangements while withholding or embezzling the plan assets. As a result of the MEWA exception from ERISA preemption that allows state insurance mandates to apply, any such state actions to prohibit the creation of new self-insured MEWAs through state insurance law are fully enforceable.

Self-insured health plans therefore cannot be made available to independent contractors in California or any other state where it would violate state insurance law because of the creation of a MEWA. Even in a state where self-insured MEWAs are permitted, offering coverage to independent contractors would still create stop-loss coverage issues for the plan that would require advance approval from the stop-loss provider.

Issue #3: Section 125 Cafeteria Plan Exclusion

Only workers who are considered employees for purposes of Section 125 may participate in a cafeteria plan. Therefore, even if the employer chose to offer coverage to independent contractors, the independent contractors would not be eligible to participate in any component of the Section 125 cafeteria plan.

The three primary effects of the cafeteria plan exclusion for independent contractors are:

1. They cannot pay premiums for any health and welfare benefits on a pre-tax basis through the Premium Only Plan (POP);
2. They cannot participate in the health FSA or dependent care FSA; and
3. They cannot make HSA contributions through payroll on a pre-tax basis.

Therefore, because self-employed individuals cannot participate in any component of the cafeteria plan, independent contractors enrolled in the health plan would have to pay the premium on an after-tax basis. The share of the premium paid by the employer would also be taxable income to the independent contractors.

Alternative Approach: Individual Coverage Reimbursement

There is no issue with an employer reimbursing all or a portion of independent contractors’ individual health coverage, such as coverage on the Exchange. This must be done on a taxable basis, with a gross-up if desired.

Reminder: ACA Employer Mandate Does Not Apply to Properly Classified Independent Contractors

The ACA employer mandate rules apply only to an employer’s common-law employees. With respect to workers who are properly classified independent contractors, the ACA employer mandate does not apply.

The ACA employer mandate rules add yet another reason why proper classification of workers as common-law employees or independent contractors is always of crucial importance. One of the many potentially costly consequences of a retroactive reclassification of independent contractors to common law employees would be “A Penalty” exposure for failure to offer coverage to at least 95% of employees (and their children to age 26).

Since the landmark Microsoft case where purported independent contractors were retroactively reclassified as common law employees, ERISA plan documents typically include a provision to clarify that any worker classified as an independent contractor who is subsequently reclassified as a common law employee is not eligible to participate in the plan on a retroactive basis. This is commonly referred to as “Microsoft language” in the plan document.

However, the IRS has confirmed that there is no ability for employers to avoid retroactive ACA employer mandate penalties where workers are retroactively reclassified. In explaining its refusal to add such protection, the IRS stated that “the relief requested would serve to increase the potential for worker misclassification by significantly increasing the benefit of having an employee treated as an independent contractor.”

Summary

For the reasons outlined above, employers should generally avoid making health plan eligibility exceptions to enroll independent contractors reported via Form 1099 (i.e., not a Form W-2 common law employee). The legal, insurance carrier, and administrative issues associated with allowing independent contractors to participate in the health plan make the approach unviable from any practical perspective—particularly with respect to the multiple thorny problems that would result from the likely inadvertent establishment of a MEWA.

Alternatively, employers can utilize the common workaround strategy of directly paying for or reimbursing all or a portion of independent contractors’ individual health coverage, such as coverage on the Exchange.

The Author

Brian Gilmore

Lead Benefits Counsel, VP, Newfront

Brian Gilmore is the Lead Benefits Counsel at Newfront. He assists clients on a wide variety of employee benefits compliance issues. The primary areas of his practice include ERISA, ACA, COBRA, HIPAA, Section 125 Cafeteria Plans, and 401(k) plans. Brian also presents regularly at trade events and in webinars on current hot topics in employee benefits law.