A principal benefit of our federalist system is that it encourages states to experiment with different strategies for addressing important issues. When a state develops a strategy that works, other states can emulate it; when a state tries a strategy that fails, other states can avoid a similar mistake.
The first anniversary of H. 4850, An Act Providing Access to Affordable, Quality, Accountable Health Care (commonly known as the “Fair Share” law), enacted in April 2006, reveals two significant flaws in the Massachusetts experiment for reducing the number of individuals without health insurance, namely, (i) it renders self-employed service providers less competitive in the marketplace, and (ii) it encourages employers to provide health-care coverage that is tax disadvantaged and that can expose the health plan providing the coverage to additional regulatory burdens.
The state’s implementation of the Fair Share law validates the inherent pressures under an employer mandate to expand as broadly as possible the individuals whom the mandate covers. In the case of the Fair Share law, such pressures have led to an overly broad definition of covered employee, making it extremely difficult for an individual to qualify as self employed. The Health Security Act, S. 1757, introduced in the 103rd Congress in 1993, and spearheaded by Hillary Clinton during her husband’s presidency, also contained an employer mandate, and it, too, contained provisions designed to prevent individuals from qualifying as independent contractors.
To be sure, independent contractors providing services in Massachusetts might find that market less inviting these days, as their clients begin to realize that the Fair Share law could cost them an additional $295 per year, per independent contractor that is reclassified as the client’s employee for purposes of Fair Share contributions.
The Massachusetts Fair Share law requires a business with 11 or more employees to cover under a group health plan each employee who works for the business at least 35 hours per week, or to make an annual Fair Share contribution of $295 for each such employee. Employers that fail to provide the requisite coverage can also be exposed to an additional “free rider surcharge” with respect to its employees who obtain free health care.
In regulations that became effective October 1, 2006, the Massachusetts Department of Labor announced the test for determining which individuals qualify as covered employees for purposes of this new law. It did so by defining the category of service providers not covered, i.e., by defining independent contractors. It defined independent contractors very narrowly, adopting a three-factor ABC test that many states, including Massachusetts, use to define independent contractors for purposes of unemployment. To qualify as an independent contractor under the restrictive ABC test, an individual must satisfy all three of the following requirements:
- The individual must be free from control and direction in the execution of his or her job,
- The individual must perform a service outside the usual course of business of the employer, and
- The individual must routinely work in an independently established trade, occupation, profession or business.
The ABC test in the context of the Fair Share law creates a much smaller universe of independent contractors than any state’s unemployment law, because all states that follow an ABC test for unemployment also have a long list of statutory exemptions. These states statutorily exempt categories of individuals, such as direct sellers, Realtors and taxi drivers, who can fail the ABC test, but still remain outside of unemployment coverage. The Fair Share law did not incorporate these exemptions, which means that many individuals who cannot satisfy the ABC test – but nonetheless are statutorily exempt from unemployment taxes – will be treated as employees for purposes of the Fair Share law.
To illustrate the narrow purview of the ABC test, the following types of individuals have been engaged as independent contractors, held to fail the ABC test and reclassified as employees for purposes of a state’s unemployment statute: truck drivers,1 health-care professionals,2 providers of home care for the elderly and disabled,3 couriers,4 Realtors,5 direct sellers,6 freelance newspaper reporters,7 baseball umpires,8 golf professionals,9 barbers,10 taxi drivers,11 commissioned sales representatives,12 and many types of freelance service providers, such as product demonstrators, who obtain client opportunities through brokers and referral agencies.13
To be sure, it will only be a matter of time before the Division of Unemployment Assistance, which has responsibility for collecting Fair Share contributions, will begin auditing businesses for Fair Share compliance. In cases where independent contractors are determined not to satisfy the ABC test, a Fair Share assessment will no doubt be imposed on the client. Also, in cases where the Division reclassifies independent contractors as employees in an unemployment audit, an assessment for Fair share contributions will likely accompany any assessment for unemployment taxes.
In addition to being overly restrictive and exposing client companies to Fair Share assessments, another problem with the ABC test being used for purposes of the Fair Share law is that its definition of independent contractor is significantly narrower than the “common-law” definition – which is used for purposes of the Internal Revenue Code and the Employee Retirement Income Security Act of 1974. This mismatch of coverage is important, because the favorable tax treatment that the tax law accords employer-provided health benefits is available only to individuals who qualify as common-law employees of the sponsoring employer.14 This means that the value of any employer-provided health benefits received by an individual who is an employee for purposes of the Fair Share law, but not under the common law, will be treated as taxable income to the individual. Furthermore, an employer-sponsored group health plan that extends coverage to individuals who are self-employed under the common-law test can be deemed a specially regulated entity called a multiple employer welfare arrangement (“MEWA”) and find itself subject to additional information-reporting obligations at the federal level and to additional regulation by state insurance laws.15
To illustrate the plight of an unwary business seeking to comply with the Fair Share law, imagine a business being audited by the Division and assessed Fair Share contributions based on common-law independent contractors being reclassified as employees for purposes of the Fair Share law. To avoid similar assessments in the future, the business covers the reclassified individuals under its group health plan. The next year, the business is audited by the U.S. Department of Labor and assessed a penalty for failing to comply with the additional reporting obligations that apply to a group health plan that covers common-law independent contractors and is deemed a MEWA. In early April of that year, the business receives an angry call from the accountant for one of the independent contractors, seeking information on the value of health benefits the independent contractor received under the group health plan. The accountant explains that in order to qualify for the tax exclusion applicable to employer-provided health benefits, an individual must qualify as a common-law employee of the sponsoring employer.
For all these reasons, companies will likely find it impractical to cover such independent contractors under a group health plan. Instead, they will pay the $295 contribution for each independent contractor that is deemed an “employee” for purposes of the Fair Share law.
Independent contractors might react to these client concerns by establishing corporations and offering their services through incorporated entities. At this juncture, it is unknown whether this strategy would protect a client against Fair Share exposure. Such a reaction would be unfortunate, however, because corporations are generally exempt from Form 1099 information-reporting requirements, and Internal Revenue Service data indicate that federal-tax compliance is approximately 97% for compensation reported on Forms 1099, but significantly lower in the absence of information reporting. States should be aware that taxpayers who do not report income for federal-tax purposes probably do not report that income on their state tax returns.
The Fair Share law’s impact on independent contractors reveals a fundamental defect in the employer-mandate approach for expanding health-insurance coverage. Companies that contract with independent contractors remain susceptible to Fair Share assessments in the event of a reclassification – making self-employed service providers far less attractive to potential clients. The resulting mismatch of coverage, as between the Fair Share law and the laws governing benefits, exposes individuals covered by health plans to vexing tax risks, and exposes health plans providing the coverage to the risk of additional regulatory burdens.
Other states considering an employer-mandate should carefully reflect on the Massachusetts experiment. States that value entrepreneurship should acknowledge the fundamental incompatibility of an employer mandate and a vibrant independent-contractor sector.
1. Truck drivers were held to be employees under the ABC test in
Alaska Contracting & Consulting, Inc. v. Alaska Department of Labor, 8 P.3d 340, 2000 Alas. LEXIS 89, Unemployment Ins. Rep. (CCH) P8171 (Alaska 2000).
2. A variety of health-care professionals were held to be employees under the ABC test in Allied Resources for Correctional Health v. Maine Unemployment Insurance Commission, 680 A.2d 456; 1996 Me. LEXIS 179 (Me. 1996).
3. Home-care providers were held to be employees under the ABC test in Home Care Professionals of Arkansas, Inc., v. Williams, 2006 Ark. App. LEXIS 339 (Ark. App. May 10, 2006).
4. Couriers were held to be employees under the ABC test in Financial Institutions Service Corp. v. Unemployment Security Commission, 1997 Me. Super. LEXIS 157 (Me. Super. 1997); Boston Bicycle Couriers v. Division of Employment & Training, 56 Mass. App. Ct. 473; 778 N.E.2d 964; 2002 Mass. App. LEXIS 1407; Unemployment Ins. Rep. (CCH) P8481 (Mass. App. 2002)
5. Beal v. Industrial Commission, 535 S.W.2d 450; 1975 Mo. App. LEXIS 1883 (Mo. App. 1975)
6. Direct sellers were held to be employees under the ABC test in House of Lloyd, Inc. v. Department of Labor, 1994 Me. Super. LEXIS 417 (Me. Super. 1994)
7. Freelance newspaper reporters were held to be employees under the ABC test in Lewiston Daily Sun v. Unemployment Ins. Commissioner, 1999 ME 90; 733 A.2d 344; 1999 Me. LEXIS 103; Unemployment Ins. Rep. (CCH) P8437 (Me. 1999)
8. A baseball umpire was held to be employees under the ABC test in In re Unemployment Insur. Tax Contribution, Pioneer Baseball League, 233 Mont. 384; 760 P.2d 93; 1988 Mont. LEXIS 255; 45 Mont. St. Rep. 1573 (Mont. 1988).
9. A golf professional was held to be employees under the ABC test in New Haven Country Club Corp. v. Administrator, 1999 Conn. Super. LEXIS 2525 (Conn. Super. 1999)
10. Barbers were held to be employees under the ABC test in Department of Employment Security v. Charlie’s Barber Shop, 187 A.2d 695 (Md. App. 1963).
11. Taxi drivers were held to be employees under the ABC test in Blue Bird Cab Co., Inc. v Maryland Department of Employment Security, 248 A.2d 331 (Md. App. 1968).
12. Commissioned sales representatives were held to be employees under the ABC test in ABC Advertising, Inc. v. Arkansas Employment Security Department, 1994 Ark. App. LEXIS 261 (Ark. App. 1994).
13. Product demonstrators who obtain client opportunities through a broker were held to be employees of the broker under the ABC test in JSF Promotions, Inc. v. Administrator, 265 Conn. 413; 828 A.2d 609; 2003 Conn. LEXIS 319 (Conn. 2003).
14. Code section 105 excludes from taxable income the amount received by an employee for medical care; Treas. Reg. § 1.106-1 excludes from the taxable income of an employee the amount of contributions made by his employer to an accident or health plan; code section 3121(a)(2)(B) and (C) exclude from FICA taxes any amount paid by an employer for insurance or directly to an employee under a plan providing benefits covering medical or hospital expenses in connection with sickness or accident disability.
15. ERISA section 3(40) defines a multiple employer welfare arrangement (“MEWA”) as including a health-benefit plan that covers one or more self-employed individuals. A MEWA is subject to increased information reporting obligations at the federal level, (e.g., the Form M-1 administered by the U.S. Department of Labor) and to state-law insurance regulation.
