As we have discussed in prior posts, many employers are looking at ways to restructure their workforces due to the ACA.  In addition to ACA issues, a worker who has been misclassified can have negative consequences on the employer’s employee benefits.  The following are just a few of the consequences in a retirement plan:

  • If misclassified, the worker may be entitled to participate in the company retirement plan going back to the date he or she would have been eligible.
    • If the plan is a 401(k) plan, the employer must contribute matching and non-elective employer contributions, just as paid to other plan participants, 50% of the average deferral percentage amount for the employee’s group, and investment earnings on incorrectly omitted plan assets.  The government essentially wants the employer to put the worker in the position he or she would have been if properly classified.
    • If the plan is a defined benefit pension, the employer must make plan contributions sufficient to fund the participant’s accrued benefit in accordance with the plan’s terms.
  • In addition to the cost involved, the plan may be deemed to have violated the minimum participation standards under ERISA.
  • Employers who mistakenly include those employees who are not eligible because they are independent contractors risk the plan’s disqualification for violation of the “exclusive benefit rule” under the IRC.

As with retirement plans, the failure to include a worker qualified to participate in a welfare benefit plan due to misclassification may expose the employer to liability for damages for benefits wrongfully denied and breach of fiduciary duty under ERISA.  Again, this could lead to the welfare plan being disqualified.  Disqualification of a welfare benefit plan under the IRC typically results in the need for employer contributions and, in some circumstances, plan benefits being includible in all participating employees’ income.

On the other hand, inclusion of a worker who is not eligible may result in a company having to reimburse its insurance or reinsurance carrier for benefits paid by the carrier from its general funds.

In addition to the problems in retirement and welfare plans, employee misclassification in a company’s cafeteria plan can cause substantial problems.  The inclusion of just one employee who is not a bona fide employee may disqualify the entire cafeteria plan.  That would result in any and all benefits received by participants from the cafeteria plan becoming includible in income in the plan year in which they are paid.