Worker Classification Rules: Impact on Group Health Plans

Navigating Worker Classification Rules and the Impact on Group Health Plans

Employees versus Self-Employed Workers

Correctly classifying workers as employees or independent contractors is essential for an organization to comply with various federal, state, and local laws.

  • Independent contractors generally do not receive the same benefits and protections under the law as employees.
  • Employers are not required to withhold or pay taxes on payments to independent contractors.

Misclassifying an employee as an independent contractor can have serious financial and legal consequences for an employer, including unpaid overtime pay, back taxes, interest and penalties, unpaid benefits and other legal damages.

This article does not walk through the details of how to correctly classify workers. Instead it addresses the importance classifying correctly, the impact of new rules, and some consequences if done incorrectly. 

A first step is understanding the various definitions of “employee.”

Distinction Between Classification Rules

The definition of an employee under ERISA and the Internal Revenue Code (IRC) rules that impact group health benefits is different than, and is not consistent with, the definition of an employee for purposes of the FLSA and employment laws.

Health Benefits Laws

  • Most employee benefit plan rules determine employee status (and who is an eligible employee) under ERISA or the IRC in conjunction with the “common-law employee” standard. 

  • For group health plan purposes, a common-law employee (who would receive a W-2 form for tax purposes) is distinguished from a worker who is an independent contractor (who would receive a 1099 form for tax purposes) or an employee of another entity.

  • There are more specifics, but generally, the test for common-law employee status focuses on who has the right to control the manner and means by which the work product is accomplished and considers the facts and circumstances of the particular situation under a multi-factor test (in which no single factor is determinative).

  • The FLSA standard for “employee” on the other hand, governs minimum wage and overtime requirements that apply to employees but not to independent contractors.

  • Although a standard already existed, in January 2024, the U.S. Department of Labor (DOL) issued a new analysis for worker classification under the FLSA. This new analysis only applies to the FLSA, it does not apply directly to employee benefits laws. 

  • There are more specifics, but generally, this new FLSA standard applies six economic reality factors to analyze and determine employee or independent contractor status.

Impact of Workers Classifications on Health Benefits Rules

Although the new FLSA classification rules do not directly apply to employee health benefits, it has an important indirect impact.  The new FLSA analysis will likely result in more workers classified as employees and a reduction of workers classified as independent contractors. 

A larger number of employees, meaning a bigger employee count, can directly impact employers that sponsor group health benefits.  For example, a larger employee count can affect whether and how an employer must comply with rules such as: ACA employer shared responsibility, ACA 1094/1095 reporting, COBRA, Form 5500 filing, and Medicare Secondary Payer (MSP). 

Worker classifications can also impact a group health plan in ways other than employer size, examples include MEWAs and the Internal Revenue Code.

Details of:

  1. the impact on employers due to increased employee count,  and
  2. the impact on employers for reasons unrelated to size, are discussed in more detail below.

Impact on employers due to increased employee count

Smaller employers that have an increased employee count due to reclassification of workers under either the new FLSA rules or existing health benefits rules should take the next step to monitor whether that increase triggers any additional compliance obligations under federal, state and local laws.

The following federal employee benefit requirements may be triggered by an increase in employee count:

GBS Health Benefits Compliance_Independent Contractors and Employees_March 2024-table
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Impact on employers for reasons unrelated to size

Another impact of worker classifications not based on size, are based instead on the classification itself. For example, whether a worker is an employee or independent contractor affects eligibility for the employer’s group health plan. Generally, an independent contractor should not be eligible for an employer’s group health plan.

Employers that sponsor group health plans are often unfamiliar with the term MEWA.  A Multiple Employee Welfare Arrangement (MEWA) is a plan that is established for the purpose of providing medical or other welfare benefits to employees of two or more unrelated employers (entities not part of a controlled group), including one or more self-employed individuals. 

MEWAs are regulated under federal ERISA, but they must also comply with state laws and regulations, (which can vary significantly between states). This dual level of regulation (federal and state/local) adds an extra layer of complexity. 

Entities that intentionally create MEWAs are often proactive about compliance and carefully establish robust policies and procedures through tax and legal professionals to ensure compliance. However, some employers unintentionally create a MEWA, not realizing the impact of their actions. 

An unintentional MEWA, also referred to as an inadvertent MEWA, is typically created when an employer:

  • offers its group health plan to one or more unrelated entities (entities not part of a controlled group)
  • offers its group health plan to one or more self-employed individuals

Note that employers may choose to permit former employees (e.g., retirees) to participate in a plan without risk of creating a MEWA.  Under IRS rules, former employees are treated as employees.  And under ERISA, a “participant” is defined to include any employee or former employee. 

What individuals are considered “self-employed”

Because a MEWA can be created if an employer or entity offers a group health plan to one or more self-employed individuals, it is important to understand who is included in the definition of a “self-employed” individual. The following are generally considered self-employed individuals:

  • partners
  • sole proprietors
  • more-than-2% shareholders in an S-corporation
  • non-employee directors
  • independent contractors

However, there are nuances that arise here.  For example, the U.S. Department of Labor (DOL) has suggested informally that a group health plan offered to independent contractors will create a MEWA, but for other types of self-employed individuals, that may not be the case.

It seems that in the DOL’s view, there is a difference in the MEWA analysis between independent contractors and the others on the list.  This may be because an independent contractor is by nature more independent and typically more  removed from the entity, whereas the others have a connection and at least some control over the entity. 


  • Partners are also generally considered self-employed, but the DOL has commented that a plan sponsored by a partnership and covering only partners and common law employees of the partnership is not considered a MEWA because partners should be treated as employees for this purpose.

Sole proprietors and more-than-2% shareholders in an S-corporation:

  • Although no specific guidance has been provided by the DOL pertaining to sole proprietors, and more-than-2% shareholders in an S-corporation, it appears reasonable to apply the same partnership analysis.

Non-employee directors:

  • Although covering non-employee directors would (by definition) create a MEWA, in 2005 the DOL refused to specifically answer whether covering both employees and non-employee directors would result in a MEWA, as they expected to issue an advisory opinion on the topic.  The DOL did not issue that advisory opinion, but it later issued regulations that exempted plans from the MEWA federal M-1 reporting requirement if less than 1% of participants are non-employee directors, and the plan would not be a MEWA but for the coverage of the non-employee directors. 
  • But note that even if the plan is exempt from the M-1 filing, the plan still meets the definition of a MEWA and is subject to applicable state laws (discussed below).

In sum, employers considering offering its group health plan to independent contractors can be confident that such a policy would likely create an inadvertent MEWA. 

Conversely, employers considering offering its group health plan to individuals that are partners, sole proprietors and more-than-2% shareholders in an S-corporation, and non-employee directors should be aware of the nuances as described above.  It would be valuable to seek counsel from its own tax and legal professionals for specific advice.  It is also important to note that the DOL enforcement efforts have historically not focused on MEWAs created by the participation of owners.  Rather, the DOL has focused on businesses that create MEWAs for the sole purpose of offering its group health plan to unrelated employers (other entities part of a controlled or affiliated service group) and  individuals classified as independent contractors. 

Consequences of Inadvertently Creating a MEWA

There are multiple reasons an employer may want to avoid creating an inadvertent MEWA. Given the potential administrative burden that results when a MEWA is created, plan sponsors should carefully consider whether covering non-employees is worth the added responsibility.

State Rules

MEWAs are subject to state rules even when the plan is subject to federal ERISA – and this consequently results in increased compliance burdens.  Most states have adopted MEWA regulations and requirements, and the impact of those state rules differs depending on the state and on whether a plan is fully insured or self-insured.  Note that some states completely prohibit all MEWAs.  Other states prohibit only self-insured MEWAs.     


MEWAs are also subject to additional ERISA requirements.  MEWAs must file a Form M-1 when the plan provides medical benefits unless an exemption exists. The Form M-1 must be filed with the DOL 30 days prior to operating in any state or new state and annually thereafter by March 1.  The Form provides the DOL with information on compliance with various federal laws, including HIPAA, MHPAEA, and other laws.

Form 5500

A plan’s MEWA status could also change its Form 5500 reporting obligations under ERISA.  Generally, when an unfunded and/or fully insured ERISA plan is not a MEWA, a small plan exception allows ERISA plans with fewer than 100 covered participants at the beginning of the plan year to avoid filing for that plan year. But, if the plan is a MEWA, the small plan exception does not apply, thereby requiring a Form 5500 every year.  Additionally, if the plan is required to file an M-1, it must indicate that on Part III of the Form 5500.

IRC Section 125 Cafeteria Plans

Most employers and employees use a cafeteria plan to allow pretax contributions toward qualified benefits (e.g., medical, dental, health FSA, etc.).  While the cafeteria plan rules allow pretax contributions for common-law employees, the regulations expressly prohibit self-employed individuals from participating in an employer’s cafeteria plan.  The cafeteria plan restriction also applies to health FSAs and pretax contributions toward dependent care FSAs (DCAPs) and health savings accounts (HSAs).

Self-employed individuals may not participate in the cafeteria plan, meaning benefits should be paid post-tax even though employees pay pre-tax.  An exception to that rule include “dual status” individuals who may participate in their capacity as an employee.

  • “Dual status” means that an individual provides services to the employer as both an employee and as a director or independent contractor. 
  • In a practical sense, this means that employers may allow cafeteria plan deductions from the individual’s W-2 income earned as an employee, but not from other income received as a director or independent contractor. 
  • The dual status rule may allow a corporation’s board member (who is also an employee) to participate in his capacity as an employee, but partners and more-than-2% shareholders in an S-corporation may not use this dual status rule to participate. 
  • Although a sole proprietor may sponsor a cafeteria plan for its employees, the sole proprietor may not participate in the cafeteria plan to make pretax contributions.

Nondiscrimination Issues

An employer sponsoring a cafeteria plan or self-insured medical plan will also need to consider any impact when extending eligibility to self-employed individuals (or their employee-spouse or dependents) on the nondiscrimination requirements of those plans.

The nondiscrimination requirements under IRC Section 125 (for cafeteria plans) and under IRC Section 105(h) (for self-insured medical plans) prohibit these plans from discriminating in favor of highly compensated/key employees (a prohibited group). For individuals who hold a dual status or are eligible through their employee family members, the dual status individual’s income and own employee-shareholder status may make them part of the prohibited group.  And family members on their own or due to constructive ownership rules may be part of the prohibited group. 

Plan sponsors should consider running preliminary tests on the plan to ensure it will pass nondiscrimination testing with the self-employed individuals on the plan. 

Fiduciary Duties under ERISA

Fiduciaries of the group health plan (employers) have a duty to specifically follow its plan documents and  administer the plan according to its written terms. Eligibility for the group health plan is outlined specifically in plan documents.  Following the plan terms also helps avoid self-insuring/stop loss claims where an insurer may refuse to pay if non-employees are not specifically made eligible for the plan under its written provisions.

Employer Steps

if an employer is considering allowing self employed individuals to participate in the group health plan, it should consider:

  • Does the individual’s participation create a MEWA and require MEWA compliance?
  • If the plan will be a MEWA, how do the applicable state MEWA laws impact the employer and plan?
  • Does the plan language need to be amended to allow these individuals to participate?
  • If the plan is insured, does state insurance law permit those participant and will the insurer agree to the contract change?


Employers should take time to revisit worker classification rules to review and properly classify (or reclassify) workers under both FLSA rules and the “common law employee” standards under ERISA and the Internal Revenue Code.

Then, with health benefits compliance in mind, determine whether any adjusted employee classifications trigger one or more compliance issues based on:  1) employer size, and 2) issues other than employer size e.g. eligibility and inadvertent MEWAs.

March 2024
This document is not intended to be exhaustive, nor should any information be construed as tax or legal advice. Readers should contact a tax professional or attorney if legal advice is needed. Although we have made every effort to provide complete, up-to-date, and accurate information in this document, such information is meant to be used for reference only. If there is any inconsistency between the information contained in this document and any applicable law, then such law will control.
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