Addressing Employee Health Plan Exception Requests: Part IV

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.

For more details, see:

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. This is treated as a personal liability of the plan administrator, and it cannot be paid with MEWA assets. Furthermore, unlike the Form 5500 DFVCP program, there is no delinquent filer program providing reduced penalties for missed Form M-1 filings.

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.

MEWAs also generally cannot take advantage of the exemption from the requirement to hold plan assets in trust that applies to most single employer plans. Accordingly, the employer would need to establish a trust to hold health plan contributions, and that trust would need to be audited with the audit report included in the Form 5500 filing.

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.

For more details, see:

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.

With respect to non-employee directors, it is also likely that offering coverage through a self-insured health plan would create a prohibited self-insured MEWA in California and other states that impose such a restriction through state insurance law. Furthermore, even if the health plan is fully insured, state insurance law in some cases will prevent extending participation to non-employee directors under the insurance policy. For example, a separate state insurance law provision in California prohibits offering coverage to non-employee directors under a fully insured plan.

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 (which, again, generally is not a viable option for all of the reasons stated above), 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:

They cannot pay premiums for any health and welfare benefits on a pre-tax basis through the Premium Only Plan (POP);

They cannot participate in the health FSA or dependent care FSA; and

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.

Note: The ACA prohibits employers from reimbursing an employee’s individual policy (outside of an ICHRA), but this prohibition does not apply to properly classified independent contractors (who are not employees).

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. (Vizcaino v. Microsoft Corp., 120 F.3d 1006 (9th Cir. 1997))

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.  Accordingly, the final regulations do not adopt this suggestion.”


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.

Relevant Cites

ERISA §514(b)(6)(A):

(6) (A) Notwithstanding any other provision of this section—

(i) in the case of an employee welfare benefit plan which is a multiple employer welfare arrangement and is fully insured (or which is a multiple employer welfare arrangement subject to an exemption under subparagraph (B)), any law of any State which regulates insurance may apply to such arrangement to the extent that such law provides—

(I) standards, requiring the maintenance of specified levels of reserves and specified levels of contributions, which any such plan, or any trust established under such a plan, must meet in order to be considered under such law able to pay benefits in full when due, and

(II) provisions to enforce such standards, and

(ii) in the case of any other employee welfare benefit plan which is a multiple employer welfare arrangement, in addition to this title, any law of any State which regulates insurance may apply to the extent not inconsistent with the preceding sections of this title.

ABA JCEB Q/A (May 18, 2005):

A follow-up question was asked regarding an arrangement offering or providing health benefits maintained by one employer and covering common law employees of the employer and several independent contractors. DoL staff indicated that they would generally read the reference to self-employed individuals in section 3(40) as resulting in such arrangements being MEWAs.

DoL staff also indicated that because they have a pending advisory opinion request on the subject, they were not prepared to provide an answer in this context on the issue of whether a health plan maintained by a single employer would be a MEWA if it were extended to cover nonemployee members of the employer’s board of directors.

29 CFR §2520.101-2(c)(2)(ii)(C):

 (ii) Nothing in this paragraph (c) shall be construed to require reporting under this section by the administrator of an entity that would not constitute a MEWA or ECE but for the following circumstances under this paragraph (c)(2)(ii).

(C) The entity provides coverage to persons (excluding spouses and dependents) who are not employees or former employees of the plan sponsor, such as non-employee members of the board of directors or independent contractors, and the number of such persons who are not employees or former employees does not exceed one percent of the total number of employees or former employees covered under the arrangement, determined as of the last day of the year to be reported or, determined as of the 60th day following the date the MEWA or ECE began operating in a manner such that a filing is required pursuant to paragraph (e)(1)(i), (2), or (3) of this section.

29 CFR §2520.101-2(c)(3), Example 4:

Example  (4)  (i) Facts. Company E maintains a group health plan that provides benefits for medical care for its employees (and their dependents) as well as certain independent contractors who are self-employed individuals. The plan is therefore a MEWA. The administrator of Company E's group health plan uses calendar year data to report for purposes of the Form M-1. The administrator of Company E's group health plan determines that the number of independent contractors covered under the group health plan as of the last day of calendar year 2013 is less than one percent of the total number of employees and former employees covered under the plan determined as of the last day of calendar year 2013.

(ii) Conclusion. In this Example 4, the administrator of Company E's group health plan is not required to report via the Form M-1 for calendar year 2013 (a filing that is otherwise due by March 1, 2014) because it is subject to the exception to the filing requirement provided in paragraph (c)(2)(ii)(C) of this section for entities that cover a very small number of persons who are not employees or former employees of the plan sponsor.

ERISA §403(a):

(a) Benefit plan assets to be held in trust; authority of trustees.

Except as provided in subsection (b), all assets of an employee benefit plan shall be held in trust by one or more trustees.


When the spouse [sic] of an ERISA-covered plan uses a MEWA to provide helath [sic] care coverage for its employees, the assets of the MEWA generally are considered to include the assets of the plan, unless the MEWA is a State licensed insurance company. In exercising discretionary authority or control over plan assets, such as paying administrative expenses and making benefit claim determinations, the person or persons operating the MEWA would be performing fiduciay [sic] acts governed by ERISA’s fiduciary provisions.

Prop Treas. Reg. §1.125-1(g)(2)(i):

(2) Self-employed individual not an employee.

(i) In general. The term employee does not include a self-employed individual or a 2-percent shareholder of an S corporation, as defined in paragraph (g)(2)(ii) of this subsection. For example, a sole proprietor, a partner in a partnership, or a director solely serving on a corporation's board of directors (and not otherwise providing services to the corporation as an employee) is not an employee for purposes of section 125, and thus is not permitted to participate in a cafeteria plan. However, a sole proprietor may sponsor a cafeteria plan covering the sole proprietor's employees (but not the sole proprietor). Similarly, a partnership or S corporation may sponsor a cafeteria plan covering employees (but not a partner or 2-percent shareholder of an S corporation).

California Insurance Code §742.24(h):

To be eligible for a certificate of compliance, a self-funded or partially self-funded multiple employer welfare arrangement shall meet all of the following requirements:

(h)  File an application with the department for a certificate of compliance no later than November 30, 1995.

California Insurance Code §10270.55(e):

(e) Nothing contained herein shall permit a director of a corporate employer to become insured under a group policy unless such person is otherwise eligible as a bona fide employee of the corporation by performing services other than the usual duties of a director.

79 Fed. Reg. 8543, 8568 (Feb. 12, 2014):

However, the relief under Section 530 applies solely for purposes of the employment tax provisions of the Code, and therefore does not apply to potential liabilities under section 4980H.

In response to the limitation on the relief under Section 530, commenters requested that the Treasury Department and the IRS formulate a similar provision in these final regulations applicable to potential liabilities under section 4980H. The Treasury Department and the IRS are concerned 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. Accordingly, the final regulations do not adopt this suggestion.

Brian Gilmore
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.

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