Update: Treatment of Temporary Employees in Employee Benefit Plans; Availability of COBRA Coverage when the Employee is Covered Under Another Group Health Insurance Plan; and IRS Guidance on Distributions to Plan Participants Who Reach Age 70

From Employee Benefits Alert

October 1998

Temporary Employees

The litigation between Microsoft and its independent contractors and temporary employees has caused many employers to reexamine their practices regarding such employees. In the original district court and appeals court cases, the courts held that independent contractors who had contractually waived their right to coverage under MicrosoftÕs 401(k) and stock purchase plans were, in fact, common law employees of Microsoft who were eligible to be covered under plans. A recent district court decision in this case has held that temporary employees hired by Microsoft from employment agencies were also common law employees of Microsoft.

After an IRS audit which found that MicrosoftÕs independent contractors should have been treated as employees for employment tax purposes, Microsoft required most of the contractors to sign agreements with temporary employment agencies so that the employment agencies could employ the workers and lease them to Microsoft. The workers performed services only for Microsoft and had no contact with the employment agency except to receive paychecks and W-2 forms.

The court listed five factors to consider in determining whether a temporary employee is a common law employee of the company for whom the services are provided: (1) whether the agency or the company recruited the worker; (2) the extent of the training the company provides to the worker; (3) the duration of the workerÕs relationship with the company; (4) the companyÕs right to assign additional projects to the worker; and (5) whether the company may influence the relationship between the worker and the agency. Based on these factors, the court held that the temporary employees were common law employees of Microsoft.

This case suggests that employers cannot simply transfer their independent contractors to a temporary employment agency and immediately hire them back from the agency. Under the standards adopted by the district court in the recent Microsoft decision, the temporary employees likely would be common law employees of the employer and thus included in the employerÕs employee benefits plan unless there was a specific, valid exclusion in each plan excluding such employees from coverage.

Another recent case reaffirms the employerÕs ability to exclude certain categories of workers from coverage under employee benefit plans. In Bronk v. Mountain States Telephone and Telegraph, Inc., the U.S. Court of Appeals for the Tenth Circuit reversed a district court decision and held that the company could exclude leased employees from its qualified plans. The district court had held that any employee meeting the common law definition of employee must be covered. The court of appeals stated that ERISA does not prohibit an employer from distinguishing between groups or categories of employees and providing benefits for some but not for others. Employers do not have complete discretion in excluding employees, however, because the Treasury Regulations require that qualified plans benefit a "reasonable classification" of employees which is established under the objective business criteria.

COBRA Coverage

In our last issue we discussed a controversy over whether an employer must provide COBRA continuation coverage to an employee when the employee has coverage under another health insurance plan at the time the employee elects to receive continuation coverage under the employerÕs plan. The United States Supreme Court has recently answered this question in its decision in Geissel v. Moore Medical Corp.

The Supreme Court held that ERISA ¤602(2)(D)(i) permits an employer to terminate an employeeÕs COBRA continuation coverage only when coverage under a second group health plan begins after the date on which the employee makes an election to receive COBRA continuation coverage. Accordingly, when an employee is covered under a second group health plan before he elects COBRA continuation coverage under the employerÕs plan, he remains eligible for continuation coverage.

For example, if an employee is covered under both her employerÕs group health plan and her husbandÕs group health plan, she may elect COBRA continuation coverage under her employerÕs health insurance plan even though she already has alternative coverage. If the employee was covered only under her employerÕs group health plan, however, and makes an election to receive continuation coverage under that plan, her right to continuation coverage would cease if she thereafter became covered under her husbandÕs group health plan or if she obtained group health coverage from a subsequent employer.

The Supreme CourtÕs decision in Geissel is contrary to the proposed Treasury Regulations issued by the IRS in 1987. The IRS has announced that employers who followed the proposed regulations in good faith prior to the Geissel decision would not be subject to excise taxes for noncompliance with COBRA. Employers who denied COBRA continuation coverage to employees in reliance on the proposed regulations may nevertheless be liable to the employee for denial of coverage.

Distributions to Employees Reaching Age 70

The IRS has issued final regulations providing relief from the anti-cutback rule which prevents an employer from eliminating an optional form of benefit from a qualified retirement plan. The final regulations permit employers to amend their plans to eliminate pre-retirement distributions to employees who reach age 70_. The regulations permit plan amendments that eliminate the right to the pre-retirement distribution with respect to employees who attain age 70_ in a calendar year that begins after the later of December 31, 1998 or the date the amendment is adopted. Employees who reach age 70_ in 1997 or 1998 must be given the option to receive pre-retirement distributions in accordance with the minimum distribution provisions of the plan. Employers who wish to eliminate the pre-retirement distribution option beginning in 1999 must adopt the appropriate plan amendment during 1998.

The final regulations do not affect profit sharing plans that permit employees to receive in-service distributions after age 59. Such plans would continue to permit pre-retirement distributions after age 70 even after the elimination of the age 70 minimum distribution rule.

For further information on these or other employee benefits matters, please contact Paul J. Powers, Jr. or Kirk H. O'Ferrall at our New York office.