Moving the HME Industry Forward

General Healthcare

Do Not Pay Commissions to 1099 Sales Reps

November 18, 2013

AMARILLO, TX – Apples and oranges. Venus and Mars. Under the law, there is a huge difference between a W2 employee and a 1099 independent contractor.

There is no such thing as a “1099 employee” and there is no such thing as a “W2 independent contractor.” Only a human being can be an employee; an “it” cannot be an employee.

In other words, while John Smith (a human being) can be an employee, John Smith Marketing Group, LLC (an “it”) cannot be an employee. John Smith is either a W2 employee or a 1099 independent contractor—but not both. The 16-year-old-kid that mows my yard on Saturday is a 1099 independent contractor; my secretary (whose office is next to mine) is my employee.

The Medicare anti-kickback statute prohibits offering, paying, soliciting, or receiving any remuneration in exchange for referring (or arranging for the referral of) a patient to a person or entity for any Medicare-covered item or service or in exchange for purchasing, leasing, ordering, or arranging for or recommending purchasing, leasing, or ordering any Medicare-covered item or service.

There are both an exception and a safe harbor to the anti-kickback statute that say that it is permissible for a health care provider (such as a DME supplier) to pay commissions to a bona fide full-time or part-time W2 employee. The reasoning behind this exception is because the supplier has the obligation to supervise and control its employee, and the supplier is liable for the acts of its employee.

On the other hand, a supplier has no duty to supervise and control a 1099 independent contractor, and the supplier is not liable for the acts of a 1099 independent contractor. And so while it is permissible for a DME supplier to pay commissions to a bona fide employee who generates business to the supplier (in which the payer is a government program), it is a violation of the kickback statute if the supplier pays commissions to a 1099 independent contractor who generates business to the supplier (in which the payer is a government program).

The anti-kickback statute cuts both ways: the payer of the money (the DME supplier) and the recipient of the money (the 1099 independent contractor) are both liable under the statute, which is a criminal statute.

A 1989 statement by the Department of Health and Human Services is illuminating: “We are aware of many examples of abusive practices by sales personnel who are paid as independent contractors and who are not under appropriate supervision. We believe that if individuals and entities desire to pay a salesperson on the basis of the amount of business they generate, then to be exempt from civil or criminal prosecution, they should make these salespersons employees where they can and should exert appropriate supervision for the individual’s acts.”

Also instructive is an OIG Advisory Opinion that addressed a proposed arrangement in which a sales representative for a medical supply manufacturer would be paid a monthly commission based on a percentage of amounts invoiced for products sold pursuant to the sales representative’s efforts.

According to the OIG: “Sales agents are in the business of recommending or arranging for the purchase of the items or services they offer for sale on behalf of their principals, typically manufacturers, or other sellers (collectively, “Sellers”). Accordingly, any compensation arrangement between a Seller and an independent sales agent for the purpose of selling health care items or services that are directly or indirectly reimbursable by a Federal health care program potentially implicates the ant-kickback statute, irrespective of the methodology used to compensate the agent. Moreover, because such agents are independent contractors, they are less accountable to the Seller than an employee…For these reasons, this Office has a longstanding concern with independent sales agency arrangements.”

However, the AO did state that in some circumstances, these type of arrangements may be permissible if the sales rep’s contact is structured to fit the Personal Services and Management Contracts safe harbor to the anti-kickback statute.

 When promulgating the proposed rule containing this safe harbor, DHHS highlighted that it was crafted in light of the fact that arrangements for services frequently arise between health care providers/suppliers and their referral sources. According to DHHS, it established the safe harbor “for joint ventures and other arrangements involving payments for personal services or management contracts, but only if certain standards are met and safeguards are present to limit the opportunity to provide financial incentives in exchange for referrals.”

Although a 1099 independent contractor relationship may be established under the safe harbor, such an arrangement must comply with the specific elements of the safe harbor, including the following: (i) payments to the 1099 independent contractor must be pursuant to a written agreement with a term of at least one year, and (ii) the aggregate compensation paid to an independent contractor must be set in advance, consistent with fair market value, and not determined in a manner that takes into account the volume or value of any referrals or business generated.

Note also that the OIG has taken the position that if a 1099 independent contractor paid on a production basis is generating both commercial and federally funded health care program referrals, any arrangement where the independent contractor is paid commissions only for the referrals of commercial patients, and is paid nothing for the patients covered by a government program, nevertheless violates the anti-kickback statute. The reasoning is that the commissions for the commercial patients, in reality, also serve as compensation for the patients covered by a government program.

As stated by the OIG: “[A]s a threshold matter, we must address whether the “carve out” of Federal business is dispositive of the question of whether the Existing Arrangement implicates the anti-kickback statute. It is not. The OIG has a long-standing concern about arrangements pursuant to which parties “carve out” Federal health care program beneficiaries or business generated by Federal health care programs from otherwise questionable financial arrangements. Such arrangements implicate and may violate the anti-kickback statute by disguising remuneration for Federal business through the payment of amounts purportedly related to non-Federal business.”

Here are the “take-aways” from all of this:

1. It is permissible to pay commissions to bona fide W2 part-time or full-time employees who generate patients to the DME supplier in which the payer is as government program.

2. The employment arrangement must be “bona fide,” not a “sham.” The smell test applies. Let’s say that the supplier and the sales rep sign a written employment agreement; let’s say that the supplier withholds taxes from the rep’s paycheck; let’s say that the supplier gives a W2 to the rep; but let’s say that the supplier, in reality, exercises no supervision and control over the rep. It is likely that the this “employment” arrangement will be considered to be a “sham” arrangement…meaning that the government will likely take the position that the rep is, in fact, a 1099 independent contractor of the supplier. This, in turn, will result in a violation of the anti-kickback statute.

3. A sales rep (who generates patients covered by a government health care program) can be a 1099 independent contractor if the arrangement complies with the Personal Services and Management Contracts safe harbor. However, a fixed annual fee arrangement (no commissions) with a sales rep is normally unrealistic.

4. If a 1099 independent contractor sales rep generates both commercial patients and patients covered by a government health care program, the parties cannot avoid violating he anti-kickback statute by the supplier paying commissions only for the commercial patients…and paying nothing for the patients covered by a government health care program.

5. Lastly, let’s say that the rep is a 1099 independent contractor, is paid commissions, and only generates commercial patients for the DME supplier. In this scenario, the Medicare anti-kickback statute will not apply. However, the parties will need to review the state’s anti-kickback statute. All states have anti-kickback statutes that are similar to the Medicare anti-kickback statute. Some state anti-kickback statutes only come into play when the payer is the state’s Medicaid program. Other state statutes come into play regardless of the payment source.

Jeffrey S. Baird, JD, is chairman of the Health Care Group at Brown & Fortunato PC, a law firm based in Amarillo, Tex. He represents pharmacies, infusion companies, HME companies, and other health care providers throughout the United States. Baird is Board Certified in Health Law by the Texas Board of Legal Specialization and can be reached at (806) 345-6320 or