Recently issued final regulations on the employer pay-or-play rules under the Affordable Care Act (ACA) clarify the requirement that employers provide health coverage to full-time employees and their dependents, or pay a penalty and provide additional transition relief for 2015.
The U.S. Treasury Department (Treasury) issued final regulations on February 10, 2014, regarding the “pay-or-play” or “employer shared responsibility” requirements under Section 4980H of the Internal Revenue Code of 1986 (Code) (hereafter, the Pay-or-Play Rules). Treasury also released a fact sheet, and questions and answers clarifying key provisions of the Pay-or-Play Rules. The employer Pay-or-Play rules originally were intended to take effect on January 1, 2014, but employers received relief this past year when Internal Revenue Service (IRS) Notice 2013-45 delayed enforcement until January 1, 2015. The final regulations further delay and modify enforcement for certain employers in 2015 as described below.
Employer Pay-or-Play Requirements
Generally, Section 4980H of the Code requires a large employer to offer health coverage to its full-time employees that both is affordable and provides minimum value, or risk being subject to tax penalties. A “large employer” is an employer that employed an average of at least 50 full-time equivalent employees during the prior year. Large employer status is determined on a controlled group basis. However, whether an employer is subject to any tax penalties under Code Section 4980H is determined separately for each member of the controlled group. For an employer that was not in existence in the prior calendar year, the determination of whether that new employer is a large employer during its first calendar year is based on the employer’s reasonable expectations at the time the business comes into existence; the preamble clarifies that a new employer will not be recharacterized as a large employer if subsequent events cause the actual number of full-time equivalent employees to exceed that reasonable expectation. The final regulations clarify that an employer is treated as not having been in existence in the prior calendar year only if the employer was not in existence on any business day in the prior calendar year.
A large employer may be subject to penalties under the Pay-or-Play Rules under Section 4980H(a) of the Code if the employer does not offer minimum essential coverage to at least 95 percent of its full-time employees (and their dependent children), and at least one employee receives a cost-sharing reduction or premium tax credit (collectively, an exchange subsidy) for coverage purchased under a state or federally facilitated Marketplace Exchange created by the Affordable Care Act (ACA). For each month that a large employer does not offer coverage or offers coverage to less than 95 percent of its full-time employees (and their dependent children), the employer will owe a Section 4980H(a) penalty equal to the number of full-time employees the employer employed for that month (minus 30), multiplied by one-twelfth of $2,000.
A large employer may be subject to Pay-or-Play penalties under Section 4980H(b) of the Code if the employer offers minimum essential coverage to at least 95 percent of its full-time employees (and their dependent children), but the coverage is either unaffordable or does not provide minimum value, and at least one full-time employee receives an exchange subsidy. If the employer offers minimum essential coverage to at least 95 percent but less than 100 percent of its full-time employees (and their dependent children), the Section 4980H(b) penalty also applies to any full-time employee who is not offered coverage and receives an exchange subsidy. The Section 4980H(b) penalty is equal to the number of full-time employees who receive an exchange subsidy for that month, multiplied by 1/12 of $3,000.
The final Pay-or-Play Rules provide the following transition relief for 2015:
- Reduced Coverage Requirement for 2015. A large employer that offers coverage to at least 70 percent of its full-time employees for the 2015 plan year will not be subject to penalties under Section 4980H(a) of the Code for 2015. However, even if a large employer meets the 70 percent threshold, it still faces the potential for the $3,000 Section 4980H(b) penalty for every full-time employee who isn’t offered affordable, minimum value coverage and receives an exchange subsidy for insurance through the Marketplace Exchange. Starting with the 2016 plan year, a large employer must offer coverage to at least 95 percent of its full-time employees in order to avoid the $2,000 Section 4980H(a) penalty.
- Non-Calendar Year Plans. Employers with non-calendar year plans that were in effect as of December 27, 2012, and that have not since modified the plan year to begin at a later calendar date will generally not have to comply with the Pay-or-Play Rules until the first day of the plan year that begins after January 1, 2015.
- Relief Until 2016 for Employers with Fewer Than 100 Employees. Compliance with the Pay-or-Play Rules is generally not required until the 2016 plan year for employers with at least 50 but fewer than 100 full-time equivalent employees in the controlled group that provide appropriate certification (as part of the informational filing that the employer will be required to make with the IRS under Section 6056).
- Transition Rule for Determining Large Employer Status. For the 2015 calendar year, an employer may determine its status as a large employer by determining whether it employed an average of at least 50 full-time employees during any consecutive period of at least six calendar months during the 2014 calendar year (rather than the entire 2014 calendar year). Starting in 2016, an employer must determine its status for the calendar year by averaging the total number of full-time equivalent employees for each of the 12 months in the preceding calendar year.
- Revised Section 4980H(a) Penalty Calculation for 2015. For the 2015 plan year, an employer may exclude the first 80 full-time employees from penalty calculations under Section 4980H(a) of the Code. This amount will decrease to 30 employees in 2016.
- Dependents. Solely for purposes of the penalties under Code Section 4980H, employers are not required to offer dependent coverage to foster children and stepchildren; employers must offer coverage only for employees’ biological and adopted children. Additionally, for purposes of Section 4980H penalties, a child must be offered coverage for the entire calendar month during which he or she attains age 26. Penalties will not apply for the 2015 plan year for certain employers that have taken steps towards satisfying the Pay-or-Play Rule requirement to offer dependent coverage. The guidance confirms that employers are not required to offer spousal coverage.
Defining Full-Time Employee and Counting Hours of Service
A full-time employee is defined as an employee who is employed on average at least 30 hours of service per week. This standard has been the subject of much debate, and legislation has been introduced in both the U.S. House of Representatives and Senate to increase the number of hours required to be considered a full-time employee, such as to 40 hours of service per week. However, because the 30-hour standard was written into the ACA legislation, Treasury has no authority to change the hours requirement.
Large employers must track all hours of service worked for which payment is made or due in order to determine an employee’s full-time status. As under the proposed regulations, this includes any payment made or due for vacation, holiday, illness, incapacity, layoff, jury duty, military duty or leave of absence. The final regulations provide that hours of service do not include any hours worked by a volunteer who does not receive compensation for his or her services or who is a “bona fide volunteer” of a government entity or 501(c) tax-exempt organization whose only compensation consists of reimbursement of reasonable expenses and certain reasonable benefits and nominal fees. Hours of service also do not include any hours worked for income that is taxed as income from sources outside of the United States. In addition, the final regulations provide that hours of service do not include hours attributable to a student participating under a federal or state-sponsored work-study program. Importantly, this exception does not include other student employees, such as students in a paid internship or externship program. Employers that have employees whose hours of service are difficult to track, such as employees who are on call or who are travelling salespeople compensated on a commission basis, must use a reasonable method of crediting hours of service.
The final regulations provide two measurement methods for an employer to determine whether an employee is a full-time employee: the monthly measurement method and the look-back measurement method. Under the monthly measurement method, an employer determines whether each employee is a full-time employee by counting the employee’s hours of service for each month. An employer will not be subject to a Pay-or-Play penalty with respect to an employee as long as the employee is offered affordable, minimum value coverage no later than the day after the end of the three-month period that begins with the first full calendar month in which the employee meets the plan’s eligibility requirements for coverage other than a waiting period. The final regulations include rules for counting hours of service under the monthly measurement method.
Under the look-back measurement method, an employer determines an employee’s full-time status during a future period known as the “stability period” based upon the employee’s hours of service in a prior period referred to as the “measurement period.” For ongoing employees, employers determine full-time employee status by reference to hours worked during a “standard measurement period” that is between three and 12 months long. Each ongoing employee who works an average of 30 hours per week during the standard measurement period is treated as a full-time employee during the subsequent stability period.
Employers may use different standard measurement periods and stability periods, as long as the periods selected are consistent for all employees in the same category. Additionally, different employer members of the same large employer may use measurement periods and stability periods that differ either in length or in their starting or ending dates. Employers may choose to use an administrative period of up to 90 days between the standard measurement period and stability period to determine full-time employee eligibility and to enroll employees in health coverage.
Transition Rule for 2015 Stability Period
Employers that wish to use a 12-month stability period for 2015 may use a shorter look-back period for purposes of identifying full-time employees. The short measurement period must be at least six consecutive months; must begin no later than July 1, 2014; and must end no later than 90 days before the first day of the plan year beginning on or after January 1, 2015. Starting with stability periods starting in 2016, employers must use a 12-month look-back period in order to use a 12-month stability period.
The final regulations continue to apply special rules to determine continuing employee hours during periods of special unpaid leave. Special unpaid leave means periods of unpaid leave subject to the Family and Medical Leave Act of 1993 (FMLA) or the Uniformed Services Employment and Reemployment Rights Act of 1994 (USERRA), or on account of jury duty. To compute an employee’s average hours for special unpaid leave during the standard measurement period, the employer will need to either ignore periods where no hours were worked or credit hours to the employee based on the average number of hours worked by the employee during the remainder of the measurement period (the result is the same under either method).
An employer may treat a rehired employee or an employee resuming service as a new employee rather than a continuing employee after a break in service in two situations. The first situation is when the employee had no hours of service for at least 13 weeks (previously, 26 weeks under the proposed regulations). Second, under the “rule of parity,” an employer may treat a rehired employee who has had a break of at least four weeks as a new employee if the employee’s break in service with no credited hours of service is longer than the employee’s period of service immediately preceding the break in service.
As with the proposed regulations, the final regulations provide that a new employee who is reasonably expected to be full time (and who is not a seasonal employee) at the time he or she is hired must be provided health coverage by the first day of the month immediately following the employee’s initial three months of employment in order to avoid potential tax penalties for that three-month period. Full-time employee status for such an employee is determined based on that employee’s hours of service for each calendar month. Employees who are not expected to work an average of 30 hours per week are referred to as variable hour employees. A new employee is a variable hour employee if the employer cannot reasonably determine if the employee will work an average of 30 hours per week using certain factors set forth in the final regulations. An employer cannot take into account the likelihood that an employee will not continue employment through the entire initial measurement period in determining whether an employee is a variable hour employee. The final regulations describe factors an employer should consider in determining whether an employee is reasonably expected to be a variable hour employee (e.g., whether the employee is replacing an employee who was a full-time employee or a variable hour employee, the extent to which the hours of service of employees in the same or comparable positions have actually varied above and below an average of 30 hours of service per week during recent measurement periods, and whether the job was advertised or otherwise communicated to the new employee as full time). The same rules that apply to variable hour employees apply to part-time employees, defined as employees who are reasonably expected to average less than 30 hours of service per week. Seasonal employees also can be treated like variable hour employees subject to the look-back rules, even if they are hired to work a full-time schedule. The final regulations clarify that seasonal employees are those employees in a position for which the customary annual employment period is six months or less, and which starts in approximately the same part of the year.
Full-time employee status for a variable hour or seasonal employee is determined using a three-to-12-month look-back period called an “initial measurement period” and is generally consistent with the determination for ongoing employees. The final regulations clarify that the initial measurement period for a new variable hour or seasonal employee may begin at any time from the employee’s start date up to and including the first day of the first calendar month following the employee’s start date. If the employer determines that the variable hour or seasonal employee is not a full-time employee, then the employer will not need to treat that employee as full-time during the stability period unless the employee is determined to be a full-time employee during the standard measurement period applicable to ongoing employees, and the stability periods overlap. Variable hour or seasonal employees who experience a change in status, such that the employee would have reasonably been expected to be employed on a non-seasonal basis on average at least 30 hours of service per week if initially hired into that position, must be provided health coverage by the first day of the fourth calendar month following the change in employment status (or, if earlier, the first day of the first month following the end of the initial measurement period (plus any applicable administrative period) if the employee averaged 30 hours of service or more per week during the initial measurement period.
Affordable Coverage Safe Harbors
Under the Pay-or-Play Rules, even an employer that offers minimum essential health coverage to 95 percent (70 percent for 2015) or more of its full-time employees may still be subject to a penalty if that coverage is either unaffordable or does not provide minimum value. Health coverage is generally affordable if the employee’s portion of the self-only premium for the employer’s lowest cost coverage that provides minimum value does not exceed 9.5 percent of the employee’s annual household income. Because it may be difficult for an employer to determine an employee’s annual household income, the Pay-or-Play Rules provide three safe harbors under which an employer may treat coverage as affordable. Under the Form W-2 safe harbor, an offer of coverage is affordable if the employee’s health care premium does not exceed 9.5 percent of that employee’s Form W-2 wages, reported in box 1 of the Form W-2, for the calendar year. Under the rate of pay safe harbor, an offer of coverage is affordable if the employee’s applicable health care premium does not exceed 9.5 percent of the employee’s monthly wages equal to 130 hours multiplied by the lower of the employee’s applicable hourly rate of pay on the first day of the coverage period or the lowest hourly rate of pay during the calendar month. The final regulations permit use of the rate of pay safe harbor even if an employee’s rate of pay is reduced during the year, contrary to the proposed regulations. Under the federal poverty level safe harbor, coverage is affordable if the employee’s applicable health care premium does not exceed 9.5 percent of the monthly equivalent of the federal poverty line. The final regulations permit an employer to use the federal poverty line in effect six months prior to the beginning of the plan year.
The IRS, and not the employer, will calculate any penalty due on an annual basis through a combination of employer and individual reporting, and will inform the employer of the assessed tax penalty. Treasury has indicated that final guidance on the employer reporting requirements under the ACA will be issued shortly.
Employers should review plan procedures and payroll practices to ensure that they have an effective strategy in place to prepare and plan for compliance with the Pay-or-Play Rules. Specifically, employers should identify and categorize employees, decide whether to adopt a monthly measurement method or look-back measurement method for identifying full-time employees, identify look-back and stability periods for measuring hours of service, and ensure that appropriate procedures are in place to track employee status and hours. The rules are complex and may require employers to amend plan documents and revise summary plan descriptions and enrollment materials. Employers should not delay in preparing for compliance with the Pay-or-Play Rules.