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Health Care Reform: IRS Issues Additional Guidance on the ACA’s Employer Shared Responsibility Requirements

January 16, 2013

The IRS recently published additional and significant guidance that addresses the application of the employer shared responsibility requirements under the Affordable Care Act (ACA), commonly referred to as the “play-or-pay” provisions. These are codified in the Internal Revenue Code at §4980H.

On December 28, 2012, it posted online a series of questions and answers regarding these requirements. It is available at: http://www.irs.gov/uac/Newsroom/Questions-and-Answers-on-Employer-Shared-Responsibility-Provisions-Under-the-Affordable-Care-Act.

On January 2, 2013, the IRS published proposed regulations in the Federal Register. This new guidance built upon the four prior notices that it had issued that:

  • Explained the requirements for determining whether an employer was an “applicable large employer” to which these rules applied, and
  • For those employers to whom they did apply, provided a safe harbor methodology for determining which employees were to be considered “full-time,” i.e., the group of employees that the employer would have to offer “minimum essential coverage” (essentially defined as any employer-provided coverage other than “excepted benefits”) that was affordable and actuarially valuable or face potential financial penalties.

This Alert gives a detailed breakdown of this recent guidance.

Even though these regulations are not yet final, the IRS has indicated that employers may rely on them until final regulations or other guidance is issued. In any event, employers may need to spend considerable time throughout 2013 to ensure compliance with these rules. The recent guidance clarifies a number of open questions and provides employers with additional flexibility in meeting these requirements. The trade-off, however, is likely to be an increased administrative tracking and recordkeeping burden to ensure compliance.

When Is an Employer an “Applicable Large Employer” to Whom These Rules Apply?

The general rule is that an applicable large employer (ALE) (this can be a for-profit, non-profit, governmental or tribal employer), for a calendar year, is one that employed an average of at least 50 full-time employees, counting full-time equivalents (FTEs), on business days during the preceding calendar year. This can be done on a month-by-month basis or as averaged over the prior calendar year.

ALE status is determined by: (i) counting the number of full-time employees, i.e., those who averaged 30 hours of service per week (130 per month) during the prior calendar year, (ii) adding up all the hours worked in the prior calendar year by all employees who are not full-time employees (though capped at 120 hours for any single employee), (iii) divide the total number in item (ii) by 120 to get the number of FTEs (including fractional FTEs), and (iv) add the number of full-time employees and FTEs (if the resulting number includes a fractional employee, the number is to be rounded down). If the resulting total is at least 50, the employer is an ALE.

Only for purposes of determining ALE status, there is a limited exception for seasonal employees. An employer will not be deemed an ALE and will not be subject to these rules if it exceeds the 50 full-time employee threshold for either a four month or 120 day period (or shorter period) during the prior year solely because of the hours of service attributable to seasonal workers. Until further guidance is issued, employers will be entitled to use a reasonable, good faith interpretation of “seasonal worker,” and this category will not be limited to agricultural or retail workers. The IRS indicated, however, that the final regulations may contain a specific time limit for determining the status of seasonal workers.

The new guidance includes the following clarifications:

  • Common Law Definition of Employee - When counting employees, the common law definition of an employee is to be used – i.e., an employment relationship exists when the person for whom the services are performed has the right to control and direct the individual who performs the service, not only as to the result to be accomplished but also as to the details and means by which that result is to be accomplished.
  • Controlled Group Issues - For purposes of determining “applicable large employer” status, all employees of a controlled group of companies are counted as a single employer and all hours of service for any member of the controlled group are counted. Thus, a controlled group member with less than 50 employees will be deemed to be an ALE if the controlled group as a whole has 50 or more full-time employees. With respect to the imposition of penalties, however, each member of the controlled group will be held liable only for the coverage it provides (or fails to provide) its own employees, and will not be penalized for the conduct of other controlled group members.
  • Successor Employers - Companies must include the employees of companies they acquired during the prior year to the extent they are successor employers under the rules used for employment taxes and may have successor liabilities for any penalty incurred by the predecessor employer.
  • New Employers - Employers that were not in existence for all of the prior calendar year are still subject to these rules if it is reasonably expected that they will employ an average of at least 50 full-time employees during the current calendar year.
  • Counting Hours of Service: General Rule - The hours to be counted are “hours of service,” not “hours worked.” Hours of service include all hours for which the employee is paid or is entitled to payment for duties performed, and hours for which the employee is entitled to payment where no duties are performed such as for vacations, holidays, illness, incapacity (including disability), layoff, jury duty, military duty or a leave of absence. There is no limit on the number of hours that maybe credited for paid leave.
  • Counting Hours of Service: Hourly Employees - Hours of service for hourly employees must be determined by counting the actual hours recorded by the company.
  • Counting Hours of Service: Non-Hourly Employees - Hours of service for non-hourly workers can by calculated by: (i) counting actual hours from company records, (ii) using a days-worked equivalency based on eight hours for each day with an hour of service, or (iii) using a weeks-worked equivalency based on crediting 40 hours for each week with an hour of service. The equivalency options cannot be used, however, if the result would be to substantially understate the employee’s hours of service to deny him or her treatment as a full-time employee. The same method need not be used for all non-hourly employees so long as the distinguishing classifications used are reasonable and consistently applied. An employer may, however, change the method for calculating non-hourly employees’ hours of service for each calendar year.
  • Hours of Service Worked Outside the U.S. - Hours of service worked outside the United States need not be counted, regardless of the residency or the citizenship of the employee.
  • Counting Hours of Service in Special Employment Situations - For employees on commission, adjunct faculty, transportation employees and similar special employment situations, employers must use a reasonable method of crediting hours of service consistent with the purpose of the statute, pending further guidance. Any method that counts only some, but not all of an employee’s hours, or that would classify an obviously full-time employee as part-time, would not be considered reasonable.
  • General Anti-Abuse Rule - The proposed regulations provide that any credited hours of service will be disregarded if done to circumvent these play-or-pay rules, or if the underlying service was requested or required of the employee for that same reason.
  • Temporary Staffing Agencies/PEO Anti-Abuse Rule - The preamble to the proposed regulations notes that it is anticipated that the final regulations will include anti-abuse rules to address situations where employers seek to use temporary staffing agencies or professional employer organizations (PEOs) purporting to be the common law employers to evade application of §4980H, and gives as an example that hours of service performed by leased employees will likely be considered as attributable to the client-employer of the staffing agency, and not as an employee of the staffing agency.
  • Transition Rule - For purposes of determining whether an employer is an “applicable large employer” to whom these rules will apply in 2014, an employer may use a six consecutive month period or more in 2013 to determine how many full-time employees and FTEs were employed.

Optional Safe Harbor for Measuring Full-Time Employee Status

The statute indicates that the determination of full-time status must be made on a month-by-month basis, but the IRS has provided an optional safe harbor methodology employers can use in making this determination.

The new guidance includes the following clarifications:

  • New Full-Time Employees - If a new employee, who is not a seasonal employee and who is reasonably expected to be scheduled for at least 30 hours of service per week when hired, is offered coverage beginning on or before his or her first three calendar months of employment, no penalty will be assessed for the employer’s failure to offer coverage for any period during that initial three months of employment.
  • New Variable Hour or Seasonal Employees - With respect to new variable and/or seasonal employees, the initial measurement period and administrative period combined cannot extend beyond the last day of the first calendar month beginning on or after the one-year anniversary of the employee’s start date (totaling at most 13 months and a fraction of a month). Though the employee may not be eligible for coverage under the employer’s plan during this period, and thus, may obtain coverage through an Exchange, the employer will not be subject to penalty for having failed to offer coverage during this period.
  • New Short Term Employees - The play-or-pay rules do not apply to full-time employees employed for three months or less, but will apply to short term full-time employees whose period of employment exceeds three months.
  • Change in Employment Status - If a new variable or seasonal employee changes his or her employment status during the initial measurement period so that, had he or she begun in that new status, they would have reasonably been expected to average at least 30 hours of service per week, that individual will be treated as a full-time employee on the first day of the fourth month following the change in employment status (or, if earlier, and the individual averaged 30 hours of service during the initial measurement period, the first day following the end of the initial measurement period and any applicable administrative period). This change of status rule applies only to new employees, not ongoing employees.
  • Rehired Employees and Those Returning from Leaves of Absence 
    1. Employees, who perform zero hours of service for at least 26 consecutive weeks and then return to employment may be treated as new hires.
    2. If the period of “no service” is less than 26 consecutive weeks, an employer may apply an optional rule of parity and treat the returning employee as a new hire if the period of “no service” is at least 4 but less than 26 weeks, and is longer than the employee’s immediately prior period of employment.
    3. If neither of these rules applies, the employee who returns to work must be treated as an ongoing employee with the same measurement and stability period status that would have applied had they not had a period of “no service.”
    4. For an ongoing employee who resumes work after an unpaid “special leave,” i.e., on account of the FMLA, USERRA, or jury duty, the employer must determine the average hours of service per week for that employee, ignoring the period of unpaid leave, and use that average for the entire measurement period.
  • Special Rule for Educational Institutions - For periods of at least four consecutive weeks that are not unpaid special leaves (e.g., summer breaks, sabbatical periods), an educational organization must either (i) calculate average weekly hours ignoring the break period, or (ii) credit employees with the average number of hours for the weeks of the break that were the average credited for the weeks without the break, but the number of hours that can be credited for any employee break period is capped at 501 hours a calendar year (not including hours credited for special unpaid leave).
  • Use of Payroll Periods - Under prior guidance, measurement and stability periods began on the first day of a calendar month and were measured by months. The proposed regulations provide that employers can adjust these periods to comport with its payroll periods. For payroll periods of one week, two weeks, or semi-monthly, an employer can treat as a measurement period a period that begins on the first day of the payroll period that includes the date that would otherwise be the first day of the measurement period and ends on the last day of the payroll period preceding the payroll period that includes the date that would otherwise be the last day of the measurement period.
  • Transition Rules
    1. Stability Period Rule - Employers intending to use a 12-month stability period beginning in 2014, may use a measurement period that is shorter than 12 months, but not less than 6 months, and that begins no later than July 1, 2013, and ends no earlier than 90 days before the first day of the plan year beginning on or after January 1, 2014.
    2. Variable Employee Rule - In 2014, the status of variable hour employees must be based on facts and circumstances specific to the new employee at his or her start date, and cannot be based on the employer’s general expectations or projections about turnover rates. In January of 2015, employers must assume that variable hour employees will be employed during the entire initial measurement period.
    3. Fiscal Year Plan Rules
      • An employer will be deemed to be offering minimum essential coverage under a plan that was maintained on a fiscal year basis as of December 27, 2012, if employees who would be eligible for coverage under the plan’s terms on the first day of the 2014 plan year, will be offered coverage no later than that same first day of the 2014 plan year.
      • An employer who maintains a Section 125 plan on a fiscal year basis may permit an employee to prospectively revoke or change his or her election and may permit an employee to begin salary reductions after open enrollment (e.g., to avoid the penalty under the individual mandate). In effect, these will be treated as status change events, even though they do not comport with the current requirements. In order to take advantage of this transition rule, the plan document/SPD for the Section 125 plan will have to be amended no later December 31, 2014, but can be made effective as of the first day of the Section 125 plan’s 2013 plan year.]
    4. Multiemployer Plan Rule - An ALE will not be subject to penalty if: (a) it is required to contribute to a multiemployer plan on behalf of a full-time employee pursuant to a collective bargaining agreement, (b) the coverage under the multiemployer plan is offered to the full-time employee, and (c) the coverage provided is afforded and provides minimum value.

Assessing the Play-or-Pay Penalties

ALEs must offer “minimum essential coverage” that is affordable and actuarially valuable to substantially all of its full-time employees (and their dependents). If it offers no coverage, and any of the full-time employees obtain coverage through an Exchange and qualify for a premium tax credit or cost sharing subsidy, it will be assessed a monthly penalty equal to 1/12th of $2,000 per employee (not counting the first 30 employees). Where the ALE is composed of controlled group members, the “30 full-time employee” reduction applicable to this “no coverage penalty” will be allocated pro-rata among the controlled group members.

If the ALE provides minimum essential coverage, but at least one full-time employee obtains coverage through an Exchange and qualifies for a premium tax credit or a cost-sharing reduction, then the ALE must pay a monthly penalty equal to 1/12th of $3,000 for each such individual, but the overall penalty amount to the employer cannot be in excess of the penalty it would have had to pay if it did not offer any health care coverage at all.

Note – For purposes of the penalty provisions of IRC §4980H, only full-time employees and dependents are considered. FTEs are ignored. FTEs are only considered in determining whether the employer is an “applicable large employer” subject to these rules at all.

The new guidance included the following clarifications:

  • No “No Coverage” Penalty if Inadequate Coverage is Offered - Employers who provide coverage to full-time employees will not be subject to the “no coverage” penalties, even if the coverage provided is unaffordable and does not provide minimum value. They will, however, be subject to a $3,000 annual penalty for any full-time employees not offered coverage, or offered only unaffordable and/or less than minimum value coverage, that obtains coverage through an Exchange and qualifies for a premium tax credit or cost sharing subsidy.
  • Substantially All - The statute requires that minimum essential coverage be offered to “substantially all” full-time employees (and dependents). The new guidance clarifies this to mean providing coverage to 95% of full-time employees (and dependents), or if larger, five full-time employees (and dependents). Thus, if an employer offers coverage to at least 95% of its full-time employees (and dependents), but less than 100%, it will not be penalized, regardless of whether the omission was intentional or inadvertent. If, however, any of those full-time employees not offered coverage receive premium tax credits or cost sharing subsidies with respect to coverage purchased on an Exchange, the employer will be penalized $3,000 on an annual basis for each such employee.
  • Dependents - For the purposes of this rule, dependents include only an employee’s son, daughter, stepson, stepdaughter, adopted child, child placed for adoption or foster child, up to their 26th birthday. Employers may rely on their employees’ representations as to the identity, number and ages of their children. Spouses are not considered dependents for purposes of this rule. Thus, employers that do not cover spouses, irrespective of whether they have other coverage, will not be penalized for that exclusion.
  • Affordability - The statute provides that coverage is affordable if the employee’s cost for single coverage under the lowest cost option providing minimum value does not exceed 9.5% of the cost of the employee’s household income. That is still the rule, but because it will likely be difficult for an employer to determine an employee’s household income, prior guidance established a Form W-2 safe harbor. This safe harbor provides that for coverage to be “affordable,” the employee’s required contribution for single coverage under the lowest cost option providing minimum value cannot be more than 9.5% of his or her Form W-2, Box 1 wages, even if the employee has family, not single, coverage.

The proposed regulations added two additional safe harbors:

    1. Rate of Pay Safe Harbor - Here, the employer takes the hourly rate of the employee, and multiplies that by 130 to determine a monthly wage. Affordable coverage would then be single coverage that costs the employee 9.5% or less of that monthly wage. This safe harbor is not available if the employer reduces wages during the year.
    2. Federal Poverty Level Safe Harbor - The affordability test will be met if the plan is designed so the cost of single coverage is not greater than 9.5% of the most recently published federal poverty level for a single person.

Note – The requirements that (i) the employee’s non-spouse dependents must be offered coverage and (ii) the affordability standard is based only on the cost of the employee’s share of single coverage may mean that while an ALE must provide dependent coverage, it need not pay for it to avoid being penalized.

  • Offer of Coverage - The proposed regulations provide that coverage will be deemed not to have been offered if the employee does not have an “effective opportunity” to accept coverage at least once each plan year. For an employer to satisfy this “offer of coverage” requirement for a particular month, it must offer coverage that, were it to be accepted, would provide coverage for that entire month. If there is a day during that month where the coverage would be ineffective, the employee is deemed not to have been offered coverage for that month. Notwithstanding the preceding sentence, an employer will be deemed to have offered coverage in any month where the lack of coverage for any part of that month is due to: (a) the employee’s termination of employment, or (b) the employee’s failure to pay the required contribution. Indeed, where the employee fails to pay the required contribution, coverage will be deemed to have been offered for the remainder of the coverage period, usually the remainder of the plan year.
  • Transition Rule for Dependent Coverage - Employers that do not currently cover dependents (as defined above) will not be penalized in 2014 if they take steps during that year to be in full compliance by January of 2015.

How Will an Employer Learn of Penalties It Might Owe? How Will It Pay the Penalty?

Since ALEs will be subject to these play-or-pay penalties only if at least one of their employees obtains coverage on an Exchange and qualifies for a premium tax credit or a cost sharing subsidy, how will they know if and when they are subject to penalty?

Under these proposed regulations, the IRS will inform an employer of its potential liability, and the employer will have an opportunity to respond before any penalty is assessed or demand for payment is made (e.g., the IRS may inform Employer A that John Doe qualified for a premium subsidy on an Exchange on July 10, but Employer A may respond that John Doe had terminated employment as of May 1). The notice for a given calendar year will not be provided until: (i) after the due date for the employee’s federal income taxes to be filed, and (ii) after the date by which the employer must file information returns pursuant to IRC §6056 identifying their full time employees (and their dependents), thus allowing it to make a the determination as to whether it met the 50 full-time employee threshold for that year. If it had not, that would be a basis for challenging the IRS’ assessment of penalties for that year.

If, following this interchange, the IRS determines that the employer is subject to a penalty, the IRS will send a notice as to the amount of the penalty and a demand for payment. The notice will instruct the employer how to make the payment. Employers will not be required to include any such payments on any tax returns they file.

Action Steps

Employers will need to spend time (possibly considerable time) during 2013 undertaking a number of tasks to ensure compliance with these play-or-pay rules. The first order of business will be to determine whether or not it is an “applicable large employer” and so will be subject to these rules. If it is not, then there may be little else to do.

If an employer determines that it is an ALE, then it will have to make a basic decision whether to offer coverage or pay the penalty. If it chooses to continue to offer coverage, it must: (i) determine whether its coverage provides minimum value, but if not, to re-design its coverage offerings to avoid penalties, (ii) assess what contribution levels it currently requires of employees and adjust them, if needed, to avoid penalties, (iii) if needed, establish beginning dates and duration periods for the initial measuring, standard measuring and stability periods it wants to apply for purposes of implementing the safe harbor methodology, (iv) decide if it wishes to utilize an administrative period when implementing the safe harbor methodology, and if so, of what length, (v) amend the plan document/SPD to reflect the safe harbor methodology requirements it has adopted, (vi) if applicable, amend the Section 125 plan document/SPD to allow for the transition rule requirements noted above, and (vii) prepare employee communication materials regarding the employer’s choices regarding any other changes needed to comply with ACA requirements for 2014. If its benefits are insured, the ALE would likely need to consult its insurer or insurance agent about any contemplated changes to the scope and/or costs of coverage.

If you have any questions about these play-or-pay provisions, any other ACA compliance requirements, or any other employee benefit matters, please contact any of the Honigman attorneys.

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