- IRS Issues Proposed Regulations on the Employer Penalty under the Affordable Care Act
- January 25, 2013 | Author: Lori A. Basilico
- Law Firm: Edwards Wildman Palmer LLP - Providence Office
Just in time for the New Year, the Internal Revenue Service released its much anticipated proposed regulations on the employer shared responsibility penalty provisions under section 4980H of the Internal Revenue Code, which was added by the Patient Protection and Affordable Care Act. Beginning on and after January 1, 2014, employers with 50 or more full-time employees, including full-time equivalents (FTEs), during the preceding calendar year (“applicable large employers”) may be subject to two separate penalty taxes, referred to as “assessable payments”, if any full-time employee is enrolled in health coverage through a state insurance exchange and is certified to receive subsidized health insurance coverage through a premium tax credit or cost-sharing reduction.
Employers that fail to offer full-time employees (and their dependents) the opportunity to enroll in minimum essential coverage under an employer sponsored group health plan may be subject to a monthly penalty equal to 1/12th of $2,000 times the number of full-time employees employed during the year, excluding the first 30 full-time employees. Employers offering coverage to substantially all full-time employees (and their dependents) may be subject to an assessable payment if the health coverage fails to provide minimum value or is unaffordable by the employee. This monthly penalty is equal to 1/12th of $3,000 times the number of full-time employees who have been certified to receive the premium tax credit or cost-sharing reduction for enrolling in a state insurance exchange. The amount of this penalty cannot exceed the amount of the penalty for failing to offer coverage.
This client advisory highlights the key provisions of the proposed regulations and discusses the transition relief offered to employers for 2014.
SUMMARY OF KEY PROVISIONS
The key provisions of the proposed regulations include the following:
- Applicable Large Employer. All employers in the same controlled group are treated as a single employer for determining whether the employer group employed at least 50 full-time employees, including FTEs, during the preceding calendar year. However, any penalty will be assessed on an employer-by-employer basis.
- The 95% Standard. For purposes of determining whether an employer offers minimum essential coverage, an employer will satisfy this requirement if it offers such coverage to at least 95% of its full-time employees and their dependents (or, if greater, to 5 full-time employees).
- Spouse is not a Dependent. Section 4980H requires employers to offer minimum essential coverage that is of minimum value and affordable to full-time employees and their dependents. Dependents include an employee’s child under age 26, but not a spouse.
- Paid Leave. Employers must count unlimited paid leave when determining an employee’s full-time status.
- Foreign employees excluded. For purposes of determining who is a full-time employee, employers may disregard hours of service performed outside of the United States.
- Look-Back Measurement Period. The look-back measurement period/stability period for determining full-time employee status is clarified and new rules are provided for variable hour/seasonal employees and employees who have a change in employment status.
- Failure to Pay. Employers that discontinue an employee’s health coverage because the employee fails to timely pay his or her share of the premium will not incur a penalty for failing to offer coverage to that employee through the end of the coverage year.
- Safe Harbors for Determining Affordability. Section 4980H requires employers to offer affordable coverage, meaning that the premium for self-only coverage cannot exceed 9.5% of the employee’s household income. The proposed regulations include three safe harbors for determining whether health coverage is affordable for employees, including Form W-2 wages, Rate of Pay and Federal Poverty Line.
- Transition Relief. The proposed regulations provide several transitional rules intended to help employers comply with these new requirements in 2014.
SUMMARY OF PROPOSED REGULATIONS
These proposed regulations incorporate previously issued guidance for determining whether an employer is subject to the mandate and how to determine which employees are considered full-time employees, which were described in our previous alerts but contain several new rules and clarifications.
Determination of Applicable Large Employer Status
Only “applicable large employers” will be subject to the penalty tax under section 4980H. Generally, an employer will be considered an “applicable large employer” if it employs at least 50 full-time employees, including full-time equivalents. According to the proposed regulations, a full-time equivalent employee is defined as a combination of employees who are not full-time employees because they are not employed, on average, at least 30 hours of service per week, but when added together are counted as the equivalent of a full-time employee. An employer’s status as large employer for a particular year will be based on all hours worked by all employees in the prior year.
The proposed regulations confirm that applicable large employer status is determined on a controlled group basis, treating all entities with a common owner as a single employer. If the total number of full-time employees for the group is at least 50, then each entity in the controlled group will be considered an applicable large employer subject to the employer shared responsibility provisions, regardless of the number of employees employed by each entity. However, the proposed regulations clarify that the determination of liability for, and the amount, of any assessable payment, is applied separately to each entity in the controlled group. In this regard, each member of the controlled group is responsible for its own penalty tax and not liable for the assessable payment of any other member of the controlled group.
Identifying Full-Time Status
Determining whether an employee is a full-time employee is one of the more challenging aspects of the employer shared responsibility provisions, particularly with respect to employees whose work schedules vary from month to month or who are not compensated based on hours worked. Generally, an employee who is employed on average at least 30 hours of service per week, or 130 hours of service per month, is considered a full-time employee.
Hours of Service Rules
Hours of service are used in determining whether an employee is a full-time employee. For purposes of determining an employee’s hours of service, the following rules apply:
- Each hour for which an employee is paid, or entitled to payment, for the performance of duties is counted.
- Each hour for which an employee is paid, or entitled to payment, on account of a period of time during which no duties are performed due to vacation, holiday, illness, incapacity (including disability), layoff, jury duty, military duty or leave of absence is counted. Under prior guidance, the IRS stated that only 160 hours of service needed to be counted for any period during which the employee was paid or entitled to payment but performed no duties. The proposed regulations remove this 160-hour limit on paid leave, so that all periods of paid leave must be taken into account.
- The full-time determination for hourly employees is made by calculating the actual hours of service from records of hours worked and hours for which payment is made or due.
- For employees not paid on an hourly basis, employers may calculate the number of hours of service under any of the following three methods: (i) counting actual hours of service (as in the case of hourly employees) from records of hours worked and hours for which payment is made or due; (iii) using a days-worked equivalency, crediting the employee with 8 hours of service per day for each day with an hour of service; or (iii) using a weeks-worked equivalency of 40 hours of service per week for each week with an hour of service. Employers may use different hours-counting methods for different classifications of non-hourly employees as long as the classifications are reasonable, consistently applied and do not substantially understate an employee’s hours of service in a manner that would cause the employee not to be treated as a full-time employee.
- Hours of service do not include hours of service worked outside of the United States, regardless of the residency or citizenship of the employee. Therefore, employees working overseas generally will not have any hours of service and will not qualify as full-time employees; however, all hours of service for which an employee receives U.S. source income are considered hours of service.
- For employees whose compensation is not based primarily on hours of service or whose active work hours may be subject to safety-related regulatory limits (such as salespeople paid on a commission basis, adjunct faculty, or airline pilots whose flying hours are subject to limits), until further guidance is issued, employers must use a reasonable method of crediting hours of service that is consistent with section 4980H. Methods of crediting hours that take into account only some of an employee’s hours of service or that would characterize a full-time employee as part-time would not be reasonable. For example, it would not be a reasonable method of crediting hours of service to fail to take into account the travel time for a traveling salesperson compensated on a commission basis or, in the case of an adjunct faculty, to take into account only classroom or other instruction time and not other hours necessary to perform the employee’s duties, such as class preparation time.
Look-Back Measurement Period
According to section 4980H, the assessable payment is determined based on the number of full-time employees, and not the number of full-time equivalents, in a given month. The IRS recognizes that applying these rules on a month-to-month basis may cause practical difficulties for employers and employees, particularly with respect to employees with varying hours or employment schedules where a month-by-month determination could result in employees moving in and out of employer coverage on a monthly basis. For these reasons, the proposed regulations incorporate the optional “safe harbor” look-back measurement method described in previous IRS guidance as an alternative to a month-by-month method of determining full-time employee status.
Under this safe harbor, an employer may calculate the number of full-time employees by looking back at a prior period selected by the employer, which must be at least three but not more than 12 months in duration (referred to as the “standard measurement period”), and determine the number of employees who were employed during the standard measurement period on average at least 30 hours of service per week. These employees will be treated as the employer’s full-time employees during a subsequent period, referred to as a “stability period”, regardless of the number of hours of service worked during the stability period, for purposes of determining which employees must be offered group health coverage under section 4980H. Employees who were employed on average less than 30 hours of service per week during the measurement period can be disregarded in the following stability period. Generally, the duration of the stability period must be at least six months and can be no shorter than the measurement period. The safe harbor also incorporates an administrative period between the end of the measurement period and the beginning of the stability period to permit the employer to determine which employees are eligible for coverage and to enroll such employees in coverage.
Example: Employer Y chooses to use a 12-month stability period that begins on January 1, and a 12-month standard measurement period that begins on October 15. Consistent with the terms of Employer Y’s group health plan, only employees classified as full-time employees using the look-back measurement period are eligible for coverage. Employer Y chooses to use an administrative period between the end of the standard measurement period (October 14) and the beginning of the stability period (January 1) to determine which employees were employed on average 30 hours of service per week during the measurement period, notify them of their eligibility for plan coverage and to enroll those employees who elect coverage.
Employee A and Employee B have been employed by Employer Y for several years. Employee A was employed on average 30 hours of service per week during the standard measurement period that begins on October 15, 2015 and ends on October 14, 2016 and for all prior standard measurement periods. Employee B was employed on average 30 hours of service per week for all prior measurement periods but is not a full-time employee during the standard measurement period that begins on October 15, 2015 and ends on October 14, 2016.
Because Employee A was employed for the standard measurement period that begins on October 15, 2015 and ends on October 14, 2016, Employee A is a full-time employee for the stability period running from January 1, 2017 through December 31, 2017. Employee A is offered group health plan coverage for the entire 2017 stability period.
Because Employee B did not work full-time during the standard measurement period beginning on October 15, 2015 and ending October 14, 2016, Employee B is not required to be offered coverage for the stability period in 2017. However, because Employee B worked on average at least 30 hours of service per week during the prior standard measurement period (from October 15, 2014 to October 14, 2015), Employee B was offered coverage through the end of the 2016 stability period and, if enrolled, would continue such coverage during the administrative period from October 15, 2016 through December 31, 2016.
Employers may choose different standard measurement periods for employees in different specified categories, but the measurement period must be applied on a uniform and consistent basis for all employees in the same category. Categories include:
- Collectively bargained and non-collectively bargained employees;
- Salaried and hourly employees;
- Employees of different entities; and
- Employees located in different states
The proposed regulations provide details on applying the safe harbor look-back measurement period and stability period to ongoing employees, new employees, variable hour and seasonal employees, employees who have a change in employment status during their initial measurement period and employees who are rehired or otherwise resume service after an absence from work.
Complying with Section 4980H
As described above, beginning as of January 1, 2014, to avoid having to pay any penalty tax, an employer must offer minimum essential coverage to substantially all of its full-time employees (and their dependents) that is affordable and provides minimum value. If the employer offers minimum essential coverage to its full-time employees (and their dependents) but does not satisfy the minimum value and affordability requirements, it may be subject to a penalty tax but these penalties generally will be at a lower level than if the employer offered no coverage at all. The proposed regulations clarify what is meant by “substantially all,” who is a dependent, and provides affordability safe harbors.
The proposed regulations quantify the “substantially all” standard and provide that an employer will be treated as offering coverage to its full-time employees (and their dependents) for a calendar month if, for that month, it offers coverage to 95% (or, if greater, to five employees) of its full-time employees (and their dependents). If the employer offers coverage to all but 5% of its full-time employees (and their dependents), the employer will not be subject to the “failure to offer” penalty of $2,000 per employee. This relief applies to any failure to offer coverage to the specified number or percentage of employees (and their dependents), regardless of whether the failure to offer is inadvertent.
If any of the 5% of full-time employees who are not offered coverage receive premium tax credits or cost-sharing assistance for coverage purchased from an Exchange, the employer will be required to pay an annual penalty of $3,000 for each employee who receives such premium tax credit or cost-sharing assistance.
The proposed rules clarify that an employer must offer minimum essential coverage to the dependents of full-time employees, and defines dependents as an employee’s child (biological or adopted child, stepchild, a child placed for adoption or an eligible foster child, as defined in Code section 152(f)(1)) who is under age 26. Interestingly, the term “dependent,” for purposes of these rules, does not include an employee’s spouse.
Affordability Safe Harbors
An employer may be subject to an assessable payment if the minimum essential coverage offered to its full-time employees is unaffordable by the employees or does not provide minimum value. Coverage under an employer sponsored plan will be considered affordable if the employee’s required contribution for self-only coverage does not exceed 9.5% of the employee’s household income for the taxable year. Because an employer generally will not know an employee’s household income, the proposed regulations provides three optional affordability safe harbors that would apply for purposes of determining whether an employer’s coverage satisfies the 9.5% affordability test.
Form W-2 Wages Safe Harbor
The employer must offer minimum essential coverage to full-time employees (and their dependents) and the required employee contribution for self-only coverage for the lowest cost option that provides minimum value must not exceed 9.5% of the employee’s Form W-2 wages for the calendar year. Wages for this purpose would be the total amount of wages which is required to be reported in Box 1 of Form W-2. Box 1 excludes the employee’s pre-tax salary reduction contributions to a 401(k) or 403(b) plan or Section 125 cafeteria plan.
If an employee was not a full-time employee for the entire calendar year, an employer would apply the Form W-2 safe harbor by adjusting the employee’s Form W-2 to reflect the period when the employee was offered coverage, and then comparing those adjusted wages to the employee’s share of the premium for that period.
Application of this safe harbor is determined on an employee-by-employee basis and after the end of the calendar year, by taking into account the employee’s Form W-2 wages and the employee’s contribution. An employer could use this safe harbor prospectively, at the beginning of the year, to set the employee’s contribution level to not exceed 9.5% of the employee’s Form W-2 wages for that year (for example, by deducting 9.5%, or a lower percentage, from an employee’s Form W-2 wages for each pay period).
Rate of Pay Safe Harbor
This safe harbor permits an employer to take the hourly rate of pay for each hourly employee who is eligible to participate in the health plan at the beginning of the year, multiply that by 130 and determine affordability based on the resulting monthly wage amount. The employee’s monthly contribution amount is affordable if it is equal to or lower than 9.5% of the computed monthly wages. For salaried employees, monthly salary may be used instead of hourly salary multiplied by 130.
This safe harbor will not apply if the employer reduces wages of hourly or salaried employees during the year.
Federal Poverty Line Safe Harbor
The proposed regulations provide that an employer may rely on a design-based safe harbor that will be satisfied only if the cost of self-only coverage does not exceed 9.5% of the most recently published federal poverty line for a single individual.
The proposed regulations provide several transition rules to help employers comply with these new requirements in 2014.
Measurement Periods for Stability Periods Starting in 2014
Solely for purposes of stability periods beginning in 2014, employers may adopt a transition measurement period that is shorter than 12 months but not less than six months, 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 (90 days being the maximum permissible administrative period).
Example: An employer with a calendar year plan could use a measurement period from April 15, 2013 to October 14, 2013 (six months) followed by an administrative period ending on December 31, 2013.
Applicable Large Employer Determination for 2014
For the 2014 calendar year, employers may use a period of at least six months in the 2013 calendar year (rather than the entire 2013 calendar year) to determine whether the employer employed an average of 50 full-time employees on business days during any consecutive six-month period in 2013.
Recognizing that some employers offer coverage only to employees and not to dependents, the proposed regulations provide a transition rule that an employer will not be liable for any assessable payment for failing to offer dependent coverage in 2014 if it takes steps during its 2014 plan year to begin offering dependent coverage.
Fiscal Year Plans
Applicable large employers that maintain fiscal year plans as of December 27, 2012 will be required to offer affordable, minimum value coverage no later than the first day of their 2014 plan year but will not be subject to an assessable payment for the months in 2014 preceding the start of their plan year.
Salary Reduction Elections for Health Plans Provided Through Cafeteria Plans
Because employees of applicable large employers may, as of January 1, 2014, wish to enroll in coverage through an Exchange or may wish to enroll in their employer’s plan, the proposed regulations provide transition relief from the cafeteria plan change in status rules. Employers that maintain cafeteria plans with a fiscal plan year beginning in 2013 may permit an employee to prospectively revoke or change his or her election once (without regard to whether the employee experienced a change in status event) or to make a prospective salary reduction election for health plan coverage on or after the first day of the 2013 plan year (without regard to whether the employee experienced a change in status event). A cafeteria plan must be amended retroactively, by December 31, 2014, to implement these transition rules.
Employers may rely on these proposed regulations pending issuance of final regulations or other guidance. Written comments on the proposed rules must be submitted by March 18, 2013, and a public hearing has been scheduled for April 23, 2013.