- Deciding Whether to Play or Pay Under the Affordable Care Act
- March 11, 2013
- Law Firm: Jones Day - Cleveland Office
The Patient Protection and Affordable Care Act (the "ACA") adds a new Section 4980H to the Internal Revenue Code of 1986, as amended, which generally requires employers to offer health coverage to their employees (the "Employer Mandate"). Following are Q&As discussing this provision. These Q&As are designed to address some of the more commonly asked questions, including which employers are subject to the mandate, who must be offered coverage to avoid a penalty, the type of coverage that must be offered to avoid said penalty, and the penalties that apply for not offering coverage. These Q&As are based on recently issued proposed regulations; the final regulations, when issued, may change the requirements. 26 C.F.R. 54.4980H-1, et seq.
Q&A 1: What Is the Employer Mandate?
On January 1, 2014, the Employer Mandate will change the landscape of health care in the U.S. by requiring large employers to offer health coverage to full-time employees and their children up to age 26 or risk paying a penalty. Large employers will be forced to make a choice: to either "play" by offering affordable health coverage that provides minimum value or "pay" by potentially owing a penalty to the Internal Revenue Service if they fail to offer such coverage. This "play or pay" scheme, called "shared responsibility" in the statute, has become known as the Employer Mandate. Although the Employer Mandate generally takes effect on January 1, 2014, the effective date is deferred for employers with fiscal year plans that meet certain requirements.
Only "large employers" are required to comply with the Employer Mandate. Generally speaking, "large employers" are employers that had an average of 50 or more full-time or full-time equivalent employees on business days during the preceding year. "Full-time employees" include all employees who work at least 30 hours on average each week. The number of "full-time equivalent employees" is determined by aggregating the hours worked by all non-full-time employees. In determining large employer status, certain related employers under common control are considered to be a single employer. (However, as discussed below, while large employer status is determined based on counting the full-time employees and full-time equivalents of all members of a group of related employers under common control, whether any penalty is owed and the amount of such penalty is calculated separately for each related employer.)
To "play" under the Employer Mandate, a large employer must offer health coverage that is "minimum essential coverage," is "affordable," and satisfies a "minimum value" requirement to its full-time employees and certain of their dependents. "Minimum essential coverage" includes coverage under an employer-sponsored group health plan, whether it be fully insured or self-insured, but does not include stand-alone dental or vision coverage, or flexible spending accounts. Coverage is "affordable" if an employee's required contribution for the lowest-cost self-only coverage option offered by the employer does not exceed 9.5 percent of the employee's household income. Coverage provides "minimum value" if the plan's share of the actuarially projected cost of covered benefits is at least 60 percent. More detail about these requirements is included in later Q&As.
If a large employer does not "play" for some or all of its full-time employees, the employer will have to pay a penalty in two scenarios.
The first scenario occurs when an employer does not offer health coverage to "substantially all" of its full-time employees and any one of its full-time employees both enrolls in health coverage offered through a State Insurance Exchange, which is also being called a Marketplace (an "Exchange"), and receives a premium tax credit or a cost-sharing subsidy (each an "Exchange subsidy"). In this scenario, the employer will owe a "no coverage penalty." The no coverage penalty is $2,000 per year (adjusted for inflation) for each of the employer's full-time employees (excluding the first 30). This is the penalty that an employer should be prepared to pay if it is contemplating not offering group health coverage to its employees.
The second scenario occurs when an employer does provide health coverage to its employees, but such coverage is deemed inadequate for Employer Mandate purposes, either because it is not "affordable," does not provide at least "minimum value," or the employer offers coverage to substantially all (but not all) of its full-time employees and one or more of its full-time employees both enrolls in Exchange coverage and receives an Exchange subsidy. In this second scenario, the employer will owe an "inadequate coverage penalty." The inadequate coverage penalty is $3,000 per person and is calculated, based not on the employer's total number of full-time employees, but only on each full-time employee who receives an Exchange subsidy. (Furthermore, the penalty is capped each month by the maximum potential "no coverage penalty" discussed above).
Because Exchange subsidies are available only to individuals with household incomes of at least 100 percent and up to 400 percent of the federal poverty line (in 2013, a maximum of $44,680 for an individual and $92,200 for a family of four), employers that pay relatively high wages may not be at risk for the penalty, even if they fail to provide coverage that satisfies the affordability and minimum value requirements. Likewise, because Exchange subsidies are not available to individuals who are eligible for Medicaid, employers may be partially immune to the penalty with respect to their low-wage employees, particularly in states that elect the Medicaid expansion. To be sure, Medicaid eligibility is based on household income. Because an employee's household may have more income than the wages he or she receives from the employer, the employee might not be Medicaid eligible, even though the employer pays a very low wage. Thus, it may be difficult for an employer to assume its low-paid employees will be eligible for Medicaid and not eligible for Exchange subsidies. But for employers with low-wage workforces, examination of the extent to which the workforce is Medicaid eligible may be worth exploring.
In addition, Exchange subsidies will not be available to any employee whose employer offers the employee affordable coverage that provides minimum value. Thus, by "playing" for employees who would otherwise be eligible for an Exchange subsidy, employers can ensure they are not subject to any penalty, even if they don't "play" for all employees.
Q&A 2: Who Is Eligible for a Premium Tax Credit or Cost-Sharing Subsidy?
As noted in Q&A 1, merely failing to offer full-time employees minimum essential coverage, or coverage that meets the affordability or minimum value requirements, is not enough to trigger liability under the Employer Mandate. Two additional things must occur before any penalty will be assessed. First, one of the employer's full-time employees must enroll in health coverage offered through an Exchange. Second, that full-time employee must receive an Exchange subsidy (a premium tax credit or cost-sharing subsidy). Thus, an employer should consider which of its employees are potentially eligible for an Exchange subsidy when deciding how to comply with the Employer Mandate. It is important to note that the employee must qualify for the Exchange subsidy; receipt of an Exchange subsidy by an employee's dependent (for an example, an adult child who is not a tax dependent of the employee) will not give rise to an Employer Mandate penalty.
Coverage Through an Exchange. In order to be eligible to receive an Exchange subsidy, an individual must enroll in health coverage offered through an Exchange. Under the ACA, an Exchange will be established in each state, either by the state or by the federal government (or a combination of the two). An Exchange is a governmental entity or nonprofit organization that serves as a marketplace for health insurance for individuals and small employers. Health insurance offered through the Exchanges must cover a minimum set of specified benefits and must be issued by an insurer that has complied with certain licensing and regulatory requirements.
Eligibility for an Exchange Subsidy. There are two Exchange subsidies available: the premium tax credit and the cost-sharing subsidy. The premium tax credit is intended to help individuals and families purchase health coverage through an Exchange. The credit is available only to legal U.S. residents whose household income is 100 percent to 400 percent of the federal poverty line ("FPL"). Legal resident aliens also qualify for the credit if their household income is below 100 percent of the federal poverty line because they are not eligible for Medicaid. Individuals who are eligible for Medicaid or Medicare, or certain other government-sponsored coverage like CHIP or veterans' health care, are not eligible for premium tax credits.
The FPL is set annually by the U.S. Department of Health and Human Services ("HHS") and is based on household size. For 2013, the FPL in the continental U.S. is $11,490 for an individual and $23,550 for a family of four; 400 percent of the FPL is $44,680 for an individual and $92,200 for a family of four. The amounts are slightly higher in Alaska and Hawaii.
An employee is not eligible for a premium tax credit if the employee is either (i) enrolled in an employer-sponsored plan or (ii) eligible for an employer-sponsored plan that meets the affordability and minimum value requirements.
Cost-sharing subsidies, which reduce cost-sharing amounts such as copays and deductibles, are available to individuals who have a household income no greater than 250 percent of the FPL and enroll in "silver-level" coverage through an Exchange. An employee whose household income is 200 percent of the FPL may therefore be eligible for a premium tax credit to help defray the cost of monthly insurance premiums, and a cost-sharing subsidy to help reduce the amount of out-of-pocket copays and deductibles to which the Exchange-enrolled employee otherwise would be subject.
"Certification" of Eligibility for an Exchange Subsidy to Employer. The Employer Mandate penalty applies only when the employer has first received "certification" that one or more employees have received an Exchange subsidy. The IRS will provide this certification as part of its process for determining whether an employer is liable for the penalty, which will occur in the calendar year following the year for which the employee received the Exchange subsidy. Under procedures to be issued by the IRS, employers that receive one or more certifications will be given an opportunity to contest the certification before any penalty is assessed.
In addition, Exchanges are required to notify employers that an employee has been determined eligible to receive an Exchange subsidy. The notification provided contemporaneously with the determination will identify the employee, indicate that the employee has been determined eligible to receive an Exchange subsidy, indicate that employer may be liable for an Employer Mandate penalty, and notify the employer of the right to appeal the determination. These notices will be useful in giving employers an opportunity to correct erroneous Exchange information and protect against erroneous penalty notices from the IRS. These notices will also be useful in budgeting for any penalties that may be owed.
The Employer Mandate penalty applies only to an employer failing to offer health coverage if one or more of its full-time employees enrolls in insurance coverage through a so-called Exchange, and actually receives either a premium tax credit or a cost-sharing subsidy. Unless a full-time employee enrolls in an Exchange and obtains the tax credit or subsidy, the employer is off the hook. This can lead to some surprising exemptions from the penalty.
Assume Employer X is a software development company with 50 full-time employees-40 are software developers whose annual income exceeds $120,000, and 10 are administrative assistants with annual income, after overtime, of no more than $40,000. None of the 40 software developers will be eligible for a premium tax credit or cost-sharing subsidy under the ACA; they are too highly compensated. Thus, Employer X is in a position of being able to avoid the penalty merely by offering health coverage to 10 of its 50 employees, which it should be able to obtain on a small business (SHOP) Exchange. It may exclude its 40 highly compensated employees from eligibility for this coverage (or require them to pay the full cost of coverage) without being exposed to the Employer Mandate penalty. And by either narrowing the eligibility for health coverage only to its 10 administrative assistants, or passing on the full cost of coverage to its software developers, it considerably reduces the risk that employers will have to bear the inflation in health costs associated with providing health coverage to the entire workforce.
This method of avoiding the Employer Mandate penalty can also be used with employees of larger employers whose income is too high for them to qualify for a premium tax credit. It should be noted that it is possible to avoid the Employer Mandate penalty but, at the same time, incur liability under certain nondiscrimination rules. Therefore, any new structure should be reviewed for compliance under both sets of rules.
Q&A 3: When Is the Employer Mandate Effective, and What Transition Rules Apply?
In general, large employers are subject to the Employer Mandate beginning on January 1, 2014. However, the effective date for employers that sponsor fiscal year health plans is deferred if certain requirements are met. There are also special transition rules for offering coverage to dependents, offering coverage through multiemployer plans, change in status events under cafeteria plans, determining large employer status, and determining who is a full-time employee.
Fiscal Year Health Plans. An employer with a health plan on a fiscal year faces unique challenges complying with the Employer Mandate. Because terms and conditions of coverage may be difficult to change mid-year, a January 1, 2014 effective date would, in many cases, force employers with fiscal year plans to be compliant for the entire fiscal 2013 plan year. Recognizing the potential burdens, the IRS has granted special transition relief for employers that maintained fiscal year health plans as of December 27, 2012. Both transition relief rules apply separately to each employer in a group of related employers under common control.
Under the first transition rule, employers will not be subject to a penalty on the basis of any full-time employee who, under the terms of a fiscal year plan in effect as of December 27, 2012, would be eligible for coverage as of the first day of the 2014 plan year. The transition rule applies only if such employee is offered coverage, no later than the first day of the 2014 plan year, that otherwise meets the requirements of the Employer Mandate.
The second transition rule applies if an employer has one or more fiscal year plans (that have the same plan year as of December 27, 2012) and, collectively, either cover at least one quarter of the employer's employees or offered coverage to at least one third of the employer's employees during the most recent open enrollment period that ended prior to December 27, 2012. If one of these prerequisites is met, the employer will not be subject to a penalty on the basis of any full-time employee who (i) is offered coverage, no later than the first day of the 2014 plan year, that otherwise meets the requirements of the Employer Mandate, and (ii) would not have been eligible for coverage under any calendar year group health plan maintained by the employer as of December 27, 2012.
Coverage of Dependents. Large employers must offer coverage not just to their full-time employees but also to their dependents to avoid the Employer Mandate penalty. A "dependent" for this purpose is defined as a full-time employee's child who is under age 26. Because this requirement may result in substantial changes to eligibility for some employer-sponsored plans, the IRS is providing transition relief for 2014. As long as employers "take steps" during the 2014 plan year to comply and offer coverage that meets this requirement no later than the beginning of the 2015 plan year, no penalty will be imposed during the 2014 plan year solely due to the failure of the employer to offer coverage to dependents.
Multiemployer Plans. Multiemployer plans represent another special circumstance because their unique structure complicates application of the Employer Mandate rules. These plans generally are operated under collective bargaining agreements and include multiple participating employers. Typically, an employee's eligibility under the terms of the plan is determined by considering the employee's hours of service for all participating employers, even though those employers generally are unrelated. Moreover, contributions may be made on a basis other than hours worked, such as days worked, projects completed, or a percentage of earnings. Thus, it may be difficult for some participating employers or the plan to determine how many hours a particular employee has worked over any given period of time.
To ease the administrative burden faced by employers participating in multiemployer plans, a special transition rule applies through 2014. Under this transition rule, an employer whose full-time employees participate in a multiemployer plan will not be subject to any Employer Mandate penalties with respect to such full-time employees, provided that: (i) the employer contributes to a multiemployer plan for those employees under a collective bargaining agreement or participation agreement, (ii) full-time employees and their dependents are offered coverage under the multiemployer plan, and (iii) such coverage is affordable and provides minimum value.
This rule applies only to an employer's employees who are eligible for coverage under the multiemployer plan; the employer must comply with the Employer Mandate under the normal rules with respect to its other full-time employees.
Change in Status Events under Fiscal Year Cafeteria Plans. The IRS has also issued transition rules that apply specifically to fiscal year cafeteria plans. (Cafeteria plans are plans that permit employees to make salary reduction elections to pay for qualified benefits, including health benefits, on a pre-tax basis.) Under the tax rules applicable to cafeteria plans, an employee's coverage elections must be made prior to the beginning of the plan year and may not be changed during the plan year, unless the employee experiences a "change in status event." An employee's mid-year enrollment in health coverage through an Exchange or in an employer's health plan to meet the obligation under the ACA's individual mandate to obtain health coverage is not a "change in status event" under the current cafeteria plan rules.
The IRS addresses this issue by providing that a large employer that operates a fiscal year cafeteria plan may amend the plan to allow for mid-year changes to employee elections for the 2013 fiscal plan year if they are consistent with an employee's election of health coverage under the employer's plan or through an Exchange (for small employers whose employees may purchase Exchange coverage through a cafeteria plan). Specifically, the plan may provide that an employee who did not make a salary reduction election to purchase health coverage before the deadline for the 2013 fiscal plan year is permitted to make such an election during the 2013 fiscal plan year, and/or that an employee who made a salary reduction election to purchase health coverage is permitted to revoke or reduce such election once during the 2013 fiscal plan year, regardless of whether a change in status occurs with respect to the employee.
This transition rule applies only to elections related to health coverage and not to any other benefits offered under a cafeteria plan. Any amendment to implement this transition rule must be adopted no later than December 31, 2014 and can be retroactively effective if adopted by such date.
Determining Large Employer Status, and Who is a Full-Time Employee. The IRS has also issued transition rules for determining large employer status and determining who is a full-time employee. In general, large employer status is determined based on the number of employees employed during the immediately preceding year. In order to allow employers to have sufficient time to prepare for the Employer Mandate before the beginning of 2014, for purposes of determining large employer status for 2014 only, employers may use a period of not less than six calendar months in 2013 to determine their status for 2014 (rather than using the entire 2013 calendar year). Likewise, employers may use a special transition measurement period for purposes of determining whether certain employees who work variable schedules are to be considered full-time employees for the 2014 plan year.