Employer Shared Responsibility/Pay or Play Requirements Under PPACA
Employee Benefits Update
Date: January 23, 2013
Thompson Hine's employee benefits lawyers understand the rising costs, increasing scrutiny and changing legal landscape facing employers who provide group health plan benefits to employees. We are working closely with our clients to help design, implement and administer health plans in this challenging environment. The breadth and depth of our experience allows us to identify best practices as they emerge and provide responsive, legally compliant and cost-effective solutions. For more information on ensuring that the design of your group health plan, employee communications and plan documentation comply with PPACA, please contact any member of our Employee Benefits & Executive Compensation practice group.
This bulletin, the first in a series examining certain provisions of the Patient Protection and Affordable Care Act (PPACA), provides a brief overview of proposed regulations issued by the Department of the Treasury and the Internal Revenue Service (IRS) that will impact group health plans.
PPACA created new Internal Revenue Code Section 4980H, which contains the "employer shared responsibility" or "employer pay or play" requirements.
On December 28, 2012, the Department of the Treasury and the IRS released proposed regulations and a number of questions and answers to provide guidance on the requirements. This guidance confirms several aspects of previously issued guidance, clarifies and modifies other aspects, and provides new information.
Employers may rely upon this guidance until final regulations are issued. Because final regulations may not be issued before the requirements become effective, employers should become familiar with the guidance, which is summarized below.
Which Employers Are Subject to the Requirements?
An employer is subject to the pay or play requirements for a calendar year if it (together with any related companies) employed at least 50 full-time employees during the prior calendar year. For this purpose, non-full-time employees are converted into full-time equivalents and included in the total.
Special rules apply to new employers and those that employ seasonal workers.
What Are the Pay or Play Requirements?
In order to avoid a penalty, an employer must offer its full-time employees (and their children) minimum essential coverage that is both affordable and provides minimum value.
If an employer does not meet these requirements for a given month, it will be subject to a penalty if any of its full-time employees obtains an insurance policy through an exchange and is certified as eligible for a premium tax credit for that month.
To be certified as eligible for a premium tax credit, an employee must obtain an insurance policy through an exchange and have household income between 100 and 400 percent of the federal poverty level. The employee also must not be eligible for minimum essential coverage, be eligible only for minimum essential coverage that is unaffordable or be eligible only for minimum essential coverage that does not provide minimum value.
How Is the Penalty Calculated?
If an employer does not offer minimum essential coverage to substantially all its full-time employees and their children for a month, the penalty is equal to:
1/12 x $2,000 x (the number of the employer's full-time employees - 30)
If an employer does offer minimum essential coverage to substantially all its full-time employees and their children for a month, the penalty is equal to:
1/12 x $3,000 x (the number of full-time employees certified eligible for a premium tax credit)
This second penalty is capped so it will never be greater than the first. In addition, the following employees are excluded from the calculation of the second penalty:
- New full-time employees during their first three months of employment.
- New variable-hour and seasonal employees during their initial measurement and administrative periods.
- Full-time employees who are offered minimum essential coverage that is both affordable and provides minimum value.
How Does an Employer Offer Coverage to Substantially All Its Full-Time Employees?
Minimum essential coverage must be offered to at least the greater of 95 percent or five of its full-time employees and their children. For this purpose, children include the employee's birth children, stepchildren, adopted children, children placed for adoption and eligible foster children, each until his or her 26th birthday.
Comment: In order to avoid a penalty, an employer must offer affordable, minimum value, minimum essential coverage to all its full-time employees and their children. If an employer offers coverage to substantially all (but not all) full-time employees and their children, it will not be subject to the first penalty but may still be subject to the second penalty.
Comment: The Department of the Treasury and IRS have requested comments on how the pay or play requirements should apply to employers who contribute to multiemployer plans. For now, if an employer is required under a collective bargaining agreement to contribute to a multiemployer plan for a full-time employee, and if that full-time employee is offered affordable, minimum value coverage through the multiemployer plan, the employer will not be subject to a penalty for failing to offer coverage to that full-time employee.
Minimum essential coverage is considered offered to an employee and his or her children for a month if it is offered to the employee and his or her children on every day in the month. However, coverage need not be offered to a terminated employee or his or her children after the date of termination, and coverage need not be offered to an employee or his or her children if the employee fails to pay for coverage by the end of a 30-day grace period.
What Is Minimum Essential Coverage?
The term "minimum essential coverage" will be defined in future guidance.
Comment: The statutory definition suggests that any employer-sponsored major medical coverage will be considered "minimum essential coverage." However, regulators have informally hinted that future guidance may impose certain requirements.
How Does an Employer Determine Whether Coverage Is Affordable?
An employer who offers minimum essential coverage to its full-time employees and their children may choose one of three safe harbors to determine whether coverage is affordable for purposes of the pay or play penalties. In each case, the employer must first identify its lowest-cost plan option that provides minimum value. The employer must then compare the employee's premium amount for the employee-only tier of that plan option to one of the following safe harbor amounts:
- The employee's wages, as reported in Box 1 of Form W-2 for the year.
- The employee's rate of pay.
- One hundred percent of the federal poverty level applicable to single individuals in the state in which the employee resides.
If the premium cost exceeds 9.5 percent of the safe harbor amount, the coverage will be considered unaffordable and could cause the employer to be subject to a penalty.
Comment: To determine eligibility for the premium tax credit, the taxpayer's modified adjusted household income is used in place of these safe harbor amounts. Therefore, the same coverage may be considered unaffordable for purposes of the premium tax credit (allowing an employee to be eligible for the credit) while being considered affordable for purposes of the pay or play penalty (allowing the employer to avoid paying a penalty).
An employer may use different safe harbors for different classifications of employees, so long as the classifications are reasonable and consistently applied.
How Does an Employer Determine Whether Coverage Provides Minimum Value?
Coverage provides minimum value if it covers at least 60 percent of the total allowed cost of benefits that are provided under the plan.
The Department of the Treasury and IRS intend to issue future guidance on this term. Based on current guidance, it appears employers will likely be given two safe harbors for determining whether coverage provides minimum value: a calculator with certain pre-programmed assumptions and a design-based checklist. It also appears that if a plan's design does not fall within the parameters of either safe harbor, an employer will be permitted to obtain an actuarial certification as to the plan's value.
Which Employees Are Considered Full-Time Employees?
Full-time employees are common-law employees who work on average at least 30 hours per week.
Comment: The guidance confirms that leased employees, sole proprietors, partners and 2 percent S-corporation shareholders are not considered "employees," but it does not otherwise elaborate on the definition.
For purposes of determining whether an employer is subject to the pay or play requirements, the determination is based on actual hours worked in the previous year. For purposes of determining whether an employer is subject to a penalty, the determination is based on hours of service that are credited during a measurement period.
How Does an Employer Credit Hours of Service?
An employee will be credited with an hour of service for each hour for which he or she is paid or entitled to be paid by the employer or a related company for performing duties for the employer or during a period of time no duties are performed due to vacation, holiday, illness, incapacity (including disability), layoff, jury duty, military duty or leave of absence.
An employer must credit hourly employees with actual hours of service, but the employer may choose to use equivalencies for non-hourly employees. An employer may choose to credit a non-hourly employee with eight hours per day or 40 hours per week, but these equivalencies may not be used if they would substantially understate an employee's hours.
Hours of service do not include hours worked outside the United States to the extent the employee receives foreign source income, regardless of the residency or citizenship of the employee.
How Does the New Guidance Impact Measurement and Stability Periods?
The guidance does not change the basic concepts of the measurement periods and stability periods that were described in Notice 2012-58. However, it does provide some useful new guidance, including:
- Employers may use different measurement and stability periods from year to year. However, a measurement or stability period may not be changed once the measurement period has begun.
- Measurement periods may be adjusted in certain ways to match payroll periods.
- For purposes of determining whether a new hire is a full-time or variable-hour employee, employers in 2015 and later years will be required to assume that a new hire will be employed for the full initial measurement period, although the employer may assume that hours will vary during that period. No special rules apply for high-turnover positions, although the Department of Treasury and IRS have requested comments about how the rules should apply to short-term employments.
- A change in employment status generally will not impact whether an employee is considered a full-time employee. However, if a new variable-hour employee changes employment to full-time status during the initial measurement period, the employer must treat the employee as a full-time employee no later than the earlier of the first day of the fourth month after the employment status change or the date the employee would otherwise be required to be considered a full-time employee.
How Does an Employer Determine if a Rehired Employee Is a Full-Time Employee?
A full-time employee who terminates employment or takes an unpaid leave of absence generally will return to employment as a full-time employee, and a non-full-time employee will generally return to employment as a non-full-time employee. In those cases, the employee will be credited with zero hours of service during the period of non-employment or unpaid leave of absence. However:
- If the period of absence is at least 26 consecutive weeks, the employee may be treated as a new hire upon return to employment.
- If the period of absence is less than 26 consecutive weeks but more than four consecutive weeks, the employer may apply a rule of parity. Under the rule of parity, if the period of absence is longer than the immediately preceding period of employment, the employee may be treated as a new hire upon return to employment.
Special rules apply to unpaid FMLA leave, unpaid military leave and unpaid jury duty leave. In addition, special rules apply to educational organizations.
How Do the Requirements and Penalties Apply to Members of a Controlled Group of Companies?
If shared ownership of one or more employers causes the employers to be part of a controlled group under Internal Revenue Code Section 414, special rules apply.
- All members of a controlled group are aggregated to determine whether the members are subject to the requirements, but the requirements apply separately to each member of the controlled group.
- When crediting hours of service to an employee, an employer must provide credit for employment with any controlled group member.
- If any member is subject to the penalty for failure to offer coverage, the 30-employee exception is allocated ratably among the members of a controlled group based on the number of full-time employees employed by each member.
Comment: Employers cannot avoid the pay or play requirements by transferring employees to related companies.
How Will a Penalty Be Imposed?
After the due date for individual income tax returns (on which taxpayers will claim the premium tax credit) and the due date for employer information returns (on which certain employers will report the coverage offered to their full-time employees), the IRS will make an initial determination about whether an employer is subject to a penalty. The IRS will contact the employer and provide an opportunity to respond to the initial determination. Following the employer's response, the IRS will finalize its determination and provide a notice and demand for payment. The notice will describe how to make the payment; payment will not be included as part of the employer's corporate tax return.
When Do the Pay or Play Requirements Become Effective?
The requirements generally become effective beginning in January 2014. However, an employer who maintains a fiscal year plan will not be subject to a penalty before the first day of its 2014 plan year if certain requirements are met.
What Should Employers Be Doing Now?
Employers who wish to continue offering coverage in 2014 should be:
- Examining their employee population now to determine which employees could be considered full-time employees in 2014 based on various measurement and stability periods. Employers who decide to use the measurement/stability period safe harbor will need to identify their measurement and stability periods before the beginning of the 2014 plan year.
- Communicating with company executives about how these requirements apply to the organization and the potential costs of extending coverage versus paying a penalty.
IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that nothing contained herein is intended to be used, or can be used, to avoid penalties imposed under the Internal Revenue Code.
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