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Summary of Treasury, IRS Proposed Regulations Regarding Employer Shared Responsibility Requirement

Jan.14.2013

On December 28, 2012, the Department of the Treasury and the Internal Revenue Service (collectively, the "Service") issued a proposed rule ("Proposed Rule") regarding the employer shared responsibility provisions – the so-called "pay or play" provisions – set forth in section 4980H of the Internal Revenue Code of 1986, as amended ("Code").

Code section 4980H, which was added by section 1513 of the Patient Protection and Affordable Care Act ("PPACA"),1 imposes new shared responsibility requirements on employers regarding the offering of health coverage by employers to their full-time employees, effective for months beginning after December 31, 2013. The Proposed Rule was published in the Federal Register on January 2, 2013. Comments are due by March 18, 2013, and a public hearing is scheduled for April 23, 2013. 

In connection with its issuance of the Proposed Rule, the also issued certain sub-regulatory guidance entitled "Questions and Answers on Employer Shared Responsibility Provisions Under the Affordable Care Act."2

Employers may rely on the Proposed Rule for guidance pending the issuance of a final rule or other applicable guidance. The preamble to the Proposed Rule does not address whether employers may rely on the Proposed Rule through 2014 even if final regulations are released before then. The preamble does state, however, that, if and to the extent future guidance is more restrictive than the guidance in the Proposed Rule, the future guidance will be applied without retroactive effect and employers will be provided with sufficient time to come into compliance with the final regulations. Of note, previous guidance issued by the Service provided for reliance through 2014 with respect to certain items described herein.

The Proposed Rule provides much needed clarification on numerous issues regarding the mechanics and application of Code section 4980H. Additionally, the Proposed Rule and the preamble provide some important transition relief for employers. Highlights of the Proposed Rule include:

  • Whether an employer is an "applicable large employer" (and thus subject to Code section 4980H) is determined across an employer's controlled group.
  • The determination of assessable payments3 under Code section 4980H does not apply on a controlled group basis, but applies on a member company-by-member company basis.4
  • The requirement to offer minimum essential coverage under Code section 4980H(a) applies not only to an applicable large employer's full-time employee, but also the full-time employee's children (within the meaning of Code section 152(f)(1)) up to age 26.
  • For purposes of Code section 4980H(b), whether a full-time employee's coverage is affordable is determined by reference to the employee's cost for self-only coverage. Thus, coverage other than self-only coverage need not be affordable to avoid Code section 4980H liability.
  • Three special safe harbors are provided for use by employers in measuring the affordability of employee coverage: the W-2 Safe Harbor, the Rate of Pay Safe Harbor, and the Federal Poverty Line Safe Harbor.
  • Proposed rules are provided regarding break in service and change in employment status/position for purposes of applying the measurement and stability period rules in determining full-time employee status.
  • Special transition rules, including:
    • For qualifying employers with non-calendar year plans, such employers will not be subject to potential liability under Code section 4980H until the first day of the 2014 plan year.
    • Employers may use a 12-month stability period in 2014 so long as they use a transition measurement period that is at least six months long, commences no later than July 1, 2013, and ends no earlier than 90 days before the start of the 2014 plan year.
    • For 2014, an employer will not be subject to an assessable payment under Code section 4980H(a)  for failing to offer child coverage if it takes steps in 2014 toward complying with this requirement.
    • Beginning in 2015, an employer will be required to assume that, although an employee's hours of service might be expected to vary, the employee will continue to be employed for the full duration of the initial measurement period. Thus, the employer cannot take into consideration the likelihood that the employee's employment will terminate in advance of the end of the initial measurement period in determining whether he or she is a full-time employee. Notwithstanding the transition relief, for purposes of 2014 and beyond, an employer may not consider aggregate employee turnover in determining whether any given employee is a full-time employee.

Overview of Code Section 4980H

Effective for months beginning after December 31, 2013, Code section 4980H generally provides that an "applicable large employer" will be liable for an "assessable payment," if certain health care coverage requirements are not satisfied. Specifically, liability for the assessable payment will be imposed on an applicable large employer if any "full-time employee" of the employer is certified as eligible to receive an applicable premium tax credit or cost-sharing reduction, and either:

  • the employer fails to offer its "full-time employees (and their dependents)" the opportunity to enroll in minimum essential coverage5 under an eligible employer-sponsored plan (very generally equal to $2,000 per each full-time employee, less the first 30 full-time employees), or
  • the employer offers its "full-time employees (and their dependents)" the opportunity to enroll in minimum essential coverage under an eligible employer-sponsored plan that, with respect to a full-time employee who has been certified for the advance payment of an applicable premium tax credit or cost-sharing reduction, either is unaffordable or does not provide minimum value (very generally equal to $3,000 per full-time employee who receives a premium tax credit and obtains coverage through a health exchange).

Liability under Code section 4980H is only imposed on applicable large employers if the health care coverage requirements described above are not satisfied. An employer is generally an applicable large employer for a calendar year if it employed an average of at least 50 full-time employees (counting full-time equivalents, as discussed below) on business days during the preceding calendar year. The amount of any assessable payment turns on how many full-time employees (not including full-time equivalents) are employed by an employer in a given year.6 

The statutory language of Code section 4980H provides that a full-time employee with respect to any month is one who is employed on average at least 30 hours of service per week (although as noted below, the Proposed Rule allows employers to use 130 hours per month in lieu of the weekly standard).

Determination of Applicable Large Employer Status

As noted above, only "applicable large employers" may be liable for an assessable payment under Code section 4980H. An employer is an applicable large employer if it employed an average of at least 50 full-time employees (taking into account full-time equivalents) on business days during the preceding calendar year.

1) Definition of "Employee" 

For purposes of determining whether an employer is an applicable large employer, "employee" means an individual who is a common-law employee. A "leased employee" as defined in Code section 414(n) is not considered an employee for purposes of Code section 4980H.

Comment: The identification of full-time employees for purposes of determining status as an applicable large employer is based on the actual hours of service of employees in the prior year. However, for purposes of determining whether an employer is an applicable large employer for 2014 (i.e., the first year of applicability of Code section 4980H), an employer has the option to determine its status as an applicable large employer by reference to a period of at least six consecutive calendar months, as chosen by the employer, in the 2013 calendar year (rather than the entire 2013 calendar year).

2) Definition of "Employer"

An "employer" for purposes of Code section 4980H is a common-law employer, including a government entity or a tax-exempt entity. The entire controlled group under Code section 414(b), (c), (m), and (o) is taken into account for purposes of deciding whether an employer is an applicable large employer.

Comment: With respect to new employers, an employer not in existence during an entire preceding calendar year is an applicable large employer for the current calendar year if it is reasonably expected to employ an average of at least 50 full-time employees (taking into account full-time equivalents, discussed below) on business days during the current calendar year.

3) Limited Exception Regarding Seasonal Employees

An employer that would otherwise constitute an applicable large employer may be excepted from application of Code section 4980H to the extent that the employer's workforce exceeds 50 full-time employees for 120 days or fewer during a calendar year, and the employees in excess of 50 who were employed during that period of no more than 120 days were seasonal workers.

The Proposed Rule provides that a period of four calendar months (whether or not consecutive) or a period of 120 days (whether or not consecutive) may be used by an employer to determine whether the seasonal worker exception applies. The Proposed Rule also clarifies that the term "seasonal worker" is not limited to agricultural or retail workers.

Comment: This exception is solely for the purposes of determining whether an employer is an applicable large employer and should not be construed to except seasonal employees from the definition of employee for purposes of Code section 4980H generally.

4) Determining Full-Time Equivalents

Solely for purposes of determining applicable large employer status, an employer must calculate the number of full-time equivalents ("FTEs") it employed during the preceding calendar year and count each FTE as one full-time employee for that year.

The Proposed Rule provides that all employees (including seasonal workers) who were not full-time employees for any month in the preceding calendar year are included in calculating the employer's FTEs for that month by (i) calculating the aggregate number of hours of service (but not more than 120 hours of service for any employee) for all employees who were not employed on average at least 30 hours of service per week for that month, and (ii) dividing the total hours of service by 120.

Comment: For purposes of performing the above calculations, fractions are taken into account in determining the number of FTEs for each month, but employers should round down the final resulting calculation to determine whether they are an applicable large employer, i.e., after adding the 12 monthly full-time employee and FTE totals and dividing by 12, employers should round the resulting number down to the nearest whole number.

Identifying Full-Time Employees for Code Section 4980H Purposes

Once an employer has determined that it is an applicable large employer for purposes of Code section 4980H, then an employer needs to determine which of its employees qualify as full-time employees for purposes of understanding its potential liability under Code section 4980H.7

The statutory language to Code section 4980H provides that a full-time employee is an employee who is employed on average at least 30 hours of service per week.

Comment: Although individual employers may use a different definition of full-time employee in their business (for example, for purposes of benefit plan eligibility), because the full-time employee definition is set forth in the statute and uses a benchmark of only 30 hours per week, employers are required to use the 30-hour maximum for determining full-time status for purposes of Code section 4980H.

In accordance with past sub-regulatory guidance, the Proposed Rule provides, in the interest of "administrative simplicity," that 130 hours of service in a calendar month is treated as the monthly equivalent of 30 hours of service per week, provided the employer applies this "equivalency rule" on a reasonable and consistent basis. This rule is based on the notion that there are generally more than four weeks in all calendar months.

The Proposed Rule further provides that an employee's hours of service include: (i) each hour for which an employee is paid, or entitled to payment, for the performance of duties for the employer; and (ii) each hour for which an employee is paid, or entitled to payment, by the employer 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.

Comment: The Proposed Rule provides that there is no limit on the amount of paid leave that must be taken into account in determining full-time status. This is a divergence from prior sub-regulatory guidance in which regulators indicated they were considering a rule that would have required employers to only take into consideration the first 160 hours of paid leave in a given calendar year.

For employees paid on an hourly basis, employers must calculate actual hours of service from records of hours worked and hours for which payment is made or due for vacation, holiday, illness, incapacity (including disability), layoff, jury duty, military duty or leave of absence.

For employees not paid on an hourly basis, employers are permitted to calculate the number of hours of service under any of the following three methods: (i) counting actual hours of service;(ii) using a days-worked equivalency method whereby the employee is credited with eight hours of service for each day for which the employee would be required to be credited with at least one hour of service under these service crediting rules; or (iii) using a weeks-worked equivalency of 40 hours of service per week for each week for which the employee would be required to be credited with at least one hour of service under these service crediting rules.

Comment: The Proposed Rule allows an employer to apply different methods for different classifications of non-hourly employees, so long as the classifications are reasonable and consistently applied. An employer may change methods for each calendar year. However, the Proposed Rule prohibits use of the days-worked or weeks-worked equivalency method if the result would be to substantially understate an employee's hours of service in a manner that would cause that employee not to be treated as a full-time employee when he otherwise should.

The Proposed Rule provides that hours of service do not include hours of service to the extent the compensation constitutes foreign source income. Thus, hours of service generally do not include hours of service worked outside the United States, without regard to the residency or citizenship status of the individual.

In addition, the Proposed Rule provides special rules that are applicable to teachers and other employees of educational organizations. The Proposed Rule also requests comments on whether and, if so, how a special safe harbor or presumption should or could be developed with respect to the variable hour employee classification of the common-law employees of temporary staffing agencies. The Service states in the preamble to the Proposed Rule that it expects that the final regulations will contain an anti-abuse rule to address situations involving temporary staffing agency structures. Under the anticipated rule, if an individual performs services as an employee of an employer, and also performs the same or similar services of that employer in the individual's purported employment at a temporary staffing agency or other staffing agency of which the employer is a client, then all the hours of service are attributed to the employer for purposes of applying Code section 4980H.

1) New Employees

a) Reasonably Expected to Work a Full-Time Schedule

With respect to an employee who is reasonably expected at his or her start date to work a full-time schedule of 30 hours per week or 130 hours per month (and who is not a seasonal employee), an employer must offer coverage to the employee at or before the conclusion of the employee's initial three calendar months of employment, or face potential liability under Code section 4980H.

For purposes of determining whether an employee is reasonably expected to work a full-time schedule, an employer must take into account all facts and circumstances known to it as of the date of the employee's hire.

Regarding employees who are not reasonably expected to work a full-time schedule upon their start dates and do not in fact work such a schedule, an employer is not subject to liability under Code section 4980H.

Comment: If employees that are not reasonably expected to work full-time hours end up working full-time hours and/or an employer cannot demonstrate that the employee did not in fact work such hours, the employer could be subject to liability. Thus, it may make sound business practice for employers to treat all employees who are not characterized as full-time employees as of their hire date as variable hour employees (see below) on a going-forward basis. This may help ensure compliance with Code section 4980H.

b) Variable Hour Employees Not Reasonably Expected to Work a Full-Time Schedule

For variable hour employees that are reasonably expected to work a full-time schedule, the Proposed Rule allows an employer to utilize an administrative scheme to determine whether an employee works a full-time schedule over a given period of time. Per this administrative scheme, an employer may use what is termed an initial "measurement period" of between three and 12 months to determine whether a newly hired variable hour employee works a full-time schedule, i.e., at least 30 hours per week or 130 hours per month.

If a variable hour employee is determined to have worked a full-time schedule during the initial measurement period, then the employer must treat the employee as a full-time employee on a going-forward basis for a specified period of time, which is termed the "stability period" in the Proposed Rule, and which must be the same length as that used for variable hour ongoing employees (see discussion below).

If a new variable hour employee is not determined to work a full-time schedule during the initial measurement period, he or she may be treated as not a full-time employee for possibly the full duration of the initial stability period, and the employer, therefore, will not be subject to an assessable payment under Code section 4980H for failing to offer any, or compliant, coverage to the employee.

Comment: It is quite possible that an employer may find itself having to treat a new variable hour employee as a full-time employee prior to the expiration of the initial stability period that applies to such employee, notwithstanding that the variable hour employee worked less than 30 hours per week or 130 hours per month on average during the initial measurement period. This is because the employer is also required to "test" the new variable hour employee's full-time status under the measurement period that applies to ongoing employees (see below). If, as a result of this test, the employee is determined to have worked a full-time schedule using the measurement period that is used by the employer for all ongoing employees, the employer must then treat the employee as a full-time employee as of the start of the next stability period that applies to ongoing employees, even if the initial stability period that applies to the new employee has not yet expired.

c) Seasonal Employees

 Notice 2012-58 provides that for purposes of Code section 4980H an employer is not required to make available coverage to "seasonal employees" regardless of whether they work 30 hours per week or 130 hours per month.

Neither Notice 2012-58 nor the Proposed Rule includes a definition of the term "seasonal employee." Significantly, the Notice permits employers to use a good faith interpretation in determining which employees are seasonal employees. The Proposed Rule specifically reserves the definition of seasonal employee for future rulemaking, but restates the relevant language from the Notice as well as the fact that employers may rely on the Notice and their good faith interpretations for 2014.

The preamble to the Proposed Rule indicates the Service is considering defining a seasonal employee, in part, to be an employee that works less than a specified period of time within a calendar year. In this regard, the Service references the existing rule in Treasury Regulation section 1.105-11, regarding the nondiscrimination rules for self-funded group health plans under Code section 105(h), which defines a seasonal employee as employees "whose customary annual employment is less than 9 months, if other employees in similar work with the same employer (or, if no employees of the employer are in similar work, in similar work in the same industry and location) have substantially more months." Treasury Regulation section 1.105-11 goes on to state that "any employee whose customary annual employment is less than 7 months may be considered as a part-time or seasonal employee."

Comment: It remains unclear the extent to which a seasonal employee may encompass only those positions that are recurring on an annual basis, perhaps also by reference to a specific time of the year (such as ski instructors in the winter in the Northeast Region), or may also encompass merely a short-term employee, i.e., an employee who is hired on a full-time basis for a limited number of days, weeks or months.

d) Permissible Administrative Period

In accordance with past guidance, the Proposed Rule also permits an employer to use for administrative convenience an "administrative period" of up to but no more than 90 days. This administrative period must occur between the measurement period and the stability period and must overlap with the close of the prior stability period. The purpose of the administrative period is to allow time for employers to make coverage options available to those employees determined to have worked a full-time schedule during the preceding measurement period and to allow such full-time employees time to make coverage elections for the following stability period.

As noted above, the initial measurement period, as with the measurement period for ongoing employees (see discussion below), may be a period between three and 12 months. Additionally, as noted above, the Proposed Rule permits the use of an administrative period that may be up to 90 days. Significantly, however, and in accordance with past sub-regulatory guidance, the Proposed Rule provides that the initial measurement period and the administrative period combined may not 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).

Comment: Given the above rule, for new variable hour employees, employers will likely be required in practice to use an initial measurement period for new employees of less than the maximum allowable 12 months because they will want to build in some time for an administrative period to allow for plan enrollment for resulting full-time employees.

If an employer complies with these requirements, then no assessable payment under Code section 4980H will be due with respect to the variable hour or seasonal employee during the initial measurement period or the administrative period.

e) Changes in Employment

Following the issuance of earlier sub-regulatory guidance, many questions and comments arose regarding how the rules apply to new employees that change positions within the organization during the initial measurement and stability periods or otherwise are terminated and rehired during the same periods. Thankfully, the Proposed Rule provides some important clarifications on these issues.

In the event a new variable or seasonal employee has a material change in the position of employment or other employment status that, had the employee begun employment in the new position or status, would have resulted in the employee being reasonably expected to be employed on average at least 30 hours of service per week during the measurement period, the Proposed Rule provides that he or she must be treated as a full-time employee under Code section 4980H as of the first day of the fourth month following the change in employment status, or, if earlier and the employee averages more than 30 hours of service per week during the initial measurement period, the first day of the first month following the end of the initial measurement period (including any optional administrative period applicable to the initial measurement period).

Comment: The Proposed Rule provides that the change in employment status rule applies only to new variable hour and seasonal employees. A change in employment status for an ongoing employee does not change the employee's status as a full-time employee or otherwise during the stability period.

f) Breaks in Service

The preamble to the Proposed Rule notes that an employee may incur an unpaid break in service, either through a termination and rehire, an unpaid leave of absence or a continuous period during which the employee is not credited with any hours of service and is not paid for some other reason. The Proposed Rule provides that if the period for which no hours of service is credited is at least 26 consecutive weeks, an employer may treat an employee who has an hour of service after that period, for purposes of determining the employee's status as a full-time employee (for employers using the look-back measurement method), as having terminated employment and having been rehired as a new employee of the employer.

For periods of less than 26 weeks, the employer may choose to apply a "rule of parity" under which an employee may be treated as having terminated employment and having been rehired as a new employee if the period with no credited hours of service (of less than 26 weeks) is at least four weeks long and is longer than the employee's period of employment immediately preceding that period with no credited hours of service. The preamble uses as an example of the application of this "rule of parity" a situation in which a newly-hired employee works three weeks for an applicable large employer, terminates employment and is rehired by that employer ten weeks after terminating employment. In that situation, the preamble notes that the "rule of parity" applies because the ten-week period with no credited hours of service is longer than the immediately preceding three-week period of employment.

If the unpaid leave of absence is less than 26 weeks and the "rule of parity" does not apply, the Proposed Rule provides that the measurement and stability period that would have applied to the employee had the employee not experienced the unpaid leave of absence would continue to apply upon the employee's resumption of service, i.e., if the employee returns during a stability period in which the employee is treated as a full-time employee, the employee is treated as full-time employee upon return and through the end of that stability period.

The Proposed Rule also identifies unpaid leave on account of jury duty and unpaid leave subject to the Family and Medical Leave Act of 1993 and the Uniformed Services Employment and Reemployment Rights Act of 1994 as "special unpaid leave." For such special unpaid leave, the Proposed Rule provides a method for averaging hours when applying the look-back measurement method. Under this method, the employer either (a) determines the average hours of service per week for the employee during the measurement period excluding the special unpaid leave period and uses that average as the average for the entire measurement period; or (b) treats employees as credited with hours of service for special unpaid leave at a rate equal to the average weekly rate at which the employee was credited with hours of service during the weeks in the measurement period that are not special unpaid leave.

Comment: In the preamble to the Proposed Rule, the Service indicates that it is considering issuing special rules regarding new short-term employees or regarding new employees hired into high-turnover positions. (See above comments and discussion regarding seasonal employees.)

2) Variable Hour Ongoing Employees

With respect to variable hour employees who have been employed by an employer for a period of time (hereinafter referred to as "ongoing employees"), an applicable large employer may either treat these employees as full-time employees or, at its election, may use a measurement period to determine each ongoing employee's full-time status. This measurement period, as with new variable hour employees, may not be less than three and not more than 12 consecutive months, as chosen by the employer. If the employer determines that a variable hour ongoing employee was employed on average at least 30 hours of service per week during the measurement period, then the employer must treat the employee as a full-time employee during the subsequent stability period, regardless of the employee's number of hours of service during the stability period, so long as he or she remains an employee. The stability period must be the greater of (i) six months, and (ii) the length of the preceding measurement period.

Comment: As with new variable hour employees, an applicable large employer may also elect to add an administrative period between the measurement period and the stability period as part of this method. Such administrative period may last up to 90 days, but may neither reduce nor lengthen the measurement period or the stability period. Also, it must overlap with the prior stability period so that for ongoing employees during any such administrative period applicable following a standard measurement period, those employees who are enrolled in coverage because of their status as full-time employees based on a prior measurement period will continue to be covered.

For an employee whom the employer determines to be a full-time employee during a measurement period, the stability period would be the period immediately following the measurement period (and any applicable administrative period), the duration of which would be at least the greater of six consecutive calendar months or the length of the standard measurement period.

For an employee whom the employer determines to not be a full-time employee during a measurement period, the employer would be permitted to treat the employee as not a full-time employee during the immediately following stability period (which may be no longer than the associated standard measurement period).

Generally the measurement and stability periods selected by an applicable large employer member must be uniform for all employees, but different periods may be applied to the following categories: (i) each group of collectively bargained employees covered by a separate collective bargaining agreement; (ii) collectively bargained and non-collectively bargained employees, (iii) salaried employees and hourly employees; and (iv) employees whose primary places of employment are in different states.

Comment: The Proposed Rule provides that, for administrative convenience, employers can adjust the starting and ending dates of their measurement periods in order to avoid splitting employees' regular payroll periods if each of the payroll periods is one week, two weeks, or semi-monthly in duration. For example, an employer using the calendar year as a measurement period could exclude the entire payroll period that included January 1 (the beginning of the year) if it included the entire payroll period that included December 31 (the end of that same calendar year).

Compliance with Code Section 4980H

Per the discussion above, the determination of whether an employer is an applicable large employer, and thus subject to Code section 4980H in the first instance, is made on a controlled group basis. Similarly, the provision in the Proposed Rule that allows an applicable large employer to disregard the first 30 employees in calculating assessable payments under Code section 4980H(a) applies across the controlled group. In this regard, the first 30 employees that may be disregarded for purposes of Code section 4980H(a) are allocated ratably among the applicable large employer members on the basis of the number of full-time employees employed by each applicable large employer member during the calendar year.8

Very significantly, the Proposed Rule provides that in determining whether an applicable large employer is subject to an assessable payment under Code sections 4980H(a) and (b), this determination is made on a member company-by-member company basis, rather than on a controlled group basis. Thus, for example, if a parent company has 20 controlled group subsidiaries, whether the assessable payments of Code section 4980H apply will be determined separately for each of the 21 members of the controlled group.

Comment: The provision in the Proposed Rule that states that the Code section 4980H assessable payments apply on a member-by-member basis (rather than across the controlled group) is welcome news for employers that had asked for the ability to choose to "pay" or "play" on a member basis. It is important for employers to keep in mind, however, that existing nondiscrimination rules for self-funded group health plans under Code section 105(h) continue to apply to employers and that to-be-issued nondiscrimination rules for insured group health plans under new Public Health Service Act ("PHSA") section 2716 will likely also apply to limit employer discretion in this regard. The to-be-issued rules under new PHSA section 2716 are to be modeled on certain aspects of the Code section 105(h) rules for self-insured plans. Although the existing regulatory scheme under Code section 105(h) is largely outdated (and we understand subject to future revision by the Service in connection with rulemaking on new PHSA section 2716), the existing regulations generally limit an employer's ability to only offer coverage to a certain group of employees within the employer's controlled group, at the exclusion of certain other employees, unless the group that is offered coverage constitutes a reasonable nondiscriminatory classification within the meaning of Treasury Regulation section 1.105-11, which incorporates by reference the rules of Code section 410(b). For purposes of determining whether an eligible class is a reasonable nondiscriminatory classification, questions remain regarding whether employers may utilize the old regulations under Code section 410(b) or whether employers must utilize the current regulations, which impose a very strict test when applied to employer-sponsored health plans that makes it very difficult to pass. Even if it is clarified that employers are permitted to use the old Code section 410(b) regulations, these regulations utilize a facts and circumstances test (rather than the strict numeric test), which could leave employers subject to challenge or second guessing by the regulators.

The preamble to the Proposed Rule makes clear that an applicable large employer cannot be liable under both Code section 4980H(a) and Code section 4980H(b) for the same calendar month. 

1) Code Section 4980H(a)

An applicable large employer is liable for an assessable payment under Code section 4980H(a) if, for any month, any full-time employee is certified to receive an applicable premium tax credit or cost-sharing reduction and the applicable large employer fails to offer its full-time employees (and their dependents) the opportunity to enroll in "minimum essential coverage" under an eligible employer-sponsored plan. Whether the minimum essential coverage is affordable or provides minimum value is not relevant.

Comment: "Minimum essential coverage" for purposes of Code section 4980H is defined by reference to new Code section 5000A(f). In what appears to have been scrivener's error, Congress failed to include a self-funded, non-grandfathered, employer-sponsored plan as one of the types of coverages that constitute "minimum essential coverage." The Service states in the preamble to the Proposed Rule that "[f]uture regulations under section 5000A are expected to provide further guidance on the definition of [minimum essential coverage] and eligible employer-sponsored plans," and that "[t]hese regulations under section 5000A are expected to provide that an employer-sponsored plan will not fail to be [minimum essential coverage] solely because it is a plan to reimburse employees for medical care for which reimbursement is not provided under a policy of accident and health insurance (a self-insured plan)." Some have expressed concern that the Service could seek to utilize its administrative prerogative (absent a technical correction by Congress) to define "minimum essential coverage" for purposes of Code section 5000A(f), and thus Code section 4980H, to mean only employer-sponsored self-funded non-grandfathered coverage that is something more than merely a self-funded plan that complies with the PPACA market reforms, i.e., a plan that includes a certain level of essential benefits. If so, this could operate to increase employer costs in complying with Code section 4980H(a) via the offering of coverage. Such a definition would also seem to be contrary to employer expectations. 

Of note, the Proposed Rule finally addresses a long-standing question regarding exactly to whom an employer must offer minimum essential coverage. As noted above, the express statutory language of Code section 4980H(a) provides that an applicable large employer must offer minimum essential coverage to all "full-time employees (and their dependents)."

As a result of the parenthetical and the absence of clear legislative history, questions remained regarding whether subject employers would be required to make available minimum essential coverage for full-time employees only (i.e., self-only coverage), or whether subject employers would also be required to make available coverage to a full-time employee's spouse and or children.

The Proposed Rule answers this question and provide that for purposes of Code section 4980H(a), an applicable large employer must offer minimum essential coverage to not only each full-time employee, but also each full-time employee's child (as defined in Code section 152(f)(1)) who is under 26 years of age. An offer of coverage to an employee's spouse is not required for purposes of Code section 4980H(a).

Pursuant to a transition rule contained in the Proposed Rule (as also discussed toward the end of this document), any employer that takes steps during its plan year that begins in 2014 toward satisfying the Code section 4980H provisions relating to the offering of coverage to full-time employees' dependents will not be liable for any assessable payment under Code section 4980H solely on account of a failure to offer coverage to the dependents for that plan year.

Comment: The proposed rule has the effect of making mandatory in some respects the adult child coverage requirement contained in the PPACA market reform provisions. Under the market reforms, only those employers that offered coverage to a child under the age of 18 were required to offer coverage to adult children up to age 26. Thus, an employer could avoid having to make available adult child coverage by choosing not to offer coverage to children under age 18. Applicable large employers will now be required to offer coverage to adult children up to age 26 – at least with respect to the children of full-time employees. It seems at least possible that such an employer could continue to not make available any child coverage for employees that are other than full-time employees.
Comment: As noted above, the Proposed Rule would require applicable large employers to pay an assessable payment under Code section 4980H(a) or otherwise make available "minimum essential coverage" to all Code section 152(f)(1) children of each full-time employee. Code section 152(f)(1) includes a somewhat broad definition of "child" that incorporates not only by blood or legal adoption, but also includes step- children and foster children. Many employers may have in good faith adopted a definition of "child" for purposes of complying with the market reform requirement (see comment above) that did not include foster children or step-children. These employers will need to revisit their plan eligibility rules to consider what changes may need to be made to their plans.

The Proposed Rule provides that if an applicable large employer member fails to offer coverage to a full-time employee for any day of a calendar month during which the employee was employed by the employer, then the employee is treated as not being offered coverage during that entire month. However, in a calendar month when a full-time employee terminates employment, if the employee would have been offered coverage for the entire month if the employee had been employed for the entire month, the employee is treated as having been offered coverage during that month.

Comment: The Proposed Rule provides that, if an employee has not been offered an effective opportunity to accept coverage, he or she will not be treated as having been offered the coverage for purposes of Code section 4980H. The employee must also have an effective opportunity to decline an offer of coverage that is not minimum value coverage or that is not affordable. Thus, an applicable large employer cannot render an employee ineligible for a premium tax credit (and thus be saved from Code section 4980H liability) by providing an employee with mandatory coverage (e.g., coverage that is a condition of employment) that does not provide minimum value or which is not affordable.

The Proposed Rule provides that if an employee enrolls in coverage but fails to pay the employee's share of premium on a timely basis (i.e., in instances where the employee's share of the premium is not collected through withholding from the employee's salary but is instead billed to the employee), the employer is not required to provide coverage for the period for which the premium is not timely paid, and the employer is treated as having offered that employee coverage for the remainder of the coverage period (generally the remainder of the plan year). The Proposed Rule adopts the rule from the COBRA regulations with regard to payment of premiums, and hence incorporates both a 30-day grace period for payment and rules with regard to timely payments that are less (but not significantly less) than the amount of the employee's share of the premium.

The preamble to the Proposed Rule notes that the Service believes it should exercise its "administrative authority to allow recognition of a margin of error consistent with an intent to recognize the possibility of inadvertent errors together with the specificity and administrability of a specific percentage." Hence, the Proposed Rule provides a "de minimis" rule for purposes of complying with the requirements of Code section 4980H(a) under which an applicable large employer member 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 all but five percent or, if greater, five of its full-time employees (provided that an employee is treated as having been offered coverage only if the employer also offered coverage to that employee's dependents).

Comment: Although unclear, it appears that the de minimis rule applies on a member company-by-member company basis, rather than across the controlled group. Thus, for example, assume a holding company, Holdco, has two subsidiaries, Sub X and Sub Y. Assume further that Sub X has 100 full-time employees and Sub Y has 100 full-time employees and that Sub X decides to comply with Code section 4980H by offering minimum essential coverage to its full-time employees "(and their dependents)",  while Sub Y chooses not to offer minimum essential coverage and simply pays its liability under Code section 4980H. Sub X, notwithstanding its best efforts, misclassifies seven variable hour employees as not full-time even though they work on average more than 30 hours per week during the measurement period. As a result, Sub X fails to offer these 7 individuals minimum essential coverage as of the start of the next stability period and only makes an offer to 93 of its 100 full-time employees. Although 7 is less than 5% of the controlled group full-time employees of Holdco, it is greater than 5% of the 100 full-time employees of Sub X. Thus, it appears that the de minimis rule does not apply to Sub X and Sub X could also be subject to liability under Code section 4980H(a).

2) Code Section 4980H(b)

Code section 4980H(b) provides that if an applicable large employer offers its full-time employees (and their dependents) the opportunity to enroll in minimum essential coverage under an eligible employer-sponsored plan but nonetheless one or more full-time employees have been certified for the payment of an applicable premium tax credit or cost-sharing reduction, the employer generally is liable for a Code section 4980H(b) assessable payment if it fails to offer minimum essential coverage that is also (i) affordable, and (ii) provides minimum value. The amount of the assessable payment is based on the number of its full-time employees receiving an applicable premium tax credit or cost-sharing reduction.

Under Code section 4980H(b), an assessable payment may be assessed against an employer if the employer's coverage is unaffordable within the meaning of Code section 36B(c)(2)(C)(i) or does not provide minimum value within the meaning of Code section 36B(c)(2)(C)(ii). (Code section 36B governs the premium tax credit.) Code section 36B(c)(2)(C)(i) generally provides that coverage is unaffordable if the employee's premium share for self-only coverage exceeds 9.5% of the employee's modified adjusted gross household income (with certain exceptions).

Comment: Regulators had indicated in prior sub-regulatory guidance that they were planning to issue proposed regulations that would provide that affordability for purposes of Code section 4980H is based solely on a full-time employee's cost of coverage. The Proposed Rule is welcome news for employers in that it confirms this interpretation. Accordingly, although a subject employer must make available minimum essential coverage to each full-time employee and such employee's child up to age 26 for purposes of Code section 4980H, an employer need only provide affordable and minimum value coverage to the full-time employee. This should reduce the costs for employers that seek to comply with Code section 4980H(b) by making available affordable, minimum value coverage to their full-time employees.

Comment: Questions remain regarding whether a full-time employee's spouse and child will be eligible for federal premium and cost-sharing tax credits under Code section 36B for the purchase of exchange-based coverage if the employer provides affordable and minimum value coverage to such full-time employee. Many employers and stakeholders support allowing the spouse and child to receive such tax credits. It is our understanding, however, that this issue remains under consideration by the Service and the Administration given the revenue costs associated with such a rule.

The Proposed Rule sets forth three affordability safe harbors for purposes of determining whether an employer's coverage satisfies the 9.5% affordability test. Specifically, the Proposed Rule provides the following safe harbors:

  1. "W-2 Safe Harbor" – This safe harbor relies on the use of an employee's Form W-2 wages in determining affordability. Wages would be the amount required to be reported in Box 1 of W-2.
  2. "Rate of Pay Safe Harbor" – Under this proposed safe harbor, an employer: (A) determines the hourly rate of pay for a given hourly employee who is eligible to participate in the health plan at the beginning of the plan year, (B) multiplies that rate by 130 hours per month, and (C) compares the resulting monthly wage amount with the cost of coverage to the employee. For salaried employees, monthly salary would be used instead of hourly salary multiplied by 130.
  3. "Federal Poverty Line Safe Harbor" – The Proposed Rule provides that an employer may also rely on a design-based safe harbor using the federal poverty line ("FPL") for a single individual. Employer-provided coverage offered to an employee is affordable if the employee's cost for self-only coverage under the plan does not exceed 9.5% of the FPL for a single individual.

The following examples are in the Proposed Rule:

  • W-2 Safe Harbor: Employee A is employed by applicable large employer member Z consistently from January 1, 2015 through December 31, 2015. In addition, Z offers Employee A and his dependents minimum essential coverage during that period that meets the minimum value requirements. The employee contribution for self-only coverage is $100 per calendar month, or $1,200 for the calendar year. For 2015, Employee A's Form W-2 wages with respect to employment with Z are $24,000. Because the employee contribution for 2015 is less than 9.5% of Employee A's Form W-2 wages for 2015, the coverage offered is treated as affordable with respect to Employee A for 2015 ($1,200 is 5% of $24,000).
  • Rate of Pay Safe Harbor: Employee D is employed by applicable large employer member W from January 1, 2015 through December 31, 2015. In addition, W offers Employee D and his dependents minimum essential coverage during that period that meets the minimum value requirements. The employee contribution for self-only coverage is $85 per calendar month. Employee D is paid at a rate of $7.25 per hour (the minimum wage in Employer W's jurisdiction), for the entire year 2015. For purposes of applying the affordability safe harbor, W may assume that Employee D earned $942.50 per calendar month (130 hours of service multiplied by $7.25 per hour). Accordingly, affordability is determined by comparing the assumed income per month ($942.50) to the employee contribution per month ($85). Because $85 is less than 9.5% of Employee D's assumed income ($85 is 9.01% of $942.50), the coverage offered is treated as affordable with respect to Employee D for 2015.
  • Federal Poverty Line Safe Harbor: Employee F is employed by applicable large employer member W from January 1, 2015 through December 31, 2015. In addition, W offers Employee F and his dependents minimum essential coverage during that period that meets the minimum value requirements. W uses the look-back measurement method. Under that method as applied by W, Employee F is treated as a full-time employee for the entire calendar year 2015. Employee F is regularly credited with 35 hours of service per week but is credited with only 20 hours of service during the month of March 2015 and only 15 hours of service during the month of August 2015. Assume for this purpose that the Federal poverty line for 2015 for an individual is $11,170. With respect to Employee F, W determines the monthly employee contribution for employee single-only coverage for each calendar month of 2015 as an amount equal to 9.5% multiplied by $11,170, which is $1,061.15, and that amount is then divided by 12, and the result is $88.43. Regardless of Employee F's actual wages for any calendar month, including the months of March 2015 and August 2015 when Employee F has lower wages because of significantly lower hours of service, the coverage under the plan is treated as affordable with respect to Employee F.

Additional examples in the Proposed Rule demonstrate how the safe harbors are calculated when an employee only works for the employer during a portion of the year.

With respect to payment mechanics, the Proposed Rule provides that the amount of the Code section 4980H(b) assessable payment cannot exceed the amount of the assessable payment that would have been imposed under Code section 4980H(a) had the employer failed to satisfy Code section 4980H(a). In addition, any assessable payment under Code section 4980H is treated as an excise tax and is payable upon notice and demand. Certain reporting requirements will be imposed on applicable large employer members under Code section 6056 beginning in 2015 (see below for further discussion); separate regulations will be issued regarding this requirement.

Transition Rules

The Proposed Rule provides a number of transition rules to assist employers in coming into compliance with the rapidly approaching effective date that applies for purposes of Code section 4980H.

1) Fiscal Year Plans

The Proposed Rule provides a special transition rule for non-calendar year, i.e., fiscal year, plans. Under the Proposed Rule, if an applicable large employer member maintains a fiscal year plan as of December 27, 2012, such employer is not subject to potential liability under Code section 4980H with respect to a given full-time employee "(and their dependents)" if the employer makes available affordable, minimum value coverage to the employee by no later than the first day of the plan year that commences in 2014.

The Proposed Rule also includes a special transition rule for applicable large employers (or members thereof) that as of December 27, 2012 have both calendar year plans and fiscal year plans. Under this special transition rule, if at least 25% of the employer's employees are covered under one or more fiscal year plans (as of December 27, 2012) that have the same plan year or if the employer offered coverage under those plans to 33% or more of its employees during the most recent open enrollment period before December 27, 2012, no payments under Code section 4980H will be due for any month prior to the first day of the 2014 plan year with respect to employees who (i) are offered affordable, minimum value coverage no later than the first day of the 2014 plan year of the fiscal year plan, and (ii) would not have been eligible for coverage under any group health plan maintained by the applicable large employer member as of December 27, 2012 that has a calendar year plan year.

Comment: Although employers that utilize the above transition rules may not be subject to liability under Code section 4980H, the preamble to the Proposed Rule makes clear that the employers will still be required to comply with the tax reporting requirements under Code section 6056 (by which an employer notices to the Service those of its employees that were covered by qualifying coverage for each month of the preceding calendar year) during the period of transition relief.

2) Salary Reduction Elections for Accident and Health Plans Provided Through Cafeteria Plans for Cafeteria Plan Years Beginning in 2013

Following the issuance of prior sub-regulatory guidance, questions were asked about whether the existing cafeteria plan regulations were sufficient to enable employers to facilitate employees' mid-year changes in salary reduction elections in connection with Code section 4980H compliance. In response to these concerns, the Proposed Rule provides transition relief to allow employers to permit either or both of the following changes in salary reduction elections (with an appropriate amendment to the cafeteria plan):

  1. An employee who elected salary reduction through the cafeteria plan for accident and health plan coverage with a fiscal plan year beginning in 2013 is allowed to prospectively revoke or change his or her election with respect to the accident and health plan once, during that plan year, without regard to whether the employee experienced a change in status event described in Treasury Regulation section 1.125-4; and
  2. An employee who failed to make a salary reduction election through his or her employer's cafeteria plan for accident and health plan coverage with a fiscal plan year beginning in 2013 before the deadline for making elections for the cafeteria plan year beginning in 2013 is allowed to make a prospective salary reduction election for accident and health coverage on or after the first day of the 2013 plan year of the cafeteria plan, without regard to whether the employee experienced a change in status event described in Treasury Regulation section 1.125-4.

The Proposed Rule provides that an applicable large employer may adopt the necessary plan amendments on a retroactive basis so long as the amendments are (i) adopted by no later than December 31, 2014, and (ii) are effective back to the first day of the cafeteria plan's 2013 plan year.

3) Measurement Periods for Stability Periods Starting in 2014

Solely for purpose of stability periods beginning in 2014, employers may adopt a transition measurement period that is shorter than 12 months but that is no less than six months long 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.

Comment: This rule will be of most help to employers that sponsor calendar year plans and that seek to utilize a 12-month stability period that commences January 1, 2014. Significantly, for these employers, they will need to commence their transition measurement period well before July 1, 2013 if they plan to use any meaningful administrative period since the measurement period must be no less than six months.  Thus, for example, if an employer with a calendar year plan seeks to commence a 12-month stability period on January 1, 2014 and to utilize an administrative period that coincides with the start of open enrollment on October 15, 2013 (which would then run from October 15, 2013 to December 31, 2013), the employer would need to commence its transition measurement period no later than mid-April 2013.

4) Applicable Large Employer Determination for 2014

The Proposed Rule includes a transition rule for small employers for purposes of determining whether they are an applicable large employer for 2014. Under the transition rule, an employer may determine its status as an applicable large employer by reference to a period of at least six consecutive calendar months, as chosen by the employer, in the 2013 calendar year (rather than the entire 2013 calendar year). Thus, an employer may determine whether it is an applicable large employer for 2014 by determining whether it employed an average of at least 50 full-time employees on business days during any consecutive six-month period in 2013.

5) Coverage for Dependents

To provide employers sufficient time to extend coverage to dependents, any employer that "takes steps during its plan year that begins in 2014 toward satisfying the Code section 4980H provisions relating to the offering of coverage to full-time employees' dependents will not be liable for any assessable payment under Code section 4980H solely on account of a failure to offer coverage to the dependents for that plan year."

6) Multiemployer Plans 

Following the issuance of prior sub-regulatory guidance, many questions were raised regarding how Code section 4980H will apply to multiemployer plans. For purposes of 2014 only, the Proposed Rule provides that an employer will not be subject to an assessable payment under Code section 4980H if (i) the employer is required to make a contribution to a multiemployer plan with respect to the full-time employee pursuant to a collective bargaining agreement or an appropriate related participation agreement, (ii) coverage under the multiemployer plan is offered to the full-time employee (and the employee's dependents), and (iii) the coverage offered to the full-time employee is affordable and provides minimum value.

Notwithstanding the transition relief, any waiting period for coverage under the plan must separately comply with 90-day limitation on waiting periods in section 2708 of the PHSA.

7) Variable Hour Employee Definition

Effective as of January 1, 2015, and except in the case of seasonal employees, the employer will be required to assume for purposes of Code section 4980H that, although an employee's hours of service might be expected to vary, the employee will continue to be employed by the employer for the entire initial measurement period; accordingly the employer will not be permitted to take into account the likelihood that the employee's employment will terminate before the end of the initial measurement period in determining whether the employee is a full-time employee.

Comment: Although this rule does not apply until 2015, the Proposed Rule provides that for purposes of 2014, the status of any individual employee as a variable hour employee cannot be based on employer expectations regarding aggregate turnover. Rather there must be objective facts and circumstances specific to the newly hired employee at the start date demonstrating that the individual employee's employment is reasonably expected to be of limited duration within the initial measurement period.

Service Questions and Answers Regarding Code Section 4980H

The sub-regulatory guidance issued by the Service in conjunction with the Proposed Rule addresses many issues, including how an employer will know that it owes an employer shared responsibility payment, and how it will make an employer shared responsibility payment. Based on informal conversations with Service representatives, it is our understanding that employers will be able to contest an assertion by an employee that he or she was not offered qualifying coverage after the payment is assessed.

Comment: Employers were previously subject to a similar regime in connection with the subsidies paid for federal continuation coverage under the American Recovery and Reinvestment Act ("ARRA Subsidies") and disputes regarding whether an employee had experienced a voluntary or involuntary termination. However, in connection with the ARRA Subsidies, the government paid the subsidy, so employers were not particularly interested in whether the determination regarding the employee was correct. In this case, the employer will be on the hook for payment, so it will be interesting to see what mechanism the Service develops and whether it will be workable for employers.

 


 

IRS CIRCULAR 230 NOTICE: As required by the Internal Revenue Service, we inform you that any tax advice contained in this document was not intended or written to be used or referred to, and cannot be used or referred to, (i) for the purpose of avoiding penalties under the Internal Revenue Code, or (ii) in promoting, marketing or recommending to another party any transaction or matter addressed in this document.

 


 

Footnotes:

1 Pub. L. No. 111-148 (as amended by section 1003 of the Health Care and Education Reconciliation Act of 2010, Pub. L. No. 111-152).
2 The Questions and Answers are available at http://www.irs.gov/uac/Newsroom/Questions-and-Answers-on-Employer-Shared-Responsibility-Provisions-Under-the-Affordable-Care-Act.
3 The assessable payment is often referred to in a non-legal sense by commentators as a "penalty."  This appears to be driven not by any legal interpretation as to whether the payment is in fact a penalty under the Code or any other law, but rather by the notion that employers that fail to provide qualifying coverage will be subject to a tax.
4 Notably, existing and future nondiscrimination rules are likely to continue and/or to apply and thus should be taken into account as part of 2014 planning.
5 The preamble of the Proposed Rule states that future regulations under Code section 5000A are to provide that an employer-sponsored plan will not fail to be minimum essential coverage solely because it is a plan to reimburse employees for medical care for which reimbursement is not provided under a policy of accident and health insurance (a self-insured plan).
6 The assessable payment under Code section 4980H(a) is based on all (excluding the first 30) full-time employees, while the assessable payment under Code section 4980H(b) is based on the number of full-time employees who are certified to receive an advance payment of an applicable premium tax credit or cost-sharing reduction.
7 As noted above, FTEs do not count for purposes of determining the assessable payment, if any, for which an applicable large employer is liable. They only count for purposes of determining an employer's status as an applicable large employer.
8 Of note, to the extent the 30-employee reduction results in an applicable large employer member being allocated more than zero but less than one full-time employee, the Proposed Rule provides that the member's share will be rounded up to one full-time employee.



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