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

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."

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 payments² under Code section 4980H does not apply on a controlled group basis, but applies on a member company-by-member company basis.³
• 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 coverage⁴ 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.⁵ 

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.⁶

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 immed