On December 28, 2012, the Internal Revenue Service (“IRS”) issued long-awaited proposed regulations regarding the “shared responsibility” penalty provisions of the Patient Protection and Affordable Care Act (“PPACA”). In addition to consolidating prior IRS guidance on the subject, the proposed regulations also contain some surprising interpretations of PPACA’s penalty provisions. Employers will likely be pleased by some of these interpretations and disappointed with others.
Effective January 1, 2014, PPACA’s shared responsibility provisions will require “large employers” (i.e., those employing 50 or more “full-time equivalents”) to offer coverage that is “affordable” and of “minimum value” to “full-time employees” and their dependents. Large employers that fail to offer such coverage to full-time employees and their dependents will be subject to a shared responsibility penalty if any of their full-time employees (or their dependents) opt to purchase tax subsidized coverage on a health care exchange. The amount of the penalty will depend on whether the employer fails to offer minimum value coverage to some or all of its full-time employees, or offers such coverage at a cost that is not affordable. Most of the “surprises” in the proposed regulations involve the definition of key terms such as “large employer”, “dependent” and “full-time employee”. In addition, the regulations elaborate on how shared responsibility penalties will be assessed and provide three affordability “safe harbors” that employers may use to avoid assessment of a penalty.
Definition of “Large Employer”
Only “large employers” are subject to the shared responsibility provisions. Notably, if related companies are deemed a single employer under “control group” tests in Section 414(b), (c), (m) or (o) of the Internal Revenue Code (“IRC”), then they will also be considered a single employer under PPACA and their employees will be combined for purposes of determining large employer status. Each separate company within a control group will be subject to the shared responsibility provisions, and the proposed regulations explain how penalties will be apportioned among them. Thus, coverage under PPACA cannot be avoided by dispersing employees among a number of companies under common control. Businesses with affiliated companies will need to analyze whether their affiliates fall within the same control group when developing a PPACA compliance strategy. Although the IRS’s intent to apply control group tests does not come as a surprise to PPACA watchers, it will likely be unwelcome news for some employers.
Definition of “Dependent”
One pleasant surprise for some employers is the definition of “dependent” contained in the proposed regulations. The term dependent is defined as a child of an employee who has not attained age 26. To the surprise of many, spouses of employees are expressly excluded from the definition. An employer who offers affordable, minimum value coverage to its full-time employees and any dependent child (as defined in Section 152(f)(1) of the IRC) will avoid shared responsibility penalties – even if no spousal coverage is provided by the employer or if spousal coverage is offered but not affordable. The preamble to the proposed regulations also outlines transitional relief for certain employers who do not currently offer coverage to dependents. If such employers take steps to satisfy the dependent coverage requirement during a plan year beginning in 2014, the preamble provides that they will not be liable for any shared responsibility penalty based solely on the failure to offer dependent coverage for part of 2014.
Definition of “Full-Time Employee”
The proposed regulations include the measurement period concepts that are to be used for purposes of determining whether an employee is “full-time” (e.g., “initial measurement periods”, stability periods”, etc.), which were previously explained in IRS Notice 2012-58 (see our prior blog article discussing IRS Notice 2012-58). However, a few new clarifications are likely to have significant ramifications for many employers.
First, the proposed regulations provide that, when calculating an employee’s average “hours of service”, all paid time off must be credited to the employee. In addition, periods of “special unpaid leave” (i.e., leaves of absence under the Family and Medical Leave Act, for military duty, or for jury duty) may not be counted against an employee to reduce his or her average hours of service.
The regulations also provide that employees of educational organizations who experience “employment break periods” of at least four consecutive weeks in duration (i.e., summer break) must have their average hours calculated irrespective of the break periods, subject to a 501 hour limit per calendar year. The IRS has “reserved” the ability to promulgate comparable provisions for non-educational employers.
Other provisions explain when an employee’s absence from work will constitute a break in service for purposes of her having to re-qualify for benefits in the event that he or she is eventually re-employed. As a general rule, an absence from work for 26 consecutive weeks is deemed a break in service for these purposes; however, other provisions may allow for breaks in service after shorter absences.
Hours of service do not include hours for which compensation constitutes income from sources outside the United States (e.g., employment outside of the U.S.).
To the extent these provisions will expand the number of employees qualifying as “full-time”, they will likely come as unwelcome news for employers.
Triggering the Shared Responsibility Penalty
Employers had feared that they could be accountable for a shared responsibility penalty if they inadvertently failed to offer coverage to several employees who straddled the boundary of full-time status. The regulations afford employers some latitude on this issue by providing that an employer is treated as offering coverage to its full-time employees for a calendar month if, for that month, it offers coverage to all but 5% (or, if greater, 5) of its full-time employees (and their dependents). Full-time employees who lack coverage due to failure to enroll or who lose coverage due to late payment of a required contribution cannot be used as grounds for assessment of a penalty; however, an employer must offer full-time employees an effective opportunity to enroll (or decline) coverage no less than once per year. This protection from penalties should come as welcome news for employers and their advisors as they plan for 2014 and beyond.
Three Affordability Safe Harbors
In prior guidance, the IRS recognized an “affordability safe harbor” for employers whose lowest-cost self-only coverage that provides minimum value is offered to employees at a contribution rate that does not exceed 9.5% of an employee’s W-2 wages for the calendar year. In other words, coverage that meets this test will be deemed affordable for the employee and his or her dependents, regardless of the actual cost to the employee of dependent coverage. The proposed regulation contains several caveats to this safe harbor; most notably, that the safe harbor shall only apply if the employee’s required contribution toward the cost of coverage remains consistent during the calendar year (or plan year). Thus, mid-year adjustments to employee contribution rates will result in the loss of the safe harbor.
The regulations also recognize two new affordability safe harbors that may benefit some employers: (a) a “rate of pay” safe harbor (applicable where an employee’s required monthly contribution for the lowest-cost self-only coverage does not exceed 9.5% of his or her approximate monthly earnings, but only if the employee’s wage/salary rate is not reduced during the calendar year); and (b) a “Federal poverty line” safe harbor (applicable where an employee’s required contribution for the lowest-cost self-only coverage does not exceed 9.5% of a monthly amount determined as the Federal poverty line for a single individual for the applicable year, divided by 12).
Although there remain a number of important questions regarding application of PPACA’s shared responsibility provisions, the new proposed regulations address many of the most pressing compliance issues facing employers. This article focuses only on the provisions of the new regulations that are most likely to surprise employers. Questions regarding this article or the proposed regulations may be addressed to any member of the McNees Labor and Employment Law Practice Group. Look for future updates on our blog at www.palaborandemploymentblog.com.