By far the most important issue for employers to consider under the Affordable Care Act (ACA) is the employer “free rider penalty,” often referred to as “pay or play.” Instead of forcing employers to provide group health insurance to employees, ACA imposes a tax on employers if they don’t offer coverage to all or substantially all of their full-time employees (and their dependents), or if that coverage fails to meet certain conditions. This “pay or play” tax is memorialized in Section 4980H of the Internal Revenue Code. The IRS recently issued comprehensive proposed regulations on pay or play, which summarize and synthesize previous IRS notices and sub-regulatory guidance.
The pay or play rules will be in effect for large employers beginning on January 1, 2014 (though transitional relief applies to employers with non-calendar year plan years, pursuant to the IRS proposed regulations). Large employers for this purpose include employers which have, on average, at least 50 full-time employees on business days during the preceding calendar year (part-time employees are included in this determination, counting each employee’s full-time equivalency). Employers within the same controlled group are considered the same employer and must be aggregated for this determination. Employers subject to the pay or play rules should begin to look at how they structure their health insurance coverage for employees, well in advance of 2014.
The amount of the tax depends both on whether the employer offers coverage to all or substantially all of its full-time employees, as well as the value and affordability of that coverage. Specifically, Section 4980H imposes one of two potential taxes:
A. Tax on Employers Not Offering Minimum Essential Coverage
If an employer does not offer health coverage to all or substantially all of its full-time employees who work at least 30 hours per week (and their dependents), it will be subject to a tax of $2,000 per year for each of its full-time employees. Under the IRS proposed regulations, the term “substantially all” allows employers to satisfy the rules by offering coverage to at least 95% of the employer’s full-time employees (and their dependents). The first 30 full-time employees are not counted for purposes of the tax. Stated simply, the failure to offer coverage to substantially all full-time employees and their dependents results in a “headcount tax,” calculated based on the number of full-time employees (but the first 30 full-time employees are “free”). The headcount tax amount will be adjusted for inflation after 2014.
B. Tax on Employers Offering Minimum Essential Coverage Which is Unaffordable or Fails to Provide Minimum Value
If the Company offers coverage to all of its full-time employees, but this coverage is either (a) “unaffordable” (i.e., the premium to be paid by the employee is more than 9.5 percent of the employee’s income); or (b) fails to provide “minimum value” (i.e. covers less than 60% of the total allowed costs of benefits), then the employer’s tax is calculated using a different method. In this case, the employer must pay an annualized tax of $3,000 each year (also adjusted for inflation) with respect to each full-time employee who opts out of the employer’s group health plan and receives subsidized coverage under a state health exchange instead. The annual penalty is capped at $2,000 times the total number of full-time employees in excess of 30 (also adjusted for inflation).
Key Decision Points
An exhaustive explanation of possible pay or play strategies is beyond the scope of this alert. There is no one-size-fits-all approach. However, employers should focus on the following key decision points as soon as possible:
Is An Exemption From Pay or Play Within Reach?
For employers who barely exceed the 50 full-time employee threshold, it may be possible to structure the work force or the controlled group so that the threshold is not exceeded. Some employers may consider mild downsizing to avoid pay or play rules entirely. Further, under transitional relief in the IRS proposed regulations, employers may utilize a six-month period in 2013 (rather than the entire 2013 calendar year) to determine whether they exceeded the 50 full-time employee threshold, and are subject to pay or play rules in 2014.
Determine the Methodology for Counting “Full-Time Employees” Now
To effectively gauge risk and apply the rules, the employer must understand which of its employees are full-time employees. The answer will be clear for many employees, but is more complicated when dealing with variable hour or seasonal employees. The IRS established safe-harbor methods for counting FTEs (in IRS Notice 2012-58) by using a “standard measurement period,” and a “stability period.” The lengths of these periods and their starting and ending dates are set by each employer and may vary between different categories of employees. Employers should begin exploring which methodology they will choose now, because determinations about which employees are full-time employees would optimally be made in advance of the open enrollment period occurring before 2014.
In addition, as specified in the IRS proposed regulations, employers have different options for determining hours of service for non-hourly employees. Further, the IRS proposed regulations provide specific rules for educational employers, to take into account the unique circumstances for certain school employees who only perform services while school is in session.
Employer Choice Remains
There is no mandate for employers to provide employee health coverage. Employers will remain free to either offer health coverage for their employees, or not, as well as determine which particular classes employees are eligible for coverage (subject to nondiscrimination rules). Therefore, the pay or play rules should not be understood as a mandate to sponsor a group health plan. Employers that don’t “play” will simply “pay” a tax instead. Depending on the taxes that employers are willing to bear, as well as the cost of insurance, some employers may decide to both play (for one group of employees) and pay (for a different group).
Flexibility With Respect to Part-Time Employees
It is important to note that the taxes under 4980H can only be imposed if the employer fails to offer coverage to all or substantially all of its full-time employees, or if a full-time employee opts out of the employer’s coverage due to its unaffordability or failure to provide minimum value. Part-time employees are thus not part of the tax equation. Employers could decide to restructure their workforce in some cases (by hiring more part-time employees), rather than making drastic benefits coverage changes. Employers should be careful to make sure that part-time employees do not exceed 30 hours per week during the relevant measurement period (if they average 30 hours per week or more, they are full-time employees under ACA regardless of the employer’s intent).
The IRS proposed regulations clarify that coverage must only be offered to the employee and the employee’s dependent children to satisfy the pay or play rules. Under the proposed regulations, coverage need not be offered to the employee’s spouse. Therefore, employers may have some flexibility in how they structure dependent coverage, and spousal coverage in particular, to avoid a tax under Section 4980H.
If the Plan Isn’t Broken, Don’t Fix It
If an employer is happy with its current group health arrangement, and offers it to all full-time employees and dependent children, and the plan is sufficient to attract and retain a high quality workforce, it is possible that no changes are necessary at all. The plan may provide minimum value already, and the level of employee premiums may make it “affordable” under ACA. Or, the number of employees for whom coverage is “unaffordable” may be insignificant and the resulting tax may be immaterial. Minimum value and affordability rules should be examined closely to determine whether the employer’s plan already passes muster.
Be Aware of Eligibility Gaps for Employees Working In Excess of 30 Hours
Some employer group health plans permit employees to participate only if they work at least 35 hours per week. Such an eligibility rule will likely result in the “headcount tax” under 4980H because employees working between 30 and 35 hours per week would not be eligible for coverage. Employers hoping to avoid the headcount tax should consider amending plan eligibility standards (by extending coverage to employees working 30 or more hours per week) to avoid this issue.