Earlier this year, the IRS issued final regulations that provide additional guidance on the employer shared responsibility rules (also called the “pay or play” rules) that will generally apply to employers’ group health plans beginning in 2015 under the Patient Protection and Affordable Care Act of 2010 (i.e., the ACA or ObamaCare). Under the ACA, an applicable large employer may be required to pay an employer shared responsibility penalty if it fails to offer affordable, minimum value health coverage to substantially all of its full-time employees and their dependents. Critical to these penalty provisions is the determination of which employers are considered “applicable large employers.” This newsletter provides a step-by-step discussion to help an employer determine whether it will qualify as an “applicable large employer” under the final rules. For more information about other aspects of these final rules, including details about the potential penalties, please refer to our related “Pay or Play Rules” newsletters
In general, an employer is considered an applicable large employer for a calendar year if it employed an average of at least 50 full-time employees and full-time equivalents FTEs) on business days during the preceding calendar year. (Keep in mind, however, that under a special transition rule, discussed in our newsletter entitled “IRS “Pay or Play” Regulations Delay Compliance Date for Certain Employers, Reduce Penalty Exposure for Others,” employers that employ between 50 and 99 full-time employees (including FTEs) on business days during 2014 will not need to comply with the shared responsibility rules until 2016). Accordingly, an employer who employed 100 or more full-time employees and FTEs during 2014 will be subject to the new rules in 2015 and an employer who employed between 50 and 99 full-time employees and FTEs during 2015 will be subject to the rules in 2016.
For many employers, this determination is a no-brainer. But an employer that is on the cusp should complete the following five steps to determine whether it is an applicable large employer subject to the final shared responsibility rules.
Step 1: Determine the “Employer”
An employer’s first step should be to identify which entity (or entities) constitutes the “employer”. The determination as to whether an employer is an applicable large employer is made on a controlled group or affiliated service group basis. This means that all entities treated as a single employer under Code Section 414(b), (c), (m), or (o) are treated as a single employer for purposes of determining whether the employer qualifies as an “applicable large employer.” Under the controlled group rules, entities are generally considered part of a controlled group if at least 80 percent of their interests are held by one or more common owners or if a significant percentage of one entity’s business is to perform management services for another entity. These rules are very complex and fact-specific. An employer should consult with qualified ERISA counsel if there are any questions.
Step 2: Identify who is an “Employee”
The final regulations use the common law standard for determining whether an individual is an employee. Under this standard, an employment relationship generally exists when the person for whom the services are performed has the right to control and direct the individual who performs the services. For purposes of the “pay or play” rules, leased employees, sole proprietors, partners in a partnership, and 2 percent S-corporation shareholders are not considered employees.
An employer should take care to ensure that a service provider who is treated as an independent contractor is not really a common-law employee. A mischaracterization may impact the employer’s status as an applicable large employer. An employer with 49 full-time employees and three full-time independent contractors, for example, could be subject to the rules (in 2016 under the transition rule) if the IRS later recharacterizes the independent contractors as common-law employees.
Step 3: Capture Each Employee’s Hours of Service
An employee is considered a “full-time employee” for a month if the employee averages at least 30 hours of service per week during that month (or averages 130 hours of service for the month). The “hours of service” that must be counted for this purpose include:
Each hour for which the employee is paid, or entitled to payment, for the performance of duties for the employer; and
Each hour for which the 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.
Hours of service with respect to foreign service income, compensation paid to certain “bona fide volunteers” and compensation paid through certain government-sponsored work study programs can be excluded.
If an employer is part of a controlled group or affiliated service group, hours of service for each member of the group must be counted.
For hourly-paid employees, an employer must count each hour of service based on the employer’s records. For non-hourly paid employees, such as salaried employees, an employer may choose to count hours of service under any one of the following methods:
Counting actual hours of service;
Crediting an employee with 8 hours of service for each day for which at least one hour of service is credited; or
Crediting an employee with 40 hours of service for each week for which at least one hour of service is credited.
An employer may change its method of crediting hours of service for non-hourly employees each calendar year and may apply different methods for counting hours of service to different classifications of non-hourly employees, so long as the classifications are reasonable and consistently applied. However, an employer is prohibited from using an equivalency method if it would substantially understate the employee’s hours of service. For example, applying the days worked equivalency method to an employee who works three 10-hour days per week is not allowed.
Step 4: Counting Full-Time Employees and FTEs
The employer must next count the number of full-time employees and FTEs in each calendar month.
First, Identify Full-Time Employees.
For each calendar month, identify each employee who averaged at least 30 hours of service per week in that month (or alternatively, 130 hours in that month). This is the number of full-time employees.
Second, Count FTEs.
All other (non-full-time) employees are considered for purposes of determining the number of FTEs. This is done by calculating the aggregate number of hours of service (not to exceed 120 hours of service per employee) for these non-full-time employees for each month, and dividing the total aggregate hours of service by 120. The result is the number of FTEs employed for the calendar month.
Step 5: Determine Applicable Large Employer Status
Finally, the employer should take the sum of the total number of full-time employees and FTEs for each calendar month in the preceding calendar year and divide by 12 (the result is rounded down to the next whole number). Please note, however, that under a special transition rule applicable for 2015 only, 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 2014 calendar year (rather than the entire 2014 calendar year).
If the result of this calculation is 100 or more (with respect to 2015) or 50 or more (with respect to 2016 and later years), then the employer is an applicable large employer for all of the next calendar year unless the seasonal worker exception described below applies. Importantly, an employer’s status as an applicable large employer is fixed as of January 1 of a particular year. So, if an employer reduces its workforce to less than 50 (or 100, as applicable) full-time employees (and FTEs) during the year, it does not change the employer’s status as an applicable large employer for that year. In such a case, the employer may cease to be considered an applicable large employer only on the first day of the following year.
Seasonal Worker Exception: If an employer’s workforce exceeds 50 (or 100, as applicable) full-time employees and FTEs for 120 days or less (note: four calendar months may be treated as the equivalent of 120 days) during the preceding calendar year, and the employees in excess of 50 (or 100, as applicable) who were employed during that period were seasonal workers, then the employer is not an applicable large employer. The regulations define “seasonal worker” as a worker who performs labor or services on a seasonal basis and retail workers employed exclusively during the holiday season. The final rules provide that employers may apply a reasonable, good faith interpretation when classifying employers as seasonal workers.
Special Rule for New Employers: If an employer was not in existence for the entire preceding year, it will be treated as a large employer if it is reasonably expected that it will employ an average of at least 50 (or 100, as applicable) full-time employees and FTEs on business days during the current calendar year and it actually employs an average of at least 50 (or 100, as applicable) full-time employees and FTEs on business days during the calendar year.
Internal Revenue Service regulations generally require that, for purposes of avoiding United States federal tax penalties, a taxpayer may only rely on formal written opinions meeting specific requirements described in those regulations. This newsletter does not meet those requirements. To the extent this newsletter contains written information relating to United States federal tax issues, the written information is not intended or written to be used, and a taxpayer cannot use it, for the purpose of avoiding United States federal tax penalties, and it was not written to support the promotion or marketing of any transaction or matter discussed in the newsletter.