"Shared Responsibility" Final Regulations and 2015 Transition Guidance

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Author, Emily Meyer, New York, +1 212 556 2312, emeyer@kslaw.com

In February, the Internal Revenue Service (the "IRS") issued final regulations under Section 4980H of the Internal Revenue Code (the "Code"), which establishes the employer "shared responsibility" (or "pay-or-play") mandate under the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act (collectively, the "Affordable Care Act"). Under Code Section 4980H, large employers are subject to penalties if they do not offer affordable health coverage to their full-time employees and their dependents. The regulations under Code Section 4980H establish which employers are subject to the penalties, which employees and dependents must be offered coverage and what constitutes affordable health coverage.

Code Section 4980H's effective date is January 1, 2014, but the IRS delayed enforcement of its requirements and penalties until 2015 pursuant to a notice issued in July 2013 (as addressed in a previous article). The final regulations apply beginning on January 1, 2015. However, enforcement of the pay-or-play requirements and penalties is modified for 2015 pursuant to special transition guidance.

The Treasury Department and IRS released a fact sheet and a question and answer list summarizing the final regulations and accompanying 2015 transition guidance.

Pay-or-Play Mandate

Under Code Section 4980H and the final regulations thereunder, an "applicable large employer" is subject to penalty taxes if it (i) fails to offer major medical coverage to at least 95% of its full-time employees and their dependents or (ii) offers coverage that fails to meet affordability and "minimum value" tests and one or more full-time employees obtain subsidized coverage on a public health insurance exchange. An "applicable large employer" is defined as an employer that had an average of 50 or more full-time employees on business days during the prior calendar year. A "full-time" employee is one whose hours of service average more than 30 per week. In determining whether an employer is an applicable large employer, however, the number of full-time employees for a month is increased by the number of "full-time equivalents" ("FTEs") for the same months, which equals the total number of hours of service performed during the month by employees other than full-time employees (up to 120 hours of service per employee) divided by 120.

2015 Transition Guidance

Under special transition guidance, enforcement of the pay-or-play mandate will be relaxed for 2015. Most notably, the threshold size for "applicable large employers" will be raised to 100 employees and the coverage availability requirement will be satisfied at 70% (rather than 95%) of full-time employees. In addition, a more generous formula will be used to calculate the penalty tax applied to employers that fail to meet these relaxed requirements. The guidance also provides transition relief on a number of technical points.

1. 100 Full-Time Employee Threshold

An employer that averages fewer than 100 full-time employees (including FTEs) during 2014 will not be subject to pay-or-play penalty taxes for the 2015 plan year as long as the employer does not (i) reduce the size of its workforce or the overall hours of service of its employees such that the full-time employee count falls below 100 during 2014 (unless the reduction is for bona fide business reasons) or (ii) eliminate or materially reduce the health coverage it offered as of February 9, 2014 between that date and the end of its 2015 plan year. An employer may change its health coverage offerings without losing eligibility for the transition relief if (i) the employer contribution continues to be at least 95% of what it was on February 9, 2014 or continues to make up the same or a higher percentage of the total cost of coverage that it did on February 9, 2014; (ii) employee-only coverage provides "minimum value" (i.e., the employer's anticipated share of the benefit cost is at least 60%) after any change to the benefits offering under employee-only coverage; and (iii) the employer does not narrow or reduce the class or classes of employees or dependents to whom coverage was offered on February 9, 2014. The applicable large employer threshold will be lowered to 50 full-time employees beginning with the 2016 plan year.

2. Coverage Availability Requirement

For 2015 (and any portion of the 2015 plan year that falls in 2016), an employer that offers coverage to at least 70% of its full-time employees and their dependents will meet the pay-or-play mandate's coverage availability requirement. An employer that meets this requirement with respect to full-time employees but not dependents may still avoid penalties as long as it "takes steps" during the 2015 plan year toward offering dependent coverage that meets the requirements of the pay-or-play mandate. The final regulations do not specify any steps an employer must take to qualify for this relief, but limit the dependents with respect to whom it may be applied to dependents who were not offered coverage for the 2013 and 2014 plan years. Beginning with the 2016 plan year, employers must offer coverage to at least 95% of full-time employees and their dependents to meet the coverage availability requirement.

3. Penalty Tax Calculation

In general, if an employer fails to offer coverage to substantially all of its full-time employees and their dependents and one or more full-time employees obtain subsidized coverage on an exchange, the employer is subject to a monthly penalty equal to the total number of its full-time employees (reduced by 30), multiplied by 1/12th of $2,000 (adjusted for inflation). For 2015 and any portion of the 2015 plan year that falls in 2016, however, the employer may subtract 80 full-time employees (instead of 30) when calculating this monthly penalty. (Where an employer offers coverage but such coverage does not meet the affordability and minimum value requirements, the employer is subject to a different penalty, calculated based on the number of full-time employees who obtain subsidized coverage on a public exchange. No transition relief was provided with respect to this penalty.)

4. Non-Calendar Year Plans

Under the final regulations, employers that sponsor non-calendar year plans do not have to comply with the pay-or-play mandate with respect to the period before the first day of the 2015 plan year if they satisfy a number of technical requirements. To be eligible for transition relief, non-calendar year plans must be in compliance with the pay-or-play mandate's requirements beginning on the first day of the 2015 plan year and must have had the same plan year since December 27, 2012.

5. Offer of Coverage in January 2015

An employee who is offered coverage no later than the first day of the first payroll period that begins in January 2015 will be treated as having been offered coverage for January 2015. (In general, an employer is treated as failing to offer coverage for a month if it fails to offer coverage on any day of that month.)

6. Counting and Identifying Full-Time Employees

To determine their applicable large employer status for 2015, employers may count employees during a period of at least six consecutive months in 2014, rather than the entire calendar year. Whether an employer meets the requirements of the seasonal worker exception for 2015 must be determined based on the entire 2014 calendar year, however.

To assess compliance with the coverage mandate or calculate penalty taxes for 2015, employers that identify full-time employees during a measurement period of at least six consecutive months that begins no later than July 1, 2014 and ends no earlier than 90 days before the first day of the 2015 plan year may rely on those classifications during a twelve month "stability period" that begins in 2015. (In general, the regulations require that a 12-month long stability period be preceded by a twelve-month long measurement period.)

New Guidance in the Final Regulations

The final regulations under Code Section 4980H adopt many of the provisions in the proposed regulations issued in December 2012, including the availability of the "look-back" measurement method as an alternative to the monthly measurement method in determining liability for pay-or-play penalties. (Under the "look-back" measurement method, employers use an employee's hours of service during a prior period, referred to as the measurement period, to determine the employee's full-time status during a subsequent period, referred to as the stability period. Under the monthly measurement method, an employee's full-time status for a month is determined by his or her actual hours of service in that month.) A number of new provisions and clarifications are notable, however.

1. Transition to Applicable Large Employer Status

The final regulations provide a three-month transition period for the first year in which an employer is subject to the pay-or-play mandate. If employees who were not offered coverage during the prior year are offered minimum value coverage on or before April 1 of the year in which the employer becomes subject to the mandate, the employer will not be subject to penalties for failing to offer those employees coverage for the preceding January, February and March.

2. Coverage of New Full-Time Employees

The final regulations provide that all employers, including employers using the monthly measurement method, may wait up to three calendar months, beginning with the first calendar month in which an employee is otherwise eligible for coverage, to offer coverage to a new full-time employee. As long as the employee is offered minimum value coverage on or before the first day of the fourth month, penalties will not apply with respect to the preceding three-month period, even if the employee is full-time or expected to be full-time. (Waiting periods are not considered in determining whether employees are "otherwise eligible for coverage.") This provision is particularly helpful for employers that hire temporary employees for periods shorter than three months.

3. Coverage of New Variable Hour and Seasonal Employees

The proposed regulations provided that employers using the look-back measurement method may wait to offer coverage to new variable hour and seasonal employees until their full-time status is determined during an "initial measurement period" of up to twelve months, that begins on the first day of either the next calendar month or payroll period after an employee's start date. The final regulations clarify that penalties will not apply with respect to variable hour and seasonal employees who are determined to be full-time employees during this initial measurement period as long as they are offered minimum value coverage on or before the first day of the thirteenth calendar month beginning after the employee's start date. (However, if the variable hour or seasonal employee experiences a change in employment status after which he or she is expected to be a full-time employee, the employer may delay offering coverage for at most three calendar months following the change in status.) Following this "initial measurement period," employers must test variable hour and seasonal employees for full-time status in the same manner as other ongoing employees.

4. Classification of Employees

Given that employers using the look-back method may delay offering coverage to variable hour and seasonal employees, the classification of a new employee determines when coverage must be offered in order for the employer to avoid penalties. The final regulations provide that the relevant facts and circumstances at the employee's start date determine whether a classification is reasonable. The final regulations list "factors to consider" in determining whether to classify an employee as variable hour or full-time, including special factors that apply to the classification of employees of temporary staffing firms. (An employee may be classified as a variable hour employee if the employer cannot determine whether he or she is reasonably expected to average 30 hours of service per week during the initial measurement period because the employee's hours are variable or uncertain.) The final regulations also list factors to consider in determining whether an employee should be classified as full-time or part-time. (An employee may be classified as a part-time employee if he or she is reasonably expected at his or her start date to average less than 30 hours of service per week during the initial measurement period. Employees classified as part-time may be treated like variable hour employees.) The final regulations do not provide additional factors to be considered in classifying an employee as seasonal, defined as an employee in a position for which the customary annual employment is six months or less.

5. Breaks in Service

Under the final regulations, a returning employee may be treated as a new employee if his or her break in service was 13 weeks or longer. (The proposed regulations required a break in service of at least 26 weeks.) In determining an employee's average hours of service for a measurement period, employers using the look-back measurement method must exclude leave taken on account of jury duty or subject to the Family and Medical Leave Act of 1993 ("FMLA") or the Uniformed Services Employment and Reemployment Rights Act of 1994 ("USERRA"). The final regulations clarify that this "special unpaid leave" rule does not apply under the monthly measurement method.

6. Use of Different Measurement Methods

The final regulations clarify that different measurement methods as well as different measurement and stability periods may be applied to salaried and hourly employees, employees whose primary places of employment are in different states, collectively bargained and non-collectively bargained employees and each group of collectively bargained employees covered by a separate collective bargaining agreement. For example, an employer may choose to use the look-back measurement method with respect to hourly employees and the monthly measurement method with respect to salaried employees. An employer may not apply the look-back method to variable hour and seasonal employees if it applies the monthly measurement method to employees with regular hours, however.

7. Determining Affordability

Under the proposed regulations, employers may use one of three safe harbor methods – the Form W-2 wages method, the rate of pay method or the federal poverty line method – to determine whether coverage is "affordable health coverage" with respect to a particular employee for purposes of the pay-or-play mandate. (In general, health coverage is affordable if the employee's portion of the self-only premium for lowest-cost coverage that provides minimum value does not exceed 9.5% of the employee's annual household income.) The final regulations adopt these three safe harbor methods with a few modifications. They permit an employer to use the rate of pay method with respect to an hourly employee whose rate of pay is reduced during the year. (To do so, employers must test affordability in each calendar month.) They also provide that employers using the federal poverty line method may use the poverty guidelines in effect six months prior to the beginning of the plan year (rather than requiring use of the most recently published guidelines). Finally, the final regulations clarify that different safe harbor methods may be used to determine affordability for different categories of employees if the categories are reasonable and based on bona fide business criteria.

8. Definition of "Dependent"

The final regulations exclude step and foster children from the applicable definition of "dependent." As a result, only an employee's biological and adopted children are "dependents" for purposes of determining whether an employer meets the requirements of the pay-or-play mandate. (Spouses and domestic partners are not considered dependents.)

Next Steps

Now that the parameters of the pay-or-play mandate appear to be set, employers should decide exactly how they will comply. Time is running short - applicable large employers that wish to use the look-back measurement method and a 90-day administrative period should begin tracking hours of service by April 2 if they have calendar year plans, and all employers must count full-time employees and FTEs during a period of at least six consecutive months in 2014.

Topics:  Affordable Care Act, Healthcare, IRS, Pay or Play, Shared Responsibility Rule

Published In: Health Updates, Labor & Employment Updates, Tax Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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