Recently, we published a Client Update explaining how the Play-or-Pay mandate, or Employer Shared Responsibility provision, under the Affordable Care Act (ACA) generally works. To summarize, we described how an employer counts its full-time employees, including full-time equivalent employees, solely for purposes of determining whether the employer is an “applicable large employer” subject to the Play-or-Pay mandate. We also explained that an applicable large employer becomes subject to an Employer Shared Responsibility Payment (the penalty tax) if (1) it fails to offer the opportunity to enroll in an employer-sponsored health plan that offers minimum essential coverage to substantially all full-time employees (and certain dependents); or (2) minimum essential coverage is offered to all of its full-time employees (and certain dependents) but it is unaffordable or does not provide minimum value; and (3) at least one of the applicable large employer’s full-time employees receives a premium tax credit or cost-sharing reduction for purchasing health insurance through an Exchange. Finally, we covered how to calculate the penalty taxes to which such an applicable large employer would be subject.
As we noted previously, the method for determining who is a full-time employee for purposes of the penalty tax is different than the method used for determining whether an employer is an applicable large employer. In this Client Update, we describe how an applicable large employer determines which employees are full-time employees for purposes of the penalty tax, as explained in the Internal Revenue Service’s (IRS) proposed regulations published earlier this year.
Look-Back Measurement Method
In general, the full-time employee determination for purposes of the Play-or-Pay mandate’s tax penalty is made on a month-by-month basis. This may cause administrative and practical problems for employers who are unable to reliably predict which of their employees will be considered full-time, particularly if such employees have schedules resulting in varying hours of service per month. The IRS recognized the potential issues and created an optional “look-back measurement method” (the look-back method) as an alternative way to determine the number of full-time employees. This look-back method essentially provides safe harbor methods for determining which ongoing employees, new employees, employees rehired after a termination of employment and employees returning to service after certain unpaid leaves of absence are considered full-time. The rules governing the look-back method are complex. This Client Update provides an overview of how they work but is not an exhaustive explanation.
The following definitions are important to comprehend as we walk through this process. The Play-or-Pay mandate only applies to “applicable large employers.” For simplicity, we use the term “employer” as shorthand for “applicable large employer” throughout the remainder of this Client Update.
A “full-time employee” is one who performs an average of at least 30 hours of service per week. For this purpose, 130 hours of service in a calendar month is treated as the monthly equivalent of at least 30 hours of service per week, provided the employer applies this equivalency rule on a reasonable and consistent basis.
“Hour of service” includes each hour for which an employee is paid, or entitled to payment, for (1) the performance of duties for the employer; or (2) for a period of time during which no duties are performed due to vacation, holiday and illness, among other reasons (paid leave). Notably, the proposed regulations omit the 160-hour limit on paid leave that was proposed in IRS Notice 2011-36, so that under the new rules all periods of paid leave must be taken into account.
A time period selected by the employer of at least three but not more than 12 consecutive calendar months during which the employer determines whether an employee is considered a full-time employee based on that employee’s average number of hours of service per week.
A time period selected by the employer that immediately follows, and is associated with, an applicable measurement period (and any applicable administrative period, defined below), during which an employee who qualified as a full-time employee based on the measurement period is treated as a full-time employee (i.e., is “locked into” full-time status) for purposes of the Play-or-Pay mandate’s tax penalty.
An optional period of no longer than 90 days beginning immediately after the end of a measurement period and ending before the associated stability period. The purpose of this period is to allow an employer time to count employees and coordinate health coverage. The administrative period must overlap with the prior stability period to ensure that no gaps in coverage occur.
Under the look-back method, an employer determines whether each employee is a full-time employee by “looking back” at the applicable measurement period. The measurement period applicable to ongoing employees is referred to as a “standard measurement period.” An “ongoing employee” is defined as an employee who has been employed for at least one standard measurement period. The employer may add an administrative period of up to 90 days between the measurement period and the stability period.
If an employer determines that an ongoing employee performed on average at least 30 hours of service per week during a standard measurement period, then that employee is treated as a full-time employee during the associated stability period as long as the employee remains employed—regardless of the employee’s actual number of hours of service during such stability period. The stability period must be at least as long as the greater of six consecutive calendar months or the length of the applicable measurement period. Therefore, even if the standard measurement period is three months, the associated stability period cannot be shorter than six months.
If an employer determines that an ongoing employee did not perform on average at least 30 hours of service per week during a standard measurement period, then that employee need not be treated as a full-time employee during the associated stability period—also regardless of the employee’s actual number of hours of service during such stability period. However, in this case, the stability period can be no longer than the standard measurement period.
The proposed regulations require that, in general, the standard measurement and stability periods must be uniform for all employees who fall into the same category. An employer may apply different periods for the following categories expressly listed in the proposed regulations:
Collectively bargained employees and non-collectively bargained employees;
Each group of collectively bargained employees covered by a separate collective bargaining agreement;
Salaried employees and hourly employees; and
Employees whose primary places of employment are located in different states.
An employer may change its standard measurement and stability periods for subsequent years but generally may not make changes once the standard measurement period has begun. The proposed regulations allow an employer to correlate the beginning and ending of a measurement period with the beginning and ending of payroll periods, as opposed to the beginning and ending of calendar months, but only if certain requirements are satisfied.
Transition Guidance for Ongoing Employees
Employers wanting to take advantage of the look-back method for 2014 must begin their measurement periods this year. However, under the proposed regulations, a 12-month stability period is only allowed with respect to employees who are determined to have performed less than 30 hours of service per week if the corresponding measurement period is also 12 months long. Because some employers may not yet have procedures in place for tracking employees’ hours of service for these purposes, the proposed regulations provide the following transition guidance.
The transition guidance only applies to stability periods beginning in 2014. If an employer adopts a measurement period that (1) is at least six but less than 12 months in length; (2) begins on or before July 1, 2013; and (3) ends no more than 90 days before the first day of the plan year that begins on or after January 1, 2014, then the employer may adopt a 12-month stability period for 2014.
New Full-Time Employees (Non-Seasonal)
Under the proposed regulations, an employer will not be subject to the penalty tax with respect to a new employee who is “reasonably expected at his or her start date to be a full-time employee (and is not a seasonal employee)” if the employer offers such employee coverage in the employer’s health plan at or before the end of the employee’s third full calendar month of employment. This exemption only applies with respect to those first three full calendar months, however. If the employer fails to offer coverage by the end of the employee’s third full calendar month of employment, the employer may be subject to the penalty tax for all three full months of employment in addition to any subsequent months during which the employer continues to fail to offer that employee coverage.
The IRS stated in the preamble to the proposed regulations that it is considering whether the following factors are appropriate or useful in determining whether a new employee is “reasonably expected” to be a full-time employee:
Whether a new employee is replacing a full-time former employee; and
Whether ongoing employees in the same or comparable positions have variable hours.
New Variable Hour Employees (Non-Seasonal)
A “new variable hour employee” is an employee for whom, on his or her initial start date and based on the facts and circumstances, it cannot be determined whether the employee will reasonably be expected to perform an average of at least 30 hours of service per week during the measurement period. The measurement period used for new variable hour employees is referred to as the “initial measurement period.” The initial measurement period can be between three and 12 consecutive months long and may begin on any date between the employee’s start date and the first day of the first calendar month following the employee’s start date. The stability period for these employees must be the same length as the stability period for ongoing employees.
If a new variable hour employee is determined to have performed on average at least 30 hours of service per week during the initial measurement period, the employee must be treated as a full-time employee during the associated stability period, which must be at least six consecutive months long and no shorter than the initial measurement period.
If, on the other hand, the new variable hour employee is determined to not have performed on average at least 30 hours of service per week during the initial measurement period, the employee need not be treated as a full-time employee during the associated stability period. This would be subject to a possible exception because the initial measurement period and the standard measurement period will overlap to some extent (see below). The stability period in this case must not be longer than the initial measurement period plus one month. And, it must not exceed the remainder of the standard measurement period (plus any associated administrative period) in which the initial measurement period ends.
Transition Guidance for New Variable Hour Employees
Until January 1, 2015, employers are allowed to take into account any expectation that a new employee’s employment will terminate before the end of the initial measurement period. For example, a new employee who is expected to perform at least 30 hours of service per week, but whose employment is expected to end after the first three months of a 12-month initial measurement period, would not average at least 30 hours per week over the entire initial measurement period. However, the preamble to the proposed regulations states that such expectation must be based on objective facts and circumstances specific to that employee at his or her date of hire and not on aggregate employee turnover. Under this transition guidance, the employer could treat the employee as a new variable hour employee and would not have to provide coverage for such employee during the initial measurement period.
On January 1, 2015, employers will no longer be able to take into account the likelihood that such an employee will terminate his or her employment before the end of the initial measurement period and, as a result, a new employee who is expected to perform at least 30 hours of service per week must be treated as a new employee rather than a new variable hour employee (except in the case of a seasonal employee, see below).
Administrative Periods Applicable to New Variable Hour Employees
An employer is permitted to apply an administrative period of up to 90 days following the initial measurement period and before the start of the stability period. For this purpose, the administrative period includes the time between the start date of a new variable hour employee and the date such employee is first offered coverage under the employer’s health plan. The entire initial measurement period is excluded, however.
For example, a new variable hour employee starts on August 15, but the initial measurement period begins on the first day of September. The days between August 15 and September 1 must be counted toward the maximum number of days in the administrative period. Similarly, any time between the end of the initial measurement period and the date on which the employee is offered health coverage must also be included and counted toward the length of the administrative period.
Material Change in Employment Status of New Variable Hour Employee
Special rules apply in circumstances where a new variable hour employee’s status materially changes before the end of the initial measurement period. This may occur when a new variable hour employee is subsequently hired into a different position and there is now a reasonable expectation that the employee will perform at least 30 hours of service per week. In such a case, the employee must be treated as a full-time employee on the earlier of:
The first day of the fourth month following the employee’s change in employment status, or
The first day of the first month following the end of the initial measurement period (including any optional administrative period) if the employee averaged more than 30 hours of service per week during the initial measurement period.
Switching to Ongoing Employee Status from New Variable Hour Status
While a new variable hour employee is in an initial measurement period, a new standard measurement period will begin for ongoing employees, and the employer must include the new variable hour employee in that standard measurement period. In other words, the initial measurement period will overlap with part of the standard measurement period, and the new variable hour employee's hours must be tracked for both measurement periods.
An employee who performed at least 30 hours of service per week during the initial measurement period, but who does not do so during the standard measurement period, must still be treated as a full-time employee through the end of the initial stability period, but not beyond.
An employee who was determined to not be a full-time employee during the initial measurement period, but who performs at least 30 hours of service per week during the standard measurement period, must be treated as a full-time employee during the entire stability period associated with the standard measurement period, even if that stability period begins before the stability period associated with the initial measurement period ends.
New Seasonal Employees
The proposed regulations do not define the term “seasonal employee,” but have reserved the definition for future guidance. For now, employers are permitted, through 2014, to use a reasonable good faith interpretation of the term.
If an employer determines that a new employee is a seasonal employee, based on its good faith and reasonable interpretation, that employee may be treated as a new variable hour employee even if the employee is expected to perform at least 30 hours of service per week during the season for which he or she was hired.
To illustrate this rule, the proposed regulations provide an example involving a ski instructor who is expected to perform 50 hours of service a week for four months. Because the ski instructor is not reasonably expected to perform at least 30 hours per week over the entire 12-month initial measurement period chosen by the employer, the ski instructor can be treated as a new variable hour employee.
Employees Rehired After a Termination of Employment
The IRS recognized the potential for abuse through terminating an employee’s employment then rehiring the employee. In theory, this would restart the initial measurement period or cause the employee to be subject to a new 90-day waiting period, thereby allowing an employer to avoid needing to provide coverage for such employee. As a result, the proposed regulations contain the following rules that apply with respect to rehiring former employees.
No Hours of Service for at Least 26 Consecutive Weeks
If, following an employee’s termination of employment, at least 26 consecutive weeks have passed during which no hours of service were credited to such employee, the employer may treat such employee upon rehire as a new employee for purposes of determining his or her status as a full-time employee.
Rule of Parity
If, following an employee’s termination of employment, (1) at least four but less than 26 consecutive weeks have passed during which no hours of service were credited to such employee, and (2) such employee’s period of employment prior to termination was shorter than the period during which no hours of service were credited to such employee, the employer may treat the employee as a new employee upon rehire.
For all other rehired employees, the measurement and stability periods that otherwise would have applied continue to apply to such employees upon rehire. These rehired employees are referred to as “continuing employees.” The proposed regulations provide that a continuing employee will be treated as having been offered coverage under the employer’s health plan if such coverage is offered as of the first day that the continuing employee is credited with an hour of service, or, if later, as soon as administratively practicable.
Special Unpaid Leaves of Absence
A special averaging rule applies for employees who return to service after unpaid leaves of absence pursuant to the Family and Medical Leave Act of 1993 and the Uniformed Services Employment and Reemployment Rights Act of 1994, and after an unpaid leave of absence on account of jury duty.
Under this rule, the employer determines the employee’s average hours of service per week for all weeks during the measurement period excluding the period of unpaid leave. This average is then used as the average for the entire measurement period.
As an alternative, the employer may choose to credit such employees with hours of service for the unpaid leave period at a rate equal to the employee’s average weekly hours of service during the rest of the measurement period.
Similar averaging rules apply to employees of educational organizations whose normal work schedules involve employment breaks up to a specified limit consistent with the academic calendar.
What Should You Do Now?
Now is the time for any employer who could potentially be subject to the Play-or-Pay mandate to implement procedures for counting employees’ hours of service.
See our prior Client Update for how to determine whether you could be an applicable large employer.
Contact counsel if you have any questions.