Beginning in 2014, large employers are subject to one of two “shared responsibility” penalties under the Patient Protection and Affordable Care Act (“ACA”), commonly known as the play or pay penalties.  The Internal Revenue Service recently issued proposed regulations and a series of Q&As providing guidance on these important provisions.  This first in a series of alerts will help employers understand whether or not they are subject to the play or pay penalties.  Additional alerts will discuss the penalties, how to avoid them, and a timeline of upcoming compliance obligations.

For the most part, the regulations follow previous informal guidance issued by the IRS, but also provide further explanations on some key issues.  Employers should be aware that the proposed regulations include several “anti-abuse” provisions intended to crack down on employer manipulation of the workforce to avoid penalties.  The preamble refers to the use of temporary employment agencies or the termination/rehire of employees as schemes the IRS has heard may be used to circumvent the penalty provisions.  The final regulations are expected to address these and other perceived employer abuse practices. 

Applicable Large Employer

The shared responsibility penalties apply only to “applicable large employers” that either fail to offer their employees (and dependents) the opportunity to enroll in minimum essential health coverage or offer coverage that is unaffordable.  An “applicable large employer” is defined as an employer that employs, on average, at least 50 full-time employees during the preceding calendar year (including seasonal workers).  Thus, employers will need to look at the 2013 workforce when the play or pay mandates come into effect in 2014.  

 A “full-time employee” is defined as someone who works at least 30 hours of service per week in a given month. This includes hours where an employee is paid even when no work is performed.  Furthermore, 130 hours in a month is treated as the equivalent of 30 hours per week. For nonhourly employees, employers have three options for counting hours: (1) count hours from records of hours worked (or paid for nonworking hours), (2) count each day worked as 8 hours of service for the day, or (3) count each week as the equivalent of 40 hours.  

To further complicate matters, in making the calculation of whether an employer is a “large employer,” the ACA provides that employers must also count the number of employees that are “full-time equivalents (FTEs).”  Under the regulations, employers are required, for each calendar month, to aggregate the hours of service for all part-time employees for that month and divide by 120.   This is the number of FTEs that need to be added to the number of full-time employees for the month. 

Measurement Period Safe Harbor

The proposed regulations closely track the previously issued IRS guidance setting forth safe harbors for counting FTEs and determining if you have an “average” of 50 employees.  In particular, the proposed regulations provide transition relief for employers by giving them the option of designating any consecutive 6 month period in 2013 as the reference point for the calculation.  This would allow the employer an opportunity to determine, before the end of the year, whether or not it is an applicable large employer. 

This grace period is helpful as the rules for counting employees are complex.  The proposed regulations include detailed provisions on how to apply the rules to new employers, new employees, variable hour employees, teachers and other educational employees, commissioned employees, changes in employment status and rehired employees.  The parameters of these provisions are beyond the scope of this alert, but employers need to be aware that the rules are complicated and thus should be tackled well in advance of 2014.

Definition of Employee

The proposed regulations define “employee” under the ACA as an individual who would qualify as an employee under the “common-law test” that has been adopted by the IRS.  The IRS common law test is a facts and circumstances test that focuses on whether or not the employer has the right to direct and control the work of the individual. 

The proposed regulations leave open how the rules will apply to employees of temporary staffing agencies.  Employees of temporary agencies, depending on the circumstances, have been considered in the past by the IRS as common law employees of both the temporary agency and the recipient employer.  As noted above, the IRS is concerned that using employees of temporary staffing agencies could be a way to avoid becoming an applicable large employer.  The IRS is seeking comments on how to address this potential abuse and how generally to handle temporary employees.  Until final regulations are issued, employers that have engaged the services of a temporary agency should be aware that temporary employees could be considered their “employees” under these rules.

Aggregation Rules

The ACA specifically provides that employers of controlled groups are aggregated and treated as a single employer.  Thus, all employees of a controlled group are taken into account in determining if the employer is an applicable large employer, i.e. a parent corporation and its wholly owned subsidiary.   However, any assessable payment would be applied separately to each employer.  Thus, only the employers in the group that actually fail to offer coverage or offer unaffordable coverage would be subject to the penalty.

Seasonal Employers

As discussed in a previous alert, the shared responsibility penalties are not applicable to certain seasonal employers.  The regulations define seasonal employers as those that employ 50 or more full-time employees for 120 days (or 4 calendar months) or less during the calendar year, and the workers in excess of 50 are “seasonal workers.”  The regulations do not provide a definitive definition of a “seasonal” worker and thus employers are permitted to use a good faith reasonable interpretation of the term through 2014.

Bottom Line

Employers that are subject to the play or pay mandates need to plan now for 2014.  Unfortunately, what should be a straightforward question—do you have 50 or more full-time employees—is anything but simple.  The IRS has signaled that it will be expansively interpreting the term “employee” and there will likely be unfavorable anti-abuse rules in the final regulations.  Employers that believe they are not covered by the rules should pay close attention to the proposed and final regulations in order to avoid any unpleasant surprises down the road.