On January 2, 2012, the Internal Revenue Service (“IRS”) published proposed regulations governing the shared responsibility provisions of the Patient Protection and Affordable Care Act (“PPACA”). The shared responsibility provisions sometimes referred to as the “Pay or Play” rules, and in general, imposed certain penalties on large employers that either fail to offer coverage to their employees or do not offer “affordable” coverage to their employees and at least one of their employees purchases coverage through an Exchange and is eligible for a subsidy.

A. Background on the Penalty

The shared responsibility provision of Code section 4980 requires an employer with 50 or more full-time employees or full-time equivalents to make an “assessable payment” if it does not provide health coverage to its full-time employees, or if the health coverage it offers to full-time employees is “unaffordable” or does not provide “minimum value” and, as a result, one or more of its full-time employees are certified to receive a premium assistance tax credit or cost-reduction payment to purchase health coverage through a state or federal exchange.

Health coverage is “unaffordable” if the premium required to be paid by the employee exceeds 9.5% of the employee’s self-only income. Health coverage does not provide “minimum value” if “the plan’s share of the total allowed costs of benefits provided under the plan is less than 60 percent of such costs.” The Pay or Play rules are effective for the first plan year after December 31, 2013, which means January 1, 2014, for plans on a calendar year.

There are two possible scenarios that may trigger an employer penalty under Internal Revenue Code § 4980H:

1. For employers that offer no coverage to their full-time employees, the penalty is computed based on $166.67 per month multiplied by the number of full-time employees, excluding the first 30 employees, or about $2,000 per year for every eligible employee. IRC § 4980H(a).
2. For employers that fail to offer affordable coverage, the penalty is computed based on the lesser of: (1) $250 per month multiplied by the number of full-time employees who qualify for and receive a premium tax credit or get a cost sharing reduction from a state insurance exchange; or (2) the penalty that would apply if the employer failed to provide coverage under Section 4980H(a). IRC § 4980H(b).

The penalties only trigger, however, if at least one of the employer’s employee purchases coverage through the Exchange and the person qualifies for a premium tax credit. In general, PPACA provides premium tax credits (e.g., a subsidy) for individuals and families: (1) With household income of atleast 100% but not more than 400% of the federal poverty level (FPL), and (2) Who are not otherwise eligible for qualifying minimum essential coverage (other than through an Exchange or the individual market) for a given month.

B. Determining Large Employer Status.

Only “applicable” large employers may be may be liable for an assessable payment under section 4980H. An applicable large employer with respect to a calendar year is defined as an employer that employed an average of at least 50 full-time employees (taking into account full-time equivalents “FTEs”) on business days during the preceding calendar year.

The proposed regulations define an employee as an individual employed under the common-law standard. Generally, under the common law standard, an employment relationship exists when the person for whom the services are performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work but also as to the details and means by which that result is accomplished. This is a fact-intensive test.

The rules propose that the control group rules will apply to determine “applicable” large employer status, but the application of the assessment, however, will be applied on an entity by entity basis. The regulations also provide that, for purposes of determining “applicable” employer status, an “employer” will include a predecessor. The IRS may issue future guidance concerning whether a successor company will be included in determing “applicable” employer status. Employers that are formed anytime during the year are, under the proposed regulations, subject to these rules.

C. Determining Full-time Employee Status

The proposed regulations define a full-time employee as an employee employed on average at least 30 hours of service per week. Hours of service are used in determining whether an employee is a full-time employee and in calculating an employer's FTEs. The proposed regulations provide that an employee's hours of service include the following:

1. each hour for which an employee is paid, or entitled to payment, for the performance of duties for the employer; and
2. each hour for which an 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.

Hourly employees: For employees paid on an hourly basis, employers must calculate actual hours of service from records of hours worked and hours for which payment is made or due for vacation, holiday, illness, incapacity (including disability), layoff, jury duty, military duty or leave of absence.

Salaried employees: For employees not paid on an hourly basis, employers are permitted to calculate the number of hours of service under any of the following three methods:

1. Counting actual hours of service (as in the case of employees paid on an hourly basis) from records of hours worked and hours for which payment is made or due for vacation, holiday, illness, incapacity (including disability), layoff, jury duty, military duty or leave of absence;
2. using a days-worked equivalency method whereby the employee is credited with eight hours of service for each day for which the employee would be required to be credited with at least one hour of service under these service crediting rules; or
3. using a weeks-worked equivalency of 40 hours of service per week for each week for which the employee would be required to be credited with at least one hour of service under these service crediting rules.

Flexibility: Under the proposed rules, an employer may apply different methods of calculating full-time status for different classifications of non-hourly employees, so long as the classifications are reasonable and consistently applied. In addition, an employer may change the method of calculating non-hourly employees' hours of service for each calendar year.

For purposes of identifying the employee as a full-time employee, all hours of service performed for all entities treated as a single employer under section 414(b), (c), (m), or (o) must be taken into account.

Look-Back Measurement Method for Determination of Full-Time Employees

Recognizing the difficulty an employer may have classifying certain employees, such as variable and seasonal employees, the proposed rules adopt the “safe-harbor” optional look back measurement method for determining full-time status as an alternative to a month-by-month calculation. The look back measurement method may be used for on-going employee and variable or seasonal employees. The proposed rules do not define the term “seasonal” employee. The IRS is reserving the definition for now. Variable hour employee is a new employee for whom an employer cannot reasonably know at the start date whether that employee will work an average of 30 hours per week. An ongoing employees is an employee who has been employed by the employer for at least one complete “Standard Measurement Period.

Consistent with earlier guidance, the rules propose the following the description of the look back measurement method:

• Standard Measurement Period. The Standard Measurement Period is the defined time period of not less than 3 but not more than 12 consecutive calendar months, as chosen by the employer, in which the employer determines the employee’s classification depending upon hours worked. The employer can select the months in which the Standard Measurement Period starts and ends, provided that the determination is uniform and consistent for all employees in the same category (i.e., collectively bargained employees and non-collectively bargained employees, salaried employees and hourly employees, employees of different entities and employees located in different states).
• Stability Period. If the employer determines that the employee averaged at least 30 hours per week during the Standard Measurement Period, the employer must treat the employee as a full-time employee during any subsequent Stability Period, regardless of the employee’s hours of service during the Stability Period, so long as the employee remains employed. The Stability Period must be the longer of (1) six consecutive calendar months or (2) the Standard Measurement Period.
• Administrative Period. An employer may choose to apply an Administrative Period (up to 90 days) between the end of the Standard Measurement Period and the beginning of the Stability Period to allow the employer time to determine which employees are eligible for coverage and to notify and enroll such employees. To prevent any gaps in coverage, the Administrative Period will overlap with the prior Stability Period, so that during any such Administrative Period applicable to employees following a Standard Measurement Period, ongoing employees who are eligible for coverage because of their status as full-time employees based on the prior measurement period will continue to receive coverage.

The measurement and stability periods may be changed in subsequent years, but generally may not be changed once the standard measurement period has begun.

Other Considerations Impacting Full-time Status

• Change in employment status. This concept means a situation where a new variable or seasonal employee converts to a full-time employee within the first measurement period. The proposed rule sets out special rules to determine when these individuals need to be counted depending on whether they work 30 hours per week or more than 30 hours per week.
• Rehires After Termination or Resumption of Service for any Other Absence. Under the proposed regulations, if the period for which no hours of service is credited is at least 26 consecutive weeks, an employer may treat an employee who has an hour of service after that period as having been terminated and having been rehired as a new employee of the employer. Or the employer may choose to apply a rule of parity for periods of less than 26 weeks. Under the rule of parity, an employee may be treated as having been terminated and having been rehired as a new employee if the period with no credited hours of service (of less than 26 weeks) is at least four weeks long and is longer than the employee's period of employment immediately preceding that period with no credited hours of service.

How is the Pay or Plan Penalty Assessed

• The proposed rules provide that an employer must offer coverage to at least 95% of full-time employees to avoid the penalty. The purpose is to allow for a five percent margin of error.
• Dependents must also be offered coverage, but the regulations define “dependent” as a child under the age of 26 years of age. The term does not include an employee’s spouse.
• The penalty will be calculated on a monthly basis.
• The rules propose three safe harbors to determine whether the plan is “affordable” under the 9.5% of self-only rule. They include: Form W-2 Safe Harbor; Rate of Pay Safe Harbor; and Federal Poverty Line Safe Harbor.