The IRS has released important new guidance on the play-or-pay penalties under Internal Revenue Code Section 4980H in the form of proposed regulations (here) and a set of FAQs (here). The guidance comprehensively addresses a number of key issues regarding the penalties and steps that may be taken to avoid them. For the sake of brevity, only a few highlights will be noted here.
Covered Employers. All common-law employers that are “applicable large employers” (generally 50 or more FTEs) are subject to the penalty rules, including tax-exempt and governmental entities.
Entity Aggregation. The Code's entity-aggregation rules (relating to controlled groups and affiliated service groups) apply for purposes of determining whether an entity is an “applicable large employer.” However, in an important clarification, the regulations confirm that each member of a controlled or affiliated group is allowed to determine separately whether it will comply with the requirements of Section 4980H or pay the penalty, and non-compliance by one group member will not be imputed to other group members.
"All" Full-Time Employees Means 95%. The requirement to offer minimum essential coverage to all full-time employees will be satisfied if the employer offers coverage to at least 95% of its full-time employees (or, if less, all full-time employees but five). This is a welcome interpretation of the statutory language that, at a minimum, will provide some protection against inadvertent failures to comply.
Dependents. The regulations confirm that Section 4980H requires offering coverage to both full-time employees and their dependents. However, the rules define “dependent” to include only dependent children and not spouses. Thus, employers could hypothetically comply with Section 4980H without offering spousal coverage.
Look-Back Measurement Method. The regulations largely incorporate the rules described in IRS Notice 2012-58 (and discussed at length in other posts on this blog) that will allow for a look-back approach to identifying full-time employees. This includes the use of measurement periods, stability periods, and administrative periods and the ability to defer covering most new “variable-hour” employees for up to 13 months after the date of hire.
Rehires. New provisions clarify when rehired employees may be treated as new employees and when they must be treated as continuing in the same status they had prior to termination. In general, if an employee is rehired within 26 weeks after termination, the employee will need to be treated as a continuing employee. Employees rehired after a 26-week absence can be treated as “new” employees.
Affordability Safe Harbors. The regulations confirm that an employer will be allowed to determine whether the coverage it offers is “affordable” to an employee by looking at just the W-2 wages that employer pays to the employee. Coverage will be affordable if the required contribution for employee-only coverage under the lowest-cost option does not exceed 9.5% of the employee’s Box 1 W-2 wages for the year.
The regulations also propose two additional safe harbors that would better allow employers to design their plans and employee-contribution structures in a way that largely ensures coverage will be “affordable” for every eligible employee without regard to the actual amount of taxable wages paid to each employee.
1. Rate-of-Pay Safe Harbor. Coverage will be affordable if the required monthly contribution for employee-only coverage under the lowest-cost option does not exceed 9.5% of an amount equal to the employee’s base rate of pay multiplied by 130 hours. (For salaried employees, monthly base pay may be used.)
2. Federal Poverty Line (FPL) Safe Harbor. Coverage will be affordable if the required monthly contribution for employee-only coverage under the lowest-cost option does not exceed 9.5% of an amount equal to 1/12 of the annual Federal Poverty Line for a single individual (currently $11,170).
Neither of these safe harbors will allow an employer to set the employee-only contribution rate very high, but they do provide bright lines, giving some assurance that a contribution structure can comply with Section 4980H by design, thereby avoiding all penalties.
Transitional Relief for Fiscal-Year Plans. The preamble to the proposed regulations provides important transitional guidance for employers that offer health coverage on a fiscal-year basis. Under certain circumstances, these employers can delay complying with Section 4980H until the beginning of the plan year commencing in 2014 and will not be exposed to penalties for the period between January 1, 2014 and the beginning of the 2014 plan year. There are two parts to the transitional relief:
1. Eligible Employees. With respect to employees who are eligible for coverage under the plan terms as they existed on December 27, 2012, there will be no penalty exposure until the beginning of the 2014 plan year, so long as those employees continue to be offered coverage under the same eligibility terms.
2. Ineligible Employees. With respect to employees who are not otherwise eligible for coverage under current plan terms, there will be no potential penalty exposure until the beginning of the 2014 plan year, so long as the current plan either is offered to at least one-third of all employees or actually covers at least one-fourth of all employees.
Although there remain a number of questions about how this transitional relief will apply, it appears employers that cannot satisfy one or both prongs of the relief may need to begin complying with Section 4980H by January 1, 2014, if not sooner.
Stay Tuned. These proposed regulations represent a good start toward solidifying the play-or-pay rules that will apply beginning in 2014, but there continue to be a number of open questions, and further refinements should be expected as the government receives comments and feedback.