The “Play-or-Pay” Provisions of Healthcare Reform: IRS Guidance for Employers and Individuals

McGuireWoods Healthcare Reform Guide: Installment No. 29

February 11, 2013

This is the 29th in a series of WorkCite articles concerning the Patient Protection and Affordable Care Act and its companion statute, the Health Care and Education Reconciliation Act of 2010 (referred to collectively as the Act). This article discusses recently-issued proposed regulations under the employer and individual “shared-responsibility” provisions of the Act, commonly known as the “play-or-pay” mandates.

The Internal Revenue Service (IRS) issued proposed regulations (the Employer Regulations) under the Act last December to address the employer shared-responsibility provisions of Section 4980H of the Internal Revenue Code (Code). Earlier this month, the IRS issued proposed regulations (the Individual Regulations) under the Act on the liability of individuals under Code Section 5000A for not maintaining “minimum essential coverage.” Piece-by-piece, the guidance issued over the last few weeks is building a picture of the contours — and the consequences — of the play-or-pay mandates.

Under Section 4980H, an “applicable large employer” must offer minimum essential coverage to full-time employees and their dependents or pay a penalty. Such employers that provide minimum coverage may still pay a penalty if the coverage does not provide “minimum value” or if it is not “affordable.” The Employer Regulations build on previous guidance issued by the IRS under Section 4980H (Notices 2011-36, 2011-73, 2012-17 and 2012-58) but include additional provisions and clarifications for employers to understand their responsibilities and to provide a basis for making decisions about their health coverage offerings in the future. The IRS also released questions and answers that provide additional guidance on the application of Employer Regulations. Employers may rely on the Employer Regulations before the issuance of final regulations; if future guidance is more restrictive than what has been proposed, such future guidance will not be applied retroactively.

Under the Section 5000A, an “applicable individual” must either maintain minimum essential coverage for himself or herself and any nonexempt family members or include an additional payment on his or her federal income tax return. This section has been described as the linchpin of the Act. The decision of the Supreme Court last June in National Federation of Independent Business v. Sebelius, 567 US __, 132 S. Ct. 2566 (2012) upholding the constitutionality of Sec. 5000A under Congress’ taxing power, enabled healthcare reform under the Act to proceed. The Individual Regulations are the first significant guidance from the IRS as to individual shared responsibility.

The balance of this article provides a brief summary of the guidance under the two sets of regulations. Part I addresses the employer play-or-pay mandate; Part II addresses the individual play-or-pay mandate.

I. Employer Play-or-Pay Mandate

The Basics

The Act does not impose a requirement on employers to offer health coverage. However, an employer with an average of at least 50 full-time employees as to a calendar year will be assessed a penalty under Section 4980H if for any month any full-time employee of the employer is certified as eligible to receive a premium tax credit or cost-sharing reduction toward purchase of insurance in a health insurance exchange and if for such month either of the following occur:

  • The employer offers no coverage to full-time employees (and their dependents) or the employer’s plan does not meet the minimum essential coverage requirements. Under Section 4980H(a), the penalty payable by such an employer will be 1/12 of $2,000 for each full-time employee in excess of 30 employees.
  • The employer offers minimum essential coverage to full-time employees (and their dependents), but either: The coverage is not considered “affordable” (the employee cost of coverage exceeds 9.5 percent of the employee’s compensation); or The coverage does not provide “minimum value” (the coverage does not pay for at least 60 percent of the cost of benefits). Under Section 4980H(b), such an employer will be required to pay a penalty equal to the lesser of (i) 1/12 of $2,000 for each full-time employee (reduced by 30); or (ii) 1/12 of $3,000 for each full-time employee who receives a premium tax credit.
  • The coverage is not considered “affordable” (the employee cost of coverage exceeds 9.5 percent of the employee’s compensation); or
  • The coverage does not provide “minimum value” (the coverage does not pay for at least 60 percent of the cost of benefits).

The Employer Regulations clarify that the determination of “applicable large employer” must be done on a controlled-group basis. The application of the penalty, on the other hand, must be applied on a pro-rata basis to each member of the controlled group when benefits are offered on a member-by-member basis. This would allow each subsidiary, for example, to offer different levels of coverage. The 30-employee offset would be prorated in such a case.

The Act also imposes new minimum coverage requirements on insured group health plans and in the absence of regulatory guidance on these requirements, it is not known how such requirements will affect these controlled-group issues.

Who is Covered by the Employer Shared-Responsibility Provisions?

  • Applicable large employers: Only “applicable large employers” are subject to the employer play-or-pay provisions. Such an employer is one who, during the prior calendar year, employed an average of at least 50 full-time employees, determined on a controlled-group basis.
  • Full-time employees: A “full-time employee” is defined as an employee who is employed on average at least 30 hours of service per week. For purposes of determining applicable large employer status only, an employer must calculate the number of full-time equivalents (FTEs) employed during the preceding calendar year and include those FTEs in the count of full-time employees. For all other purposes, determining the number of full-time employees will be based on 30 hours of service per week; a monthly equivalent of 130 hours of service is available. The equivalency rule must be applied on a reasonable and consistent basis.
  • Dependents: Dependent coverage must be offered in order to have a qualifying offer of coverage; however, coverage does not have to be offered to spouses. “Dependent” is defined in reference to Code Section 152(f).

Determining Full-time Employees for Determining Applicable Large Employer Status

To determine whether an employer is an applicable larger employer, the employer must count all full-time employees and FTEs employed during the preceding calendar year. Therefore, in addition to full-time employees (those employed on average for at least 30 hours per week), the employer must calculate FTEs. The number of all employees (including “seasonal workers”) who were not classified as full-time employees must be used in the calculation as follows: (a) determine the aggregate number of hours of service for the month (up to 120 hours of service for any one employee) for all employees who are not full-time employees for that month; and (b) divide the total from (a) by 120. The result is the number of FTEs to be added to the number of full-time employees for that month.

Determining Full-time Employees for Other Section 4980H Purposes

An applicable large employer must count only full-time employees (not FTEs) when determining its potential liability under Section 4980H. The Employer Regulations set forth additional details to assist employers in identifying full-time employees for purposes of offering coverage and assessing penalties for either failure to offer coverage or failure to offer coverage that is minimum essential coverage and affordable. For hourly employees, actual hours of service are counted. For employees not paid on an hourly basis, the employer may use actual hours, days-worked equivalency or weeks-worked equivalency. The standard is hours worked or hours for which payment is due for vacation, holiday, illness, incapacity (including disability), layoff, jury duty, military duty or leave of absence.

Keeping Track of Full-time Employees

The Act requires employers to track full-time status on a month-by-month basis. As with prior guidance, the Employer Regulations have recognized the impracticability of the month-to-month approach and outline instead a “look-back/stability period” safe harbor. The safe harbor allows that full-time status may be determined over a measurement period of up to 12 months. The measurement period is followed by a stability period of the same duration. For full-time employees, coverage must be offered for the duration of the stability period as long as the individual remains employed by the employer. The employer may also add an administrative period up to 90 days between the end of the measurement period and the start of the corresponding stability period; the administrative period allows the employer to process eligibility determinations and other enrollment matters. However, an administrative period cannot reduce or lengthen the measurement period or the stability period. Also, to prevent potential gaps in coverage, the administrative period must overlap with the prior stability period. The safe harbor is complex and will require careful assessment and ongoing compliance procedures to ensure that employers are paying the correct assessable amount for their workforces. The next step is to determine the categories of employees that must be tracked under this method.

The look-back measurement period methods now cover both ongoing employees and new hires. The Employer Regulations address measurement for full-time status for the following categories of employees:

  • Ongoing employees: Full-time employees (working at least 30 hours per week) will be treated as full-time for the subsequent stability period. Part-time employees will be treated as “variable-hour” ongoing employees. The employer may treat these employees as full-time and offer coverage; or the employer may use its chosen measurement period to determine which variable-hour ongoing employees must be treated as full-time.
  • Full-time employees (working at least 30 hours per week) will be treated as full-time for the subsequent stability period.
  • Part-time employees will be treated as “variable-hour” ongoing employees. The employer may treat these employees as full-time and offer coverage; or the employer may use its chosen measurement period to determine which variable-hour ongoing employees must be treated as full-time.
  • New employees hired as full-time: Expectation of working on average 30 hours per week or more; no measurement required; the employer must offer coverage within three calendar months.
  • Newly hired variable-hour employees: Employees who, when hired, are not reasonably expected to work a full-time schedule must be tracked during the applicable measurement period. Any such employee who actually works on average more than 30 hours per week must be offered coverage for the next stability period.
  • Seasonal employees: Seasonal employees will be tracked as variable hour employees; no further definition of “seasonal employee” has been provided in the new guidance and employers may use a reasonable, good faith interpretation until further guidance is issued. “Seasonal employees” are not the same as “seasonal workers,” the latter being a term used in determining the status of employees when determining whether an employer is an applicable large employer.
  • Rehires and employment status changes: If a new employee (variable-hour, including seasonal employees) has a change in employment status during an initial measurement period, such employee will be treated as a full-time employee on the earlier of (i) the first day of the fourth month following the change in status, or (ii) if the employee averages more than 30 hours of service per week during the initial measurement period, the first day of the first month following the initial measurement period. If an employee earns no service for 26 consecutive weeks and is then rehired, the employee’s status must be determined at the time of rehire (not based on prior service).
  • Variable measurement periods: Generally, the measurement and stability periods used by the employer must apply to all employees. However, employers may use different measurement periods and stability periods for the following categories of employees: (i) each group of collectively bargained employees covered by a collective bargaining agreement; (ii) collectively bargained employees and non-collectively bargained employees; (iii) salaried employees and hourly employees; and (iv) employees located in different states.

Affordable Coverage

Whether an employee’s coverage is “affordable” is based on the employee’s cost for self-only coverage. Also, the coverage may be offered under only one employer plan option; that option must be minimum essential coverage but does not have to be in any particular program or all programs offered by the employer. For example, if the employer’s group health plan offers health maintenance organization (HMO) option, a preferred provider organization (PPO) option and a health savings account (HSA) with a high-deductible health plan, self-only coverage under only one of those options must be affordable.

The Employer Regulations provide three affordability safe harbors (described below) to determine whether the employer will be subject to a penalty under Section 4980H(b):

  • The full-time employee’s required contribution for the calendar year for the employer’s lowest-cost self-only coverage does not exceed 9.5 percent of that employee’s calendar year wages reported on Form W-2 from that employer;
  • The full-time employee’s required contribution does not exceed 9.5 percent of an amount equal to 130 hours multiplied by the employee’s hourly rate of pay as of the first day of the coverage period (the plan year); or
  • The full-time employee’s required contribution does not exceed 9.5 percent of the federal poverty level for a single individual (using a design-based safe harbor); the current federal poverty level for an individual is $11,170.

Transition Rules

An employer intending to adopt 12-month measurement and stability periods must use 2013 data for 2014. Accordingly, for purposes of stability periods beginning in 2014, such employers may use a transition measurement period that is shorter than 12 months but is no less than six months; it must begin no later than July 1, 2013, and end no earlier than 90 days before the first day of the plan year beginning on or after Jan. 1, 2014, (based on the maximum 90-day administrative period). The Employer Regulations also include transition relief for non-calendar year plans.

Employers – Next Steps

The balance of 2013 will find employers and their service providers planning and putting in place procedures for implementation of the Act’s play-or-pay provisions. Compliance efforts may require coordination of personnel from several company departments — payroll, information technology, tax, finance and legal — in addition to the human resources and employee benefits personnel. Systems and procedures must be established for identifying and tracking variable-hour employees; assessing and budgeting for applicable assessable penalties; developing internal audit and reporting capabilities; and communicating these changes and challenges to senior management and to employees.

In particular, all these play-or-pay provisions involve potentially significant tax consequences. For large employers, the prospect of paying an additional tax of $2,000 per employee should encourage the employers to ensure that their health plans offer minimum essential coverage. Providing affordable coverage with minimum value may be more challenging. Employers will want to obtain as much legal certainty as possible about their tax positions for 2014 under the Act and in most cases will want to do so before filing their first estimated tax return for 2014.

II. Employee Play-or-Pay Mandate

The Act requires that all individuals must maintain minimum essential coverage or make a shared-responsibility payment. The Individual Regulations provide further guidance on who is covered by the individual mandate, what individuals must do to comply and how liability is calculated if an individual fails to maintain minimum essential coverage. Though this part of the shared-responsibility provisions under the Act falls on individuals, employers need to know what is expected of their employees and how this coordinates with the employer shared-responsibility provisions.

Who is Covered?

The individual play-or-pay mandate applies to “applicable individuals,” which means every individual unless an exemption applies to him or her (explained below). Individuals covered by the mandate include single adults, married couples and their dependents, employed, not employed and retirees. An adult or a married couple who claim a child or another individual as a dependent for federal income tax purposes will be responsible for coverage or for the tax liability for the dependent. Individuals (including dependents) who qualify for an exemption will not be assessed the shared-responsibility payment. Exemptions may be available for the following reasons:

  • Religious conscience: Members of a religious section that is recognized as conscientiously opposed to accepting insurance benefits (as determined by the Social Security Administration)
  • Healthcare sharing ministry: Members of a recognized healthcare sharing ministry
  • Indian tribes: Members of a federally recognized Indian tribe
  • No income tax return required to be filed: Household income for the individual(s) is below the minimum threshold for filing a federal income tax return
  • Short-coverage gap: The individual(s) went without coverage for a period of less than three consecutive months during the calendar year
  • Hardship: The individual has a hardship, as certified by an “American Health Benefit Exchange” (Exchange) under the Act
  • Coverage unaffordable: The individual(s) cannot afford coverage because the premium cost is greater than 8 percent of his/their household income
  • Incarceration: The individual is in jail, prison or other correctional facility
  • Not lawfully present: The individual is not a U.S. citizen, a U.S. national or alien legally residing in the U.S.

To claim an exemption for religious conscience or hardship, the individual must apply for an exemption certificate through an Exchange. The exemptions for members of Indian tribes, members of health caring ministries and individuals who are incarcerated are available by applying for an exemption certificate or by filing a federal income tax return. Exemptions for unaffordable coverage, short-coverage gaps and those not lawfully present in the U.S. are only available as part of a federal income tax filing. For individuals whose income is under the federal tax return filing threshold, the exemption is available automatically. Proposed regulations providing details for administering exemptions through an Exchange were issued by the Department of Health and Human Services (HHS) earlier this month.

What is “Minimum Essential Coverage”?

For purposes of the individual mandate, “minimum essential coverage” is broadly defined at this point. This does not mean that any coverage is minimum essential coverage; employer group health plans, insurance issuers and the Exchanges will be responsible for providing minimum essential coverage (and certifying the same). Individuals will therefore be required to secure only minimum essential coverage through one of the following:

  • Employer-sponsored coverage, including COBRA coverage and retiree coverage
  • Grandfathered group health plans
  • Coverage purchased in the individual market
  • Medicare Part A coverage
  • Medicaid or the Children’s Health Insurance Program
  • TRICARE (for service members, retirees and their families)
  • Certain coverage for U.S. veterans

In a proposed regulation, HHS has designated the following types of coverage as also providing minimum essential coverage:

  • Self-funded student health coverage
  • Coverage for noncitizens residing in the U.S., provided by their home country
  • Refugee medical assistance supported by the Administration for Children and Families
  • Medicare advantage plans
  • State high-risk pool coverage (subject to further review by HHS)
  • Coverage for AmeriCorps volunteers

What Must Individuals Do?

Simply stated, everyone must show that they have minimum essential coverage or have an exemption; anyone not covered or exempt will be required to pay the penalty for failure to maintain coverage pursuant to Code Section 5000A. This provision is effective beginning in 2014; individuals will need to report coverage (or exemptions) or make payments in conjunction with the filing of their 2014 federal income tax returns.

The initial penalty (2014) is $95 per adult and $47.50 per child (up to $285 per family) or 1 percent of family income, whichever is greater. For 2015, the amounts increase to $325 per adult and $162.50 per child (up to $975 per family) or 2 percent of family income, if greater. For 2016 and later, the amounts are $695 per adult and $347.50 per child (up to $2,085 per family) or 2.5 percent of family income, if greater.

The individual penalty will be prorated based on the number of months when no coverage is maintained. There is no penalty, however, for a single gap in coverage of less than three months in any calendar year. The penalty may not exceed the national average premium for “bronze-level” coverage in an Exchange. Penalty amounts will be increased by a cost of living adjustment each year, starting in 2017.

Employers are required under the Act to report the value of employer-provided coverage on each employee’s Form W-2, beginning with the 2012 tax year. This information is evidence of minimum essential coverage for the employee and any dependents also covered by the employer plan. Similarly, insurance companies, the Centers for Medicare and Medicaid Services (on behalf of Medicare recipients) and the Exchanges will provide evidence of coverage that individuals may use to report that they have minimum essential coverage — and therefore are “playing” in compliance with the individual mandate.

For more information on the Act’s play-or-pay rules, please contact any of the authors, Sally Doubet King, Steven D. Kittrell, Katie M. Rak and Elizabeth A. Diller, or any other member of McGuireWoods’ employee benefits team.