United States: Final "Play-Or-Pay" Rules Under Healthcare Reform Announced

Last Updated: February 24 2014
Article by Felicia L. Mitchell, Sally Doubet-King and Larry R. Goldstein

This is the 42nd 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 provides a brief summary of the final regulations under the Act's mandate for certain employers to offer healthcare coverage to full-time employees.


The Act added Section 4980H, commonly known as the employer "play-or-pay" mandate, to the Internal Revenue Code (Code). Under Section 4980H, an "applicable large employer" must offer minimum essential coverage to full-time employees and their dependents that is "affordable" and that provides "minimum value" or pay a penalty. Last week, the Treasury Department and the Internal Revenue Service (IRS) issued final Section 4980H regulations (Final Regulations) on the mandate.

The Final Regulations clarify and provide additional provisions to assist employers with understanding their responsibilities as to the mandate. In the preamble to the Final Regulations, significant transition relief for compliance has been provided.

Employer Play-or-Pay Mandate Generally

An employer that does not comply with the mandate may be liable for one of two separate penalties.

An employer with an average of at least 50 full-time employees in the prior calendar year (i.e., an "applicable large employer") will be assessed a penalty if, for any month of the current calendar year, (i) any full-time employee of the employer is certified as having enrolled for such month in a health plan under an insurance exchange established under the Act as to which a premium tax credit or cost-sharing reduction is allowed for or paid as to such employee and (ii) either of the following occurs:

  • The employer offers no coverage to at least 95 percent of its full-time employees (and their dependents) or the employer's plan does not meet the Act's minimum essential coverage requirements. This first penalty, which is assessed under Section 4980H(a), is 1/12 of $2,000 (subject to an index for inflation) for each full-time employee in excess of 30 employees for such month. "Minimum essential coverage" includes coverage under an employer-sponsored group health plan, but a plan that provides only "excepted benefits," such as dental or vision benefits, does not provide minimum essential coverage.
  • 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 self-only coverage exceeds 9.5 percent of the employee's "household income"); or
    • the coverage does not provide "minimum value" (the coverage does not pay for at least 60 percent of the cost of benefits).
    This second penalty, which is assessed under Section 4980H(b), is equal to the lesser of (i) 1/12 of $2,000 (subject to an index for inflation) times the number of full-time employees (reduced by 30); or (ii) 1/12 of $3,000 (subject to an index for inflation) for each full-time employee who receives a premium tax credit or cost-sharing reduction for such month. The cap is meant to ensure that the penalty for an employer that offers coverage can never exceed the penalty that employer would owe if it had not offered coverage.

    Note: Transition relief has been provided in connection with the Final Regulations for calculating these penalty payments in 2015, as described below.

If an employer is a member of a controlled group, whether the 50-full-time-employee threshold is met is determined by reference to all members of the controlled group as if they were a single employer. If the threshold is met as to the group, all group members are subject to the mandate, and each member of such a group is referred to in the Final Regulations as an "applicable large employer member." Hereafter in this article, "member" means an applicable large employer member and "applicable large employer" means an employer subject to the mandate, including an employer that is not in a controlled group as well as all members of a controlled group that, when aggregated, are subject to the mandate.

The Final Regulations clarify that dependent coverage must be offered to a "dependent," as the term is defined under Code Section 152(f). Coverage must cover an employee's child for the entire month in which the child attains age 26. Dependent coverage, however, does not have to be offered to spouses, grandchildren, qualifying relatives, foster children or stepchildren.

Observations: A group health plan may extend a dependent child's coverage to the end of the plan year in which the child attains age 26, although this is not required.

The preamble states that commenters requested that the definition of "dependent" be expanded to include grandchildren and qualifying relatives (within the meaning of Section 152) and that the Final Regulations do not include these categories because such a definition would be inconsistent with the typical coverage provided by employer-sponsored plans. The exclusion of both foster children and stepchildren in the Final Regulations represents a change from what was provided in the proposed regulations. In our experience, however, many group health plans, particularly self-insured plans of large employers, do cover grandchildren, foster children and stepchildren.

The Final Regulations eliminate the pro rata application of penalties found in the proposed regulations issued in 2013. The Final Regulations provide that if a full-time employee performs service for more than one member, the member who has the greatest number of hours of service for the month is assessed the penalty. If no member has more hours of service from that employee than another member does, generally the member who reported the full-time employee in its Code Section 6056 statement to the IRS will be assessed the penalty.

Penalties under Section 4980H are not self-assessed. Instead, under Section 4980H(d), the IRS will contact employers to inform them of their potential liability and provide employers an opportunity to respond before any liability is assessed or notice and demand for payment is made. This process is expected to occur after the due date for employees to file individual tax returns claiming premium tax credits and after the due date for applicable large employers to file the information returns identifying their full-time employees and describing the coverage that was offered (if any) for any year of potential liability. As such, the first notifications of potential liability for 2015 would not occur until sometime in 2016 at the earliest.

Observation: Each member is liable for its penalty assessment only (regardless of whether another member in its controlled group is also assessed a penalty). Moreover, out of concerns for increased administrative complexity and potential for abuse, the Final Regulations do not adopt the request of some commenters on the proposed regulations that employers be permitted to aggregate members within an applicable large employer for purposes of determining Section 4980H liability.

This is a departure from the normal modus operandi for testing employee benefit plans under the Code. For example, in determining whether a qualified retirement plan of an employer that is a member of a controlled group satisfies the minimum coverage requirements of Code Section 410(b), all employees of all employers in the group are treated as employed by a single employer. Under Section 410(b), of course, employer self-assessment applies, with the IRS monitoring compliance through the audit process. It is doubtful that the IRS could ever effectively assess Section 4980H penalties if it first had to determine whether an employer was a member of a controlled group.

Determining Applicable Large Employer Status

To determine whether an employer is an applicable large employer, the employer must count all "full-time employees" (discussed below) and "full-time equivalents" (FTEs) during the preceding calendar year. FTEs are included in the calculation by:

  • determining 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
  • dividing the aggregate hours of service by 120.

The employer may round the FTE calculation to the nearest one-hundredth.

The following process is used to determine whether an employer (treating all employers in a controlled group as a single employer) has met the 50-full-time-employee threshold for the current calendar year:

  • First, determine the total number of full-time employees, including seasonal employees and FTEs, for each calendar month in the prior calendar year.
  • Second, divide the total full-time employees and FTEs by 12.
  • Third, round the result to the next-lowest whole number.

If the result is less than 50, then the mandate does not apply to the employer (and other employers in the controlled group) for the current calendar year. If the result is 50 or more, then the mandate applies to the employer (and other employers in the controlled group) for the current calendar year, although there is a seasonal worker exception that applies in some cases.

The Final Regulations clarify that a new employer that was not in existence on any business date in the prior calendar year is permitted to determine its applicable large employer status based on the average number of employees that it is reasonably expected to employ on business days in the current calendar year. This determination is based on the new employer's reasonable expectations at the time the business comes into existence (irrespective of whether subsequent events cause the actual number of full-time employees and FTEs to exceed that expectation). If an employer offers minimum value coverage to all full-time employees by April 1 of the first year in which it becomes an applicable large employer, the employer will not be assessed a penalty under Section 4980H(a) for the first three months of that calendar year.

In general, all applicable large employers are subject to the mandate (i.e., for-profit, nonprofit, and government entity employers). The Final Regulations continue to reserve guidance on the application of the controlled-group aggregation rules to predecessor employers, successor employers, governmental entities, churches and church conventions, and associations. Until further guidance is issued, those entities may apply a reasonable good-faith interpretation of the aggregation rules in determining their applicable large employer status.

Note: Transition relief has been provided in connection with the Final Regulations for determining which employers are applicable large employers in 2015, as described below.

Determining Who Are Full-Time Employees

An applicable large employer counts only full-time employees (not FTEs) when determining its potential liability under Section 4980H. A "full-time employee" is defined as an employee who is employed on average at least 30 hours of service per week (or a monthly equivalent of 130 hours of service per calendar month). For hourly employees, actual hours of service are counted. For employees not paid on an hourly basis, the employer may use actual hours, a days-worked equivalency or a 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, and hours of service must be aggregated as to all members in the same controlled group.

Treatment of Certain Employees

The Final Regulations clarify that hours of service performed by volunteer employees, student employees and members of religious orders may be excluded from the determination of whether the individual is a full-time employee. In addition, they also provide guidance on the treatment of seasonal employees, adjunct faculty, airline employees and on-call employees as "full-time" employees.

Identifying Full-Time Employees

The Final Regulations retain the two measurement methods in the proposed regulations that establish the minimum standards for identifying an applicable large employer's full-time employees:

  • The monthly measurement method, whereby the employer determines whether each employee is a full-time employee by counting his or her hours of service for each calendar month based on a four-week (or, if applicable, a five-week) period. The Final Regulations provide further guidance as to tracking employees using this method.
  • The "look-back" method, which is a safe harbor, allows full-time status to be determined over a "measurement period" of up to 12 months followed by a "stability period" of the same duration. If the employer determines that an employee was employed on average at least 30 hours of service per week during the standard measurement period, then it must treat the employee as a full-time employee during a subsequent stability period, regardless of the employee's number of hours of service during the stability period, so long as he or she remains an employee. The Final Regulations describe the approaches that must be used under this method in various circumstances, such as for employees who work variable-hour schedules, seasonal employees and employees of educational organizations. The Final Regulations also modify the break-in-service rule to reduce the length from 26 weeks to 13 weeks; once an employee has experienced a 13-week break-in-service, he or she may be treated as a new employee upon rehire.

Because an applicable large employer must apply the monthly measurement method or the look-back method consistently for all employees in the same classification category (i.e., salaried employees and hourly employees, employees whose primary places of employment are in different states, collectively bargained employees and non-collectively bargained employees, and each group of collectively bargained employees covered by a separate collective bargaining arrangement), the Final Regulations include rules for when an employee moves from one category to another that may affect the tracking method to be used for him or her.

Affordable Coverage

As indicated above, coverage under an employer's group health plan is not considered "affordable" if the employee cost of self-only coverage exceeds 9.5 percent of the employee's "household income." The Final Regulations continue to provide three affordability safe harbors (i.e., the W-2 safe harbor, rate-of-pay safe harbor and federal poverty level safe harbor) that an applicable large employer may use in lieu of trying to determine an employee's household income. The Final Regulations clarify certain aspects of these safe harbors, to determine whether the employer will be subject to a penalty under Section 4980H(b).

Offer of Coverage

The Final Regulations clarify that an offer of coverage includes one made by a multiemployer plan, single-employer Taft-Hartley plan or multiple-employer welfare arrangement (MEWA) on behalf of the contributing employer/applicable large employer for that employee. However, as to employers using staffing agencies, such an offer of coverage through a plan maintained by the agency will not be considered valid unless the employer pays a higher fee for the staffing agency to provide enrollment in health coverage.

Transition Relief

In Notice 2013-45, the IRS announced that no penalties would be enforced for 2014. In the preamble to the Final Regulations, additional significant transition relief has been provided, including the following:

  • Limited Transition Relief for January 2015 Implementation: For January 2015 only, employees who are offered coverage no later than the first day of the first payroll period will be treated as having been offered coverage for the entire month of January 2015.
  • Transition Relief for All Applicable Large Employers: Applicable large employers that offer coverage to at least 70% (instead of 95%) of their full-time employees and their dependents will not be subject to the penalty under Section 4980H(a) in 2015 (or in any month in 2016 that relates to the 2015 plan year).
  • Transition Relief for Applicable Large Employers With Fewer Than 100 Full-Time Employees: Applicable large employers who employ on average at least 50 but fewer than 100 full-time employees (including FTEs) during 2014 will not be subject to penalties under Section 4980H in 2015 (or in any month in 2016 that relates to the 2015 plan year), provided the employer certifies to its eligibility for the relief. To be eligible for this relief, the employer may not reduce the size of its workforce or the overall hours of service of its employees to limit the size of the workforce, except for bona fide business reasons. Thus, for example, reductions of workforce size or overall hours of service because of business activity such as the sale of a division, changes in the economic marketplace in which the employer operates, terminations of employment for poor performance, or other similar changes unrelated to eligibility for the transition relief will be considered bona fide business reasons and will not affect eligibility for this transition relief. In addition, the employer will not be eligible for this transition relief if the employer eliminates or materially reduces the health coverage it offered as of Feb. 9, 2014, during the transitional relief period. New employers that were not in existence on any day in 2014 are eligible for this relief.
  • Transition Relief for Applicable Large Employers With 100 or More Full-Time Employees: For 2015 (or any month in 2016 that relates to the 2015 plan year), applicable large employers with at least 100 full-time employees that fail to offer coverage to at least 70 percent of their full-time employees may subtract 80 (instead of 30) from the number of full-time employees from any penalty assessed under Section 4980H(a). For purposes of this relief, the 80-full-time-employee reduction is allocated ratably among all controlled-group members that constitute an applicable large employer. Moreover, the relief serves as a cap on the assessable payment determined under Section 4980H(b) in the event the applicable large employer provides coverage to at least 70 percent of its full-time employees, but such coverage is not affordable or does not provide minimum value.
  • Transition Relief for Non-Calendar-Year Plans: Limited transition relief is available for the period before the first day of the first non-calendar-year plan year beginning in 2015 (the 2015 plan year) for applicable large employers that maintained non-calendar-year plans as of Dec. 27, 2012, only if the plan year was not modified after Dec. 27, 2012, to begin at a later calendar date.

    • Pre-2015 Eligibility Transition Relief: Applicable large employers maintaining non-calendar-year plans will not be subject to penalties under Section 4980H until the first day of the 2015 plan year, if they offer affordable coverage that provides minimum value as of the first day of the 2015 plan year.
    • Significant Percentage Transition Relief for All Employees: Even though the Final Regulations generally require employers to determine their applicable large employer status based on the entire preceding calendar year, the transition relief permits employers with non-calendar-year plans to use a shorter period of at least six consecutive calendar months during the 2014 calendar year for determining their applicable large employer status in 2015.
    • Significant Percentage Transition Relief for Full-Time Employees: The Final Regulations require a member using the look-back method to have a stability period that is as long as its measurement period. However, the transition relief permits an applicable large employer that maintains a non-calendar-year plan to use a transition measurement period of at least six consecutive months in 2014 for determining full-time employee status in 2015, even if its stability period is 12 months during the 2015 plan year.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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