Health care reform’s “pay or play” rules require an “applicable large employer” to pay substantial excise taxes if (1) it does not provide adequate coverage to all full-time employees (and their dependents) or (2) it provides adequate coverage that is not “affordable,” and any full-time employees obtain government-subsidized coverage on an exchange.  Specifically, beginning in 2014, employers face penalties of $2,000 per full-time employee if the employers fail to offer “minimum essential coverage” (basically, group health coverage) to them and their dependents and $3,000 per full-time employee who receives government assistance (such as a tax credit) to purchase coverage on an exchange if the employers’ coverage is not “affordable” or does not provide “minimum value.”

The IRS recently proposed regulations implementing these rules, which take a refreshingly pragmatic approach to several key requirements. 

Here are some highlights:

  • Avoiding the “Pay or Play” Rules Altogether -- Having Fewer Than 50 Full-Time (and Full-Time Equivalent) Employees.  For any calendar year, an “applicable large employer” subject to the “pay or play” rules is generally an employer with an average of at least 50 full-time employees and full-time equivalents (determined in accordance with the regulations) on business days during the preceding calendar year.  For any month, a “full-time employee” is an employee who is employed on average at least 30 hours weekly.  In determining whether the 50 full-time employee threshold is reached, full-time employee equivalents (for work performed in the U.S.) are also included.

Some employers that are near the break point to be an “applicable large employer” may find planning opportunities in the proposed rules, particularly with respect to a special six-month lookback period available only for 2014 and special measurement and stability periods for counting full-time employees.  For many employers, however, the  fundamental question will be whether they do or can operate their business with fewer than 50 full-time employees.

  • “Paying” -- Minimizing or Eliminating Penalties.  For those “applicable large employers” that do not offer affordable minimum essential coverage to their employees, the statute and regulations offer several ways to minimize or even eliminate the penalties.

First, because penalties only apply with respect to full-time employees, employers may find it desirable to monitor hours of part-time employees to make sure they do not inadvertently become full-time employees.  Other employers might consider increasing utilization of part-time employees.  Final regulations will include an anti-abuse rule to prohibit evasive schemes, such as using temporary worker agencies to provide a portion of an employees’ hours.  However, final regulations are expected to allow some flexibility to employers seeking to restructure their workforces to minimize or avoid penalties.  Nevertheless, employers should proceed cautiously.  In addition to the possibility of running afoul of anti-abuse rules, relevant considerations when restructuring workforces include business exigencies, union negotiations, employee relations, public relations and practical matters such as the need to track employee hours accurately enough to properly administer a plan and respond to an IRS audit.

Second, although the regulations provide that all companies under common control or part of a controlled group are treated as a single employer for purposes of determining if there are 50 full-time employees or full-time equivalents, the proposed regulations provide that the penalties will be assessed on a company-by-company basis. Organizations with a range of business units can choose to cover employees in certain companies but not others, thus limiting the $2,000 penalty to the uncovered subsidiaries. This offers planning opportunities if, for example, some business units are in low wage industries where providing health coverage would be prohibitively expensive. To take advantage of this flexibility, controlled groups may desire to move divisions with uncovered groups into separate corporations or LLCs.

  • “Playing” -- Substantial Compliance.  While the statute applies penalties if coverage is not offered to all full-time employees, the IRS recognized that there can be inadvertent failures despite good-faith efforts to comply.  Under the proposed regulations, if no more than 5 percent of the employer’s full-time employees (or five full-time employees, if greater) are not offered coverage, whether intentionally or unintentionally, the standard will be considered met.  Remember that this is applied on an employer-by-employer basis within the controlled group.
  • “Playing” -- Affordability.  Coverage is “affordable” if the employee’s premium cost is no more than 9.5 percent of family income.  The IRS had previously indicated that employers could use an employee’s W-2 compensation (rather than household income) for this measure.  The proposed regulations retain this W-2 compensation safe harbor, provide additional safe harbors based on employees’ rates of pay and federal poverty levels and clarify that “affordability” is based on the lowest-cost employee-only coverage made available.
  • “Playing” -- Minimum Value.  To satisfy the minimum value requirements, the actuarial value of benefits provided under the plan (instead of through deductibles and co-pays) must be at least 60 percent of the actuarial value of benefits provided under the benchmark health plan designated with respect to the state involved.  HHS has issued regulations regarding how the benchmark health plan is determined for each state, and the IRS has indicated that it will provide employers with a calculator to use to determine whether the minimum value requirements are satisfied.  The good news is that most employer group health plans are expected to easily satisfy this requirement.
  • “Playing” -- Covering Dependents.  Coverage must be offered to each full-time employee and their dependents.  Under the proposed regulations, spouses are not “dependents” for this purpose.  Dependent children are expansively defined to include children by birth, adoption and placement for adoption, stepchildren and foster children.  However, plans that do not provide coverage for children (or any of these classes of children) will not be subject to the $2,000 penalty because of this failure until 2015.

There are many open questions that may be addressed in the final regulations or additional proposed regulations.  Please stay tuned.