The IRS recently released clarifying guidance that should make it easier for hospitality employers to control health care costs starting in 2014 when the employer "play or pay" mandate kicks in.

Background - Calculating the Play or Pay Penalty

The Affordable Care Act requires large employers (those employing 50 or more full-time equivalent employees) to either offer affordable health care coverage or pay a penalty. The play or pay penalty is made up of two components: (a) a penalty for failure to offer coverage to all full-time employees, and (b) a penalty for failure to offer "affordable" coverage. The penalties are calculated as follows:

Failure to Offer Coverage Large employers who fail to offer major medical coverage to all full-time employees (those working thirty or more hours per week) must pay an excise tax of $2,000 per full-time employee (excluding the first thirty employees from the calculation), as long as at least one employee receives a tax credit through the 2014 health care exchanges offered in each state.

Failure to Offer Affordable Coverage

The Affordable Care Act treats coverage as "affordable" if (a) the employee's premium does not exceed 9.5% of that employee's household income, and (b) the employer covers at least 60% of the actuarial value of coverage. A large employer that fails to offer affordable coverage will be subject to an excise tax of $3,000 per employee who receives a tax credit through the exchanges. While this is a larger dollar amount than the tax for failure to offer coverage, this tax is only multiplied by the number of employees who receive a tax credit, rather than by all full-time employees.

Affordable Care Act Creates Confusion Regarding the Affordability Test

The statutory definition of "affordable" created two problems for employers:

1.The Affordable Care Act did not specify whether affordability (i.e., premium contribution not to exceed 9.5% of household income) was measured using the premium for employee-only coverage or the premium for the coverage the employee actually elected (e.g., employee plus one, family, etc.). Employers often subsidize employee-only coverage more heavily than family coverage. So, if the IRS calculated the penalty using the premium for the coverage the employee actually elected, the likely result would be that more employers would face greater penalties for offering coverage deemed "unaffordable" by the IRS.

2."Affordable" coverage is measured by comparing the premium cost to the employee's "household income." While most employers know how much they pay the employee, they have no way of calculating an employee's household income. As a result, it would be difficult for employers to price employees' premium to avoid the penalty.

IRS Guidance Makes Affordability Test More Predictable

Recent IRS guidance detailed how to calculate the 2014 penalty. The guidance provided a favorable interpretation of the affordability test. First, the guidance indicated that the penalty would be calculated based on the cost of employee-only coverage, regardless of the coverage selected by the employee. So, the cost of employee-only coverage cannot exceed 9.5% of the employee's household income, regardless of the actual level of coverage elected by the employee.

For example, assume an employee has $30,000 a year in household income. The employer covers at least 60% of the actuarial value of coverage. Employees must pay a premium of $2,400 for employee-only coverage (8% of household income) and $3,000 for family coverage (10% of household income). The employer will be deemed to have offered the employee affordable coverage, even if the employee elects family coverage.

Second, the guidance indicated that future regulations will create a "safe harbor" to address the unpredictability involved in calculating employees' household income. Under the proposed safe harbor, employers that meet certain conditions, such as offering all full-time employees coverage, will not be subject to the penalty if the employee premium does not exceed 9.5% of the employee's current W-2 wages. This is merely a safe harbor. If the employee's premium contribution exceeds 9.5% of the employee's W-2 wages, but the premium is still less than 9.5% of the employee's household wages, the employer will be deemed to have offered affordable coverage. For example, assume an employer knows the lowest-paid full-time employee makes $30,000 in W-2 wages per year. If the employer (a) covers at least 60% of the actuarial value of coverage, and (b) sets the employee-only premium for health coverage at $2,850 (i.e., 9.5% of W-2 wages) no employee will ever become eligible for tax credits through the exchanges, and the employer will not be liable for the play or pay penalty.

What This Means For Hospitality Employers

Under the new rules, employers should be able to better calculate and predict their potential tax liability starting in 2014 when the employer mandate begins. Employers may consider designing a benefit option that provides minimum value and does not require an employee premium payment that would exceed 9.5% of any full-time employee's W-2 wages (in essence, a "bare bones" plan). Employers will still face the decision of whether to stop offering coverage entirely, send all employees to the exchanges for health insurance, and simply pay the penalty for all full-time employees.