On January 1, 2014, the most significant provisions of the Patient Protection and Affordable Care Act1, as amended by the Health Care and Education Reconciliation Act2, (Health Care Reform) become effective. As this deadline fast approaches, federal regulators, states, insurance companies, health care providers, and many other interested parties scramble to prepare for and implement the sweeping changes to the insurance and health care industries included in Health Care Reform. Among these changes are significant new requirements for employers.
This article identifies several issues affecting employers that have not been in the Health Care Reform headlines, but could cause significant penalties for unwary employers. As explained below, in order to comply with the shared responsibility requirements, employers should analyze their workforce to identify all common law employees and union employees of the employer, and related employers, and develop comprehensive procedures for determining the full-time status of employees.
Shared responsibility penalties
Health Care Reform imposes significant penalties, called the shared responsibility penalties, on large Idaho employers that do not provide qualified health coverage to their full-time employees.3 Employers with 50 or more full-time equivalent employees are considered large employers for purposes of the shared responsibility penalties. Small employers with less than 50 full-time equivalent employees are not subject to the shared responsibility penalties.4
No coverage penalty
One of these penalties, the no coverage penalty, applies if a large employer does not provide major medical coverage to at least 95% of its full-time employees and one or more full-time employee(s) obtains subsidized health coverage on a health insurance exchange, such as the Idaho health insurance exchange (subsidized health care coverage will generally be available to individuals with household income of 100% to 400% of the federal poverty level). This all or nothing penalty starts at $40,000 per year for an employer with 50 full-time employees and increases by ,2,000 for each additional full-time employee of the employer.5 For example, if an employer with 100 full-time employees fails to cover as few as 6 full-time employees, it will be subject to a penalty of $140,000.
Insufficient coverage penalty
If an employer does provide major medical coverage to at least 95% of its full-time employees, it still may be subject to the second shared responsibility penalty, the insufficient coverage penalty, if the coverage is not affordable or does not provide minimum value (as defined by IRS regulations). This penalty is $3,000 for each full-time employee who obtains subsidized coverage on a health insurance exchange.6 For example, if an employer with 100 full-time employees covers all of its full-time employees but the coverage is not affordable to 10 full-time employees and 6 of those full-time employees obtain subsidized exchange coverage, the employer will be subject to a penalty of $18,000 (6 x $3,000).
The perils of the shared responsibility rules
Under the shared responsibility requirements, an employer must identify its common law employee workforce (which, as explained more fully below, includes all workers who the employer has power to direct and control) in order to (i) determine whether an employer is a large employer, (ii) determine whether coverage is provided to 95% of the employer’s full-time employees, and (iii) calculate the amount of any shared responsibility penalties. 7 For these purposes, an employee is considered full-time if the employee works 30 or more hours per week. Rather than rely on an employer’s classification of an employee’s full-time status, employees’ full-time status must be based on actual hours worked.8
Because the shared responsibility penalties are tied to the number of an employer’s common law employees, each Idaho employer must look closely at the nature of its workforce and its business structure to ensure that it has identified all full-time common law employees. In particular, employers should carefully examine non-traditional workers and the employer’s corporate structure to confirm that all common law employees are identified. They should also confirm that union employees have sufficient coverage to satisfy the shared responsibility requirements. Finally, employers should establish administrative procedures for identifying which common law employees are full-time employees.
Common Law Employees v. Non-Traditional Workers
For many years the IRS has actively audited employers that, inadvertently or intentionally, misclassify common law employees as agency workers, independent contractors, and/or leased employees and, as a result, avoid payroll tax and benefit obligations for these workers.9 The IRS has the power, for example, to reclassify an independent contractor as a common law employee if that is the reality of the relationship.10
In the past, many employers have not been diligent in correctly classifying workers because penalties for misclassification were insignificant and enforcement by state and federal regulators has been minimal. However, Health Care Reform significantly raises the stakes of misclassifying workers because it is possible that the addition of a few common law employees due to reclassification could cause an employer to become subject to significant shared responsibility penalties. For example, an employer that provides no medical coverage to its employees because it believes it has 49 full-time employees (and, as a result, is not subject to the shared responsibility penalties) could be subject to a shared responsibility penalty of $40,000 if one of its independent contractors is reclassified as a common law employee.
Determining independent contractor status
Under IRS rules, a worker is a common law employee if, based on all the facts and circumstances, the business has the right to direct and control the worker.“ This analysis is especially difficult because the IRS considers a wide variety of factors in determining control, including factors relating to whether the employer has behavioral control over the worker, the financial arrangement between the worker and the business, and the relationship between the parties. 12
Some of the most important factors considered by the IRS include the following:
- Does the business require a worker to perform a job in a certain way, impose detailed instructions on the worker, and/or train the worker extensively on how the job must be performed?
- Is the worker free to seek out independent business opportunities?
Under the financial arrangement, may the worker realize a profit or incur a loss?
- Is the worker’s compensation structure different from how an employee is compensated?
- Is the work performed by the worker a key aspect of the regular business of the company?13
Accordingly, employers should carefully review their staffing, leasing, and independent contractor arrangements to confirm that they are not common law employee relationships, and properly monitor and document the non-employee status of these workers. In addition, employers that hire agency workers or leased employees should review their staffing agency agreements and confirm that the staffing agency will take proper steps to ensure that the employer will not be subject to shared responsibility penalties with respect to the agency or leased employees and indemnify the employer if shared responsibility penalties are imposed.
Complex Business Structures
In addition to the challenge of properly identifying common law employees, some businesses may find it difficult to properly determine whether related entities must consider their employees together for the purpose of the shared responsibility requirements. This problem often arises when a business consists of complex ownership structures and business ventures.
Identify controlled groups
The IRS has rules for treating all related business entities (including c-corporations, s-corporations, limited liability companies, partnerships, etc.) as a single employer for tax purposes. Previously these rules applied for several purposes, including the administration of retirement plans. These rules now also apply for the purpose of the shared responsibility requirements.14
The rules for determining whether related businesses are treated as a single employer are complicated but, in general, the following apply:
- Parent-subsidiary controlled group. An entity and any entity it substantially owns are treated as a single employer.
- Brother-sister controlled group. If five or fewer individuals together substantially own multiple entities, the entities are treated as a single employer.
- Affiliated service group. Multiple professional organizations that work together to provide services to clients may be treated as a single employer.15
For example, a business owner who owns two companies with 30 employees each may mistakenly believe that neither business is subject to the shared responsibility penalties because neither company has 50 employees. However, under IRS rules, the businesses are treated as a single employer with 60 employees and subject to the shared responsibility penalty.
These rules present a significant area of risk for employers in the retail, hospitality, medical, and construction industries because complex ownership structures are common.
All employers should examine their corporate structure to confirm that all related entities with employees have been identified. Employers should also closely monitor changes in corporate structures and ensure that the shared responsibility implications of any such changes are carefully considered.
Analyze union coverage
Employers that contribute to a union health plan, also known as a multiemployer health plan, for their union employees should carefully review the union coverage to confirm it will satisfy the employer’s shared responsibility obligation with respect to its union employees.
The IRS has not yet determined how union health coverage will be treated under the shared responsibility rules, but it has provided transition relief for 2014. Under the transition relief, an employer will not be subject to shared responsibility penalties for a union employee as long as:
- The employer is obligated to contribute to the multiemployer plan pursuant to a collective bargaining agreement.
- The union coverage is offered to the employee (and dependents).
- The union coverage is affordable and provides minimum value. 16
Employers should confirm that union coverage is affordable, provides minimum value, and is available to all union employees that are full-time employees under the shared responsibility rules. If not, the employer may be treated, for the purposes of the shared responsibility requirements, as if it were not providing coverage at all to its union employees. Employers should explore the possibility of limiting a union’s ability to make unilateral coverage changes that could affect the employer’s shared responsibility obligations. For example, an employer may want to seek, through the collective bargaining process, to limit the union’s ability to increase employee premiums and, as a result, cause the union coverage to be unaffordable.
Identifying full–time employees
Once an employer has identified its common law employees, it must identify which employees are full-time for the purpose of the shared responsibility requirements. In the past, an employer limiting coverage to full-time employees could exclude part-time employees based on the number of hours the employee was expected to work and disregard the actual number of hours worked. However, for the purpose of the shared responsibility penalties, full-time employees must be determined based on actual hours worked.17
Consequently, employers will have to establish new procedures in accordance with IRS rules to determine full-time employees. Under these procedures, the employer must be able to identify the full-time status of employees from year to year, including employees with variable hours that may work 30 or more hours per week during some periods and less than 30 hours per week during other periods. The procedures must also allow an employer to determine when new variable hour employees become full-time employees (required to be offered coverage). The rules and challenges for identifying these employees are described below.
Employees reasonably expected to work 30 or more hours per week
Initially, an employer should identify all the employees that it reasonably expects to work 30 or more hours per week. These employees are full-time employees under the shared responsibility requirements and should be covered in order to avoid the shared responsibility penalties.18
Ongoing variable hour employees
For employees that are not reasonably expected to work 30 or more hours per week, the IRS allows an employer to establish standard measurement periods during which the employer determines whether variable hour employees will be treated as full-time employees.19 The employer tracks employee hours during the measurement periods, which may be from 3 to 12 months. At the end of each measurement period, the employer determines whether employees averaged at least 30 hours per week.
Employees that average 30 or more hours per week during a measurement period must be treated as full-time employees for a period that is at least as long as the measurement period (the IRS refers to this period as a stability period). If an employer does not offer coverage to employees who average at least 30 hours per week during the measurement period, the employer may be subject to a shared responsibility penalty for that period.20
Most employers will make their standard stability periods the same as their plan years. As a result, employees determined to be full-time during the immediately preceding measurement period will be offered coverage during the open enrollment period preceding the plan year/stability period and will be covered during the plan year/stability period. For each plan year, an employer must review the hours worked by each variable hour employee during the previous measurement period to determine which employees worked sufficient hours to be classified as full-time and eligible for coverage during the plan year.
New variable hour employees
When an employer is unable to reasonably determine whether a new hire will work at least 30 hours per week, the employer may exclude the employee from the plan for up to 12 months without incurring a shared responsibility penalty while the employer determines the full-time status of the employee. Following this initial measurement period the employee will have a stability period at least as long as the measurement period.21 After this initial measurement period and stability period, the employee’s full-time status will be determined based on the employer’s standard measurement periods and stability periods (as described above for ongoing variable hour employees).22
Transition relief for 2014 administrative periods
Under transition relief provided by the IRS, employers may begin measurement periods for 2014 stability periods as late as July 1, 2013.23 Employers should begin tracking hours now for any variable hour employees whose hours are not currently tracked. Generally, no administrative change will be required for hourly employees because their hours are already tracked. However, employers may have to implement procedures for tracking part-time salaried employees who are excluded from coverage. Generally, the only way to confirm that part-time salaried employees are not full-time employees for the purpose of the shared responsibility requirements will be to count their hours.24
New administrative burden
Although employers have significant flexibility in establishing procedures under the IRS rules for determining full-time employees, these procedures will be a significant and ongoing administrative requirement for health plans. The procedures are similar in many respects to the comprehensive eligibility rules that currently apply to retirement plans. Even employers that decide to pay the shared responsibility penalty instead of covering employees will need to establish procedures for determining full-time employees because the number of full-time employees is required in order to calculate the shared responsibility penalty.
In order to ensure compliance with the shared responsibility requirements, employers should take a close look at their employee population and develop comprehensive procedures for determining the full-time status of all common law employees in compliance with IRS rules. These procedures should be put in writing. Written procedures are important for consistent administration from year to year and to be able to confirm the non-full-time status of any employee in the event the IRS questions the employer’s determination. Once the procedures are established, they must be carefully implemented so that all full-time employees are properly identified each year.
Analyze the risk
Employers who fail to properly identify their full-time common law employees may unexpectedly become subject to the shared responsibility penalties.
This problem is particularly acute for large employers that believe they have complied with the shared responsibility requirements by offering major medical coverage, but fail to provide coverage to misclassified employees or full-time employees that were improperly identified as non-full-time employees. In such a case, shared responsibility penalties may apply, even though many employees were provided coverage.
For example, an employer could provide coverage to all 60 of its full-time employees but not to its 7 independent contractors who each work more than 35 hours per week for the employer. If the IRS audits the employer and determines that the 7 independent contractors are actually common law employees of the employer, the employer will be subject to the shared responsibility penalty because it failed to cover 7 full-time employees. Even though the employer made significant contributions to its health plan and intended to cover all of its full-time employees, the employer will be subject to a penalty of $74,000 because it misclassified the independent contractors.
Employers need to begin planning now for compliance (or noncompliance) with the shared responsibility requirements and other Health Care Reform requirements that become effective from now until the end of 2014. In determining compliance with the shared responsibility requirements, employers should closely examine their employment and contractor agreements, evaluate their ownership structures, review union coverage, and identify full-time employees. Employers should consider taking the following actions:
- Develop an initial list of potential areas of risk.
- Address risks with the board of directors and/or benefits committee.
- Prepare a comprehensive shared responsibility action plan to address risk and compliance:
- Review corporate ownership structure and identify all related entities.
- Determine whether related entities must be aggregated under IRS rules.
- Identify all non-traditional workers, including agency employees, independent contractors, and leased employees.
- Review each agency employee, independent contractor, and leased employee and determine whether the worker is a common law employee of the employer.
- Analyze the risk of misclassification and potential shared responsibility penalties.
- Revise contracts relating to agency employees, independent contractors, and leased employees based on risk analysis and add appropriate indemnification language.
- Confirm whether union coverage is affordable and provides minimum value.
- Analyze workforce and develop procedures for determining full-time status of employees.
- Evaluate minimum essential coverage, minimum value, and affordability.
- Implement any plan changes during open enrollment for 2014.
- Prepare employee communications (revised summary of benefits and coverage (SBCs), notice of exchanges).
- Prepare plan amendments, policies, notices to document compliance.
- Report compliance efforts to board of
directors and/or benefits committee.
At a minimum, in order to ensure compliance with the shared responsibility requirements, employers should carefully review their workforce to identify all common law employees of the employer and related entities, confirm that union employees have sufficient coverage, and establish procedures for identifying full-time employees.
For more information please contact a member of our Employee Benefits & Compensation Group or call 208.344.6000.
*Article published in the June/July 2013 edition of The Advocate.
1 Pub. L. No. 111-148, 124 Stat. 119-1025 (2010).
2 Pub. L. No. 111-152, 124 Stat. 1029-1084 (2010).
3 I.R.C. § 4980H.
4 I.R.C. § 4980H(c)(2).
5 I.R.C. § 4980H(a); Prop.Treas. Reg. § 54.4980H4. Although the IRS has not finalized the shared responsibility regulations, it has indicated that employers may rely on the proposed regulations. Prop. Treas. Reg. § 54.4980H-0, Preamble
6 I.R.C. § 4980H(b); Prop. Treas. Reg. 54.4980H-5.
7 Prop. Treas. Reg. § 4980H-1(a)(13).
8 I.R.C. § 4980H(c)(4); Prop.Treas. Reg. § 4980H-1(a)(18), -3.
9 See Treas. Reg. § 31.3121(d)-1 (c).
10 E.g., James v. Commissioner, 25 T.C. 1296 (1956).
11 Treas. Reg. § 31.3121(d)-1(c); Treas. Reg. 31.3306(i)-1; Treas. Reg. § 31.3401(c)-1; Rev. Rul. 87-41.
12 Independent Contractor or Employee? Training Materials, IRS Training Course 3320102, TPDS 842381 (October 30, 1996); Rev. Rul. 87-41.
14 Prop. Treas. Reg. § 4980H-1(a)(14); I.R.C. §§ 414(b) (aggregating related corporations), 414(c) (aggregating other related business entities), 414(m) & (o) (aggregating business entities of professionals under certain circumstances).
15 I.R.C. § 414(b), (c), (m) and (o).
16 Prop. Treas. Reg. § 54.4980H-0, Preamble IX.D.
17 I.R.C. § 4980H(c)(4); Prop. Treas. Reg. § 4980H-1(a)(18), -3.
18 Prop. Treas. Reg. § 4980H-3(c)(2).
19 Prop.Treas. Reg. § 4980H-3(c)(1).
20 Prop.Treas. Reg. § 4980H-3(c)(1)(iii).
21 Prop. Treas. Reg. § 4980H-3(c)(3).
22 Prop. Treas. Reg. § 4980H-3(c)(1); Prop. Treas. Reg. § 4980H-1(a)(27).
23 Prop. Treas. Reg. § 54.4980H-0, Preamble IX.C.
24 Prop. Treas. Reg. § 4980H-3(b)(2).