“….the IRS is putting a great deal of thought into identifying and blocking stratagems that employers may use to try to evade the requirements of the mandate. ”
By Timothy Jost
On December 28, 2012, one of the last major regulatory building blocks of the Affordable Care began to fall into place. The Internal Revenue Service of the Department of Treasury issued a notice of proposed rulemaking (NPRM) addressing “Shared Responsibility for Employers Regarding Health Coverage” — the employer mandate. The IRS also released a series of questions and answers, explaining the provisions of the proposed rule in simplified form.
This post analyzes the provisions of the employer mandate NPRM. It also provides a brief analysis of a guidance released by the Center on Medicare and Medicaid Services on December 28, instructing the states on how to convert their current Medicaid and CHIP net income eligibility thresholds into the modified adjusted gross income (MAGI) standards that will be used for determining eligibility for Medicaid, CHIP, and premium tax credits beginning in 2014.
The IRS NPRM addresses a modest number of seemingly simple but surprisingly complex questions. When does an employer have fifty employees, and thus become a “large employer” subject to the ACA employer mandate? When is an employee a “full-time” employee, for whom a large employer must either provide “affordable” and “adequate” coverage or pay a penalty if the employee receives premium tax credits or cost-sharing reduction payments through the exchange? Who are the “dependents” of an employee for whom an employer must also provide coverage? How will the penalties be assessed? How will the now surprisingly short transition to 2014 be handled?
The NPRM builds on a series of notices issued in recent months by the IRS — here, here, here, here, and here — signaling the directions it intended to take in implementing the employer mandate, as well as on an NPRM issued late in November explaining how the “minimum value” of a group health plan will be determined for establishing whether coverage under the plan is “adequate” for purposes of the employer mandate. There are thus few surprises in the proposed rule. The preamble to the rule shows, however, that the IRS is putting a great deal of thought into identifying and blocking stratagems that employers may use to try to evade the requirements of the mandate. The preamble also reveals that there are still complex issues that the IRS has not entirely worked through, and on which it requests comments.
Comments on the proposed rule are not due until March 18, 2013, and a public hearing will be held on the proposal on April 23, 2013. This is in stark contrast to the 30-day comment periods imposed on the proposed market reform and essential health benefits rules recently released by HHS, and suggests that establishing the requirements that apply to employers in 2014 is not as urgent a task as is clarifying what insurers must do in the very near future to prepare for markets that will open for business in the fall of 2013. In any event, the IRS clarifies that employers may rely on the proposed rule for planning purposes pending the issuance of a final rule.
The ACA provides that a large employer is subject to a tax penalty for each month in which it fails to offer its full-time employees (and their dependents) the opportunity to enroll in minimum essential coverage under an eligible employee benefits plan and one or more full-time employee receives a premium tax credit or cost-sharing reduction payment through the exchange. A large employer may also have to pay a tax penalty if in any month one or more of its full-time employees receives a premium tax credit or cost-sharing reduction payment because coverage offered by the employer is either unaffordable or does not provide minimum value.
The assessable penalty tax for failing to offer coverage is $2000 for each (excluding the first 30) full-time employee employee if any employee receives a premium tax credit. If the employer offers coverage for some months but not for others, the penalty is 1/12th of $2000 for each (excluding the first 30) full-time employee for each month in which the employer fails to offer coverage and at least one full-time employee receives a premium tax credit through the exchange. The penalty for failing to offer affordable or adequate coverage is 1/12 of $3000 for each month for each full-time employee who receives premium tax credits or cost-sharing reduction payments (up to a maximum of 1/12 of $2000 times the number of full-time employees less 30). For purposes of the employer mandate, a “large employer” is defined as an employer that employed an average of at least 50 full-time or full-time equivalent (FTE) employees on business days during the preceding calendar year. A “full-time employee” with respect to any month is an employee who is employed an average of at least 30 “hours of service” per week.
“Minimum essential coverage” is health insurance coverage under an insured or self-insured group health plan, and does not include “excepted benefit” coverage. Coverage provides “minimum value” if it covers at least 60 percent of the total allowed cost of benefits provided under the plan as determined using the HHS and IRS minimum value calculator. Large employer plans are not required to cover the essential health benefits that individual and small group plans must cover. Employer coverage is “affordable” if the employee’s required contribution for self-only coverage does not exceed 9.5 percent of the employee’s modified adjusted gross household income for the taxable year. The proposed rule includes safe harbors, discussed below, that employers may rely on in attempting to offer affordable coverage.
Defining a “large employer”. The first question addressed by the NPRM is the definition of “large employer.” For purposes of this definition, the terms “employer” and “employee” are defined as under the common law in terms of authority of the employer to direct and control the manner in which services will be performed by the employee. The employer mandate applies not only to for-profit entities, but also to federal, state, local, and Indian tribal governmental entities and to tax-exempt organizations. Affiliated entities and entities under common control (such as a parent corporation and wholly owned subsidiary corporations) are treated as a single entity for determining large employer status.
Large-employer status is determined based on the actual hours of service of employees worked in the prior calendar year. For this determination, successor employers are considered to be the same as predecessor employers. The status of new employers is determined based on whether they are reasonably expected to employ at least 50 full-time employees and FTEs in the current year. An employer whose workforce exceeds 50 full-time employees for 120 days or fewer during a calendar year is not a large employer if the employees in excess of 50 during those 120 days were seasonal workers, such as agricultural workers during the harvest or retail employees during the holiday season.
Large-employer status is determined by adding the number of the employer’s full-time employees to the number of FTEs employed during the prior calendar year. FTEs are determined by calculating for each month of the prior calendar year the aggregate number of hours of service (not exceeding 120 hours for any one employee) worked by all non-full-time employees (those not employed for an average of 30 hours per week), including seasonal employees, and dividing by 120, and then adding the number of monthly FTEs together and dividing by 12. “Hours of service” includes not only hours when work is performed, but also hours for which an employee is entitled to payment even though no work is performed due to holidays, vacation, illness, incapacity, layoff, jury duty, military duty, or leave of absence.
For employees not paid on an hourly basis, hours of service can be determined using actual hours worked or a days-worked or weeks-worked equivalency basis as long as equivalency methods do not substantially understate an employee’s hours of service (for example, treating an employee who generally works three ten hour days a week as having worked 24 hours a week). Hours of service do not generally include hours worked outside of the United States. Special rules are applied for educational institutions (which customarily have long vacation periods) and further guidance is under consideration for employees not customarily paid on an hourly basis (like adjunct faculty or employees compensated by commission) or employees whose hours of service are limited for safety reasons (like airline pilots).
Defining a “full-time” employee. The most complicated problem addressed by the proposed rules is how to determine whether an employee is a “full-time” employee for penalty assessment purposes. For new employees hired to work full time or current employees who in fact work full time on an on-going basis, there is little problem (although coverage can be delayed for a waiting period not exceeding 90 days for new employees). The problem is that many employees work variable hours, working 30 or more hours in some weeks, fewer hours in others. Other employees are hired on a seasonal basis or are hired to work full time but only for a short period of time.
Employees may work “full time” for a period of time, then be reduced to fewer hours, while, on the other hand, part-time employees may become full-time employees. Obviously the rule cannot require employers to offer insurance for a week in which an employee works 30 hours or more and cancel the insurance the next week if the employee works fewer than 30 hours. Employers can, of course, offer coverage the employees who are not full-time employees, but a method is necessary to define the “full-time” employees to whom coverage must be offered by an employer to ensure that the employer will not risk a penalty.
The IRS proposes to address the issue of variable-hour employees through a “look-back measurement” method. The full complexities of this approach will not be explored here, but the basic idea is that a large employer has the option of determining the full-time status of employees who work variable hours by calculating the average hours the employee works during a “measuring period” lasting from three to twelve months. If the average number of hours worked equals or exceeds 30 hours per week during this period, the employee is considered a full-time employee for an ensuing “stability period” of at least the length of the measurement period or six months, whichever is longer. If the average number of hours worked is less than 30, the employee may be considered to not be a full-time employee for a stability period that is not longer than the measurement period.
An employer may impose an “administrative period” of up to 90 days between the measurement period and the stability period as long as it does not reduce or lengthen the measurement or stability periods. Generally an employer must apply uniform measurement and stability periods to all employees, but different periods can be used for certain categories of employees, such as hourly and salaried employees or employees in separate collective bargaining units.
Similar rules are used for determining the full-time status of employees who are newly hired as variable-hour or seasonal employees. Special rules apply for new variable or seasonal employees who have a change of employment status (such as a promotion) during the measurement period and for employees who are terminated and then rehired or who take an unpaid leave during the measurement or stability periods (or during the 90-day waiting period before coverage must begin for full-time employees). Special rules again also apply for employees of educational institutions.
The IRS requests further comments on a number of issues, such as how to treat short-term employees or employees in high-turnover positions or employees of temporary staffing agencies. The IRS understands that special circumstances may warrant special treatment, but it is also very much aware of the possibilities that exist for abuse by employers, such as schemes where an employer would purport to hire an employee for only 20 hours a week and then retain the same employee through a temporary staffing agency for the remainder of the week.
Affiliated members of a controlled group of large employers are treated as a single employer for purposes of determining large employer status, but as separate employers for assessing penalties. Large employee members must allocate the 30 full-time employee exclusion ratably amongst themselves for penalty assessment purposes based on each employer’s proportion of full-time employees.
Defining “dependents”. The proposed rule defines dependents, who must be offered coverage by the employer, to include children up to age 26 but not spouses. Coverage must only be offered and not necessarily accepted, but an employee who declines affordable and adequate coverage is not eligible for premium tax credits through the exchange. If an employee fails to pay the employee’s share of the premium for coverage, the employer has no further obligation after a 30-day grace period.
Recognizing that employers may make inadvertent errors, the proposed rule also provides that an employer will be treated as offering coverage to all of its full-time employees for any month in which it offers coverage to all but five percent of its employees or, if greater, five full-time employees. The employer will not be liable if one of those employees receives premium tax credits or cost-sharing reduction payments.
Defining “affordable” coverage. As noted earlier, coverage is affordable for purposes of the employer responsibility provision if the employee’s premium obligation for self-only coverage does not exceed 9.5 percent of the employee’s household’s modified adjusted gross income. An employer, however, will often not know what an employee’s household income is, as the employee or a member of the employee’s household may have other sources of income. The proposed rule, therefore, provides employers with three safe harbors to avoid liability.
First, the employer is not subject to a penalty if the employee’s share of the cost of self-only coverage does not exceed 9.5 percent of the employee’s W-2 income (prorated for months of coverage if the employee is employed full-time for less than a year). Second, the employer is not liable if the self-only premium for the lowest-cost coverage offered by the employer does not exceed 9.5 percent of the lowest-hourly rate paid by the employer (or an actual employee’s hourly wage or salary rate) times 130 hours per month. A third safe harbor protects the employer if the employer charges employees no more than 9.5 percent of the federal poverty rate for employee coverage.
The proposed rule does not explicitly address the thorniest issues raised by the affordability standard. Employer coverage is affordable under the rule if self-only coverage is available for 9.5 percent or less of an employee’s income. Family coverage, however, may cost far more than 9.5 percent of an employee’s income. Indeed, by basing affordability on self-only coverage, the proposed rule encourages employers to offer affordable self-only coverage, but to charge more for family coverage, making it effectively unaffordable. Employees can only get premium tax credits, however, if employer coverage is unaffordable. Without premium tax credits, family coverage may cost more than lower-income employees can afford.
The IRS initial proposed rule on premium tax credits suggested that employees would be ineligible for premium tax credits for family coverage if employee self-only coverage was affordable. The final IRS premium tax credit rule, however, left open the question of the affordability of family coverage. The NPRM notes this fact in a footnote, but tellingly states early in the preface, “. . . an employee’s receipt of a premium tax credit or cost sharing reduction with respect to coverage for a dependent will not result in liability for the employer. . .”
This quote suggests that the IRS may be considering a rule that would permit employees to obtain premium tax credits to purchase exchange coverage for their families even if they cannot obtain tax credits for their own coverage because they can afford self-only coverage through their employers. This would increase the cost of the premium tax credit program and not entirely solve the problem for employees, since they might still have to spend more than 9.5 percent of their income to get full family coverage, but it might be a step in the right direction.
Employers will receive notice if their employees are certified for premium tax credits and will have an opportunity to respond. The IRS will then present the employer with a notice and demand for payment. It appears that this will happen in 2015 for penalties owed for 2014. Until that time, any challenges to the law by employers will be barred by the Tax Anti-Injunction Act because the penalty is explicitly called a tax.
The NPRM includes transition rules for 2014, recognizing that employers with non-calendar plan years will need time to transition for plans that begin in 2013 and extend into 2014. Transition rules are also proposed for employees who will have to make changes in salary reduction agreements for cafeteria plans and for determining full-time employer status for variable employees if the employer chooses to apply a twelve-month measurement period. Transition rules are provided for determining large-employer status for 2014 and for determining coverage under multiemployer plans. Employers who do not currently cover dependents are excused from penalties for 2014 if they take steps during 2014 toward compliance with the requirement.
CMS Guidance On Converting Medicaid/CHIP Net Income Eligibility Thresholds
On December 28, 2012, the Centers for Medicare and Medicaid Services of HHS also issued guidance on the conversion of state net-income Medicaid eligibility standards to modified adjusted gross income (MAGI) standards. As of January 1, 2014, Medicaid and CHIP eligibility must be determined based on MAGI for most Medicaid and CHIP enrollees, including children, pregnant women, parents and other caretaker relatives, and the new adult expansion group. Currently, states determine eligibility for Medicaid for these populations by first determining gross income using a combination of federal and state rules regarding household and family composition and then deducting or disregarding income amounts not considered countable as net income, such as childcare expenses. As of January 1, 2014, all states will use the same MAGI-based methodology; hence, it is necessary to convert current state standards to MAGI-based standards. MAGI will also be used by the exchanges for determining eligibility for premium tax credits.
The Guidance requires each state to submit a “MAGI Conversion Plan.” States will use the converted MAGI income standards to establish income eligibility standards; determine minimum eligibility standards that cannot be reduced until ACA maintenance-of-effort requirements expire (on January 1, 2014 for adults, October 1, 2019 for children); identify premium payment income thresholds for states that tie premium payments to income; and establish income levels for determining whether adults are “newly eligible” for Medicaid, and thus eligible for 100 percent federal matching funds beginning in 2014. “Newly eligible adults” are adults who would not have been eligible for Medicaid coverage in a state on December 1, 2009.
CMS offers two options for MAGI conversion. The first is the “Standardized MAGI Conversion Methodology.” Under the standardized methodology, the Medicaid net-income eligibility standard for each eligibility group is adjusted by calculating the average size of income disregards for people whose net income falls within 25 percentage points of the federal poverty level (FPL) below the net-income standard and adding this average disregard amount, expressed as a percentage of FPL, to the net income standard, expressed as a percentage of FPL. The Guidance gives the following example: If the net income standard was 80 percent of FPL, and the average disregard for individuals with net incomes between 55 and 80 percent of FPL was 7 percent of FPL, the 7 percent would be added to the 80 percent resulting in a converted standard of 87 percent of FPL. States can use either national survey data provided by CMS or their own state data to make the conversion. Alternatively, as a second option, states may propose their own alternative conversion methodology instead.
The Guidance also sets out a timeline for MAGI conversion. By January 15, 2013, CMS will send each state a template mapping each states eligibility standards and rules. States will review these and confirm the accuracy of the information. Apparently most states have already done this. By February 15, states must submit a nonbinding statement of intent as to their conversion methodology.
Between January and April of 2013, CMS will develop converted MAGI-based standards using federal data and submit them to the states for review. States that choose to use the CMS-derived MAGI standards must submit their final conversion plans no later than May 31, 2013. States deciding to use their own data or an alternative methodology should submit their plans by April 30, 2013. In either event, states will be notified of final approval by June 15, 2013. Finally, state MAGI-based income standards must be shared with the exchange by June, 2013, to support open enrollment by October 1, 2013. The MAGI-based standards must also be memorialized in a state plan amendment.