Affordable Care Act Employer Mandate Review #6: Section 4980H(a): What do I need to know about the big penalty?

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1 CLIENT ALERT TO: FROM: RE: Clients and Contacts D. Brent Wills, Esq. Affordable Care Act Employer Mandate Review #6: Section 4980H(a): What do I need to know about the big penalty? DATE: October 15, 2014 Earlier this year, the Internal Revenue Service ( IRS ) published final regulations (the Final Rule, or the Rule ) 1 to implement Section 4980H of the Internal Revenue Code ( Section 4980H, and the Code ), the so-called Employer Mandate, enacted as part of the Patient Protection and Affordable Care Act (the ACA ) in As you may be aware, under Section 4980H, certain large employers (in general, employers with 50 or more employees, but subject to certain transition relief next year 3 ) will be required to offer certain health insurance coverage to their full-time employees or pay a penalty. Initially, Section 4980H was scheduled to take effect beginning in Last year, however, the IRS delayed enforcement of Section 4980H until Moreover, the Final Rule includes transition relief that, subject to certain conditions, (i) may exempt certain large employers with fewer than 100 employees from the penalty provisions of Section 4980H until 2016; and (ii) may exempt certain large employers that have non-calendar year health plans (i.e., plans with plan years that begin on a date other than January 1) from certain Section 4980H penalties until the first month of the plan year in 2015 (i.e., the 2015 plan year) (in the case of certain large employers with 100 or more employees) or the beginning of the 2016 plan year (in the case of certain large employers that have fewer than 100 employees). The ACA also established certain reporting rules to support enforcement of Section 4980H (the Reporting Rules ). The Reporting Rules are set forth in Section 6055 and 6056 of the Code and final regulations published earlier this year 5 and will apply to all large employers (i.e., regardless of whether the employer has fewer than 100 employees) beginning in See Shared Responsibility for Employers Regarding Health Coverage (Final Rule), Department of the Treasury Internal Revenue Service, 79 Fed. Reg (Feb. 12, 2014). 2 See Patient Protection and Affordable Care Act, Public Law (Mar. 23, 2010). 3 The various items of transition relief included in the Final Rule are addressed in more detail in a separate Gilpin Givhan Client Alert. 4 See Treasury Notice (July 9, 2013). 5 See Department of the Treasury, Internal Revenue Service, Information Reporting of Minimum Essential Coverage (Final Regulations), 79 Fed. Reg (Mar. 10, 2014) and Department of the Treasury, Internal Revenue Service, Information Reporting by Applicable Large Employers on Health Insurance Coverage Offered Under Employer-Sponsored Plans (Final Regulations), 79 Fed. Reg (Mar. 10, 2014). The Reporting Rules are addressed in more detail in a separate Gilpin Givhan Client Alert

2 Section 4980H penalties overview Section 4980H includes multiple penalty provisions, namely the following: Under Section 4980H(a), a large employer must offer minimum essential health insurance coverage to its full-time employees and their dependents (subject to certain transition relief and other qualifications, discussed below) or pay a penalty. The amount of the penalty will be $167 per month multiplied by the employer s total number of full-time employees for the month (subject to certain transition relief and other qualifications, as discussed below). The penalty under Section 4980H(a) will apply if any full-time employee qualifies for and obtains a premium tax credit authorized by the ACA to obtain health insurance coverage on a health insurance marketplace (i.e., a premium tax credit) for the month. If a large employer offers minimum essential coverage to its full-time employees and their dependents, the employer may still be subject to a penalty under Section 4980H(b) if the coverage does not provide minimum value (in general, if the employer s health plan does not cover at least 60 percent of the cost of plan benefits). The amount of the penalty will be $250 per month multiplied by the number of full-time employees who qualify for and obtain a premium tax credit in that month. If the large employer offers minimum essential coverage to its full-time employees and their dependents that provides minimum value, the employer may still be subject to a penalty under Section 4980H(b) with respect to any full-time employee (i) for whom the coverage is not affordable (in general, the full-time employee s cost to obtain the coverage exceeds 9.5 percent of the employee s household income); and (ii) who qualifies for and obtains a premium tax credit for the month. The amount of the penalty will be $250 per month multiplied by the number of fulltime employees who meet the criteria described in both (i) and (ii) above. 6 The amount of the penalty under Section 4980H(b) in a given month, if any, may not exceed the amount of the Section 4980H(a) penalty that would apply for the month if the employer did not offer minimum essential insurance coverage to the requisite number of its full-time employees. A key distinction between the Section 4980H(a) penalty and the Section 4980H(b) penalties is that the Section 4980H(a) penalty, if triggered, is determined (subject to transition relief and other qualifications, discussed below) based on the large employer s total number of full-time employees, whereas the Section 4980H(b) penalties, if triggered, will apply only with respect to certain full-time employees. For this reason, the Section 4980H(a) penalty is often referred to the big penalty, or something similar. This Client Alert provides additional details regarding the Section 4980H(a) penalty. The next section 6 Whether, and in what circumstances, minimum essential coverage offered by a large employer provides minimum value and/or is affordable to a full-time employee and related issues are addressed in more detail in a separate Gilpin Givhan Client Alert

3 of this Alert addresses certain key terms in Section 4980H(a). The following section highlights key differences between the application of Section 4980H(a) in 2015 versus 2016 and later years. Key terms and concepts Minimum essential health insurance coverage In short, minimum essential health insurance coverage means most any health insurance plan, including employersponsored health plans and government health plans such as Medicare and Medicaid. That is, a large employer may avoid the big penalty under Section 4980H(a) by offering most any health insurance plan to its full-time employees and their dependents (subject to transition relief and other qualifications, as discussed below). Large employers are not required to offer essential health benefits (another key ACA term that applies in other contexts), for example, to avoid a penalty under Section 4980H(a). One consequence of this low threshold is that some large employers, in lieu of providing robust coverage, on the one hand, and foregoing offering coverage and just paying the penalty, on the other, are considering, and at least some may implement, so-called low cost or skinny health plans, or high deductible plans, either as a sole option or as an alternative to other, more robust coverage, that provide minimum essential health coverage at relatively low cost. 7 Offer of Coverage. A large employer is only required to offer minimum essential health insurance coverage to its full-time employees to avoid a penalty under Section 4980H(a); it is not required to pay all or any portion of the cost of the coverage. There is no penalty in the event a full-time employee declines an offer of minimum essential coverage. Large employers should keep in mind, however, as noted above, that an offer of minimum essential coverage may still trigger a penalty under Section 4980H(b) if the offered coverage is not affordable or does not provide minimum value. Dependents. For purposes of Section 4980H(a), a full-time employee s dependents are limited to the employee s children under the age of 26 and do not include spouses. The Final Rule includes important transition relief available next year in regard to dependent coverage. Specifically, a large employer will not be subject to a penalty under Section 4980H(a) in any month during 2015 (or, in the case of a large employer that qualifies for transition relief available with respect to non-calendar year health plans, in any month prior to the beginning of the employer s 2016 plan year) solely because it does not offer dependent coverage; provided, however, that the employer must take steps do so beginning in its 2016 plan year. This transition relief is generally not available, however, to a large employer that offered dependent coverage during the employer s 2013 or 2014 plan years but no longer offers such coverage. Safe harbor(s); transition relief. Given the administrative burden created by the IRS s decision to impose Section 4980H penalties on a month-to-month basis, and the potentially catastrophic results for some large employers of (even inadvertently) triggering 7 See, e.g., Jay Hancock, 16% of Large Employers Plan to Offer Low-Benefit Skinny Plans Despite ACA: Survey, Kaiser Health News (Aug. 13, 2014), available at stories/2014/august/13/16-percent-of-large-employers-offer-low-benefit-skinny-plans.aspx

4 a penalty under Section 4980H(a) (see discussion below, under Penalty calculation ), Section 4980H(a) provides a critical safe harbor, and the Final Rule provides important transition relief, to help large employers that offer coverage to most, but perhaps not all, of their full-time employees in a given month. Specifically, as discussed further below, Section 4980H(a) provides, generally, that a large employer that offers minimum essential coverage to at least 95 percent of its full-time employees and their dependents in a particular month will not be subject to a penalty under Section 4980H(a) for that month. Moreover, the Final Rule includes transition relief that lowers this threshold to 70 percent, for 2015 only (i.e., for any month during calendar year 2015 and, in the case of a large employer that qualifies for transition relief available with respect to non-calendar year health plans, any month prior to the first month of its 2016 plan year). An employer that fails to offer minimum essential coverage to the applicable minimum safe harbor percentage of its full-time employees (and their dependents) for any month, however, will be subject to a penalty under Section 4980H(a) based on its total number of full-time employees (subject to certain reductions, as noted below) for the month. Large employers should note that the penalty under Section 4980H(a) will apply regardless of whether the employer offers (and even pays for) health insurance coverage for certain of its full-time employees (but less than the safe harbor percentage). It is therefore critical that large employers that wish to avoid a Section 4980H(a) penalty have a clear understanding regarding the safe harbor percentages and reliable systems in place to ensure they offer minimum essential coverage to (at least) the applicable minimum safe harbor percentage of their full-time employees each month. Independent contractors and other personnel. To ensure that they offer minimum essential coverage to the applicable minimum safe harbor percentage of their full-time employees, as discussed above, and do not (inadvertently) trigger a penalty under Section 4980H(a), large employers must ensure they account for all their (potentially full-time) employees. In particular, many employers hire individuals to work, or to provide particular services or perform particular tasks, from time to time, or on an as needed basis. Regardless of how the employer and/or the worker treat the arrangement, the IRS may treat the worker as an employee if the employer is in control of the arrangement, within the meaning of applicable IRS rules. For example, if the employer dictates whether and when, or how, the worker does the job, or provides the facilities and tools or other means to perform the work, or if the worker does most or all the worker s work for the employer, the IRS may attempt to reclassify the worker as an employee, even if the employer issues the worker a Form Penalty reduction; transition relief. In the event a large employer is subject to a penalty under Section 4980H(a), Section 4980H(a) carves out a specified number of fulltime employees from the penalty calculation. Specifically, as noted further below, in the event of a penalty under Section 4980H(a) for a month during 2015 (and, in the case of a large employer that qualifies for transition relief available with respect to non-calendar year health plans, for any month in 2016 that is within the employer s 2015 plan year), the penalty calculation will not take into account the first 80 full-time employees. In 2016 and subsequent years, the penalty calculation will not take into account the first 30 full-time employees. Again, however, the penalty calculation will not take into account whether or

5 to what extent the employer actually offers (or pays for) health coverage for certain employees. In other words, a large employer that fails to offer minimum essential coverage to at least the minimum safe harbor percentage of its full-time employees may be exposed to a substantial penalty under Section 4980H(a) in addition to its cost to offer the health insurance coverage it offers, if any. Application of Section 4980H(a) in 2015 To recap, next year, large employers (other than large employers with fewer than 100 employees who qualify for transition relief under the Final Rule that will postpone enforcement of Section 4980H until 2016) 8 will be subject to a penalty under Section 4980H(a) in any month in which they do not offer minimum essential health insurance coverage to at least 70 percent of their full-time employees and their dependents (i.e., children under 26), unless the employer qualifies for the transition relief discussed herein regarding dependent coverage. A large employer that does not offer minimum essential coverage as specified above will be subject to a penalty under Section 4980H(a) for the month in the amount of $167 multiplied by the total number of the employer s full-time employees not taking into account the first Thus, for example, in any month during 2015, if a large employer has 200 full-time employees, the employer will be required to offer minimum essential health insurance coverage to at least 140 of its full-time employees (200 full-time employees x 70%) and their children under the age of 26 (unless the employer qualifies for the transition relief discussed above regarding dependent coverage) to avoid a penalty under Section 4980H(a). If the employer does not do so, and one or more of its full-time employees qualifies for and obtains a premium tax credit, the employer will be subject to a penalty under Section 4980H(a) in the amount of approximately $20,040 [( x $167] for the month, or $240,480 for the calendar year, if the employer does not offer minimum essential coverage as specified above for any month during the year. Moreover, the amount of the penalty would be the same regardless of whether the employer offered (and even paid for) minimum essential coverage to 139 of its full-time employees (including children and spouses) or none of them. Application of Section 4980H(a) in 2016 and later years Beginning in 2016, 10 large employers will be subject to a penalty under Section 4980H(a) in any month in which they do not offer minimum essential health insurance 8 Whether and in what circumstances a large employer may qualify for this transition relief is addressed in more detail in a separate Gilpin Givhan Client Alert. 9 As noted above, in the case of a large employer that qualifies for transition relief available with respect to non-calendar year health plans, the transition relief lowering the safe harbor percentage to 70 percent and increasing the number of full-time employees omitted from the Section 4980H(a) penalty calculation to 80 will apply for all months during calendar year 2015 and any months during calendar year 2016 that fall within the employer s 2015 plan year. 10 See note 9 above

6 coverage to at least 95 percent 11 of their full-time employees and their dependents (i.e., children under 26). 12 A large employer that does not offer minimum essential coverage as specified above will be subject to a penalty under Section 4980H(a) for the month in the amount of $167 multiplied by the total number of the employer s full-time employees not taking into account the first 30. The foregoing applies with respect to all large employers, including large employers with fewer than 100 employees. For example, in any month during 2016, if a large employer has 200 full-time employees, the employer will be required to offer minimum essential health insurance coverage to at least 190 of its full-time employees (200 full-time employees x 95%) and their children under the age of 26 to avoid a penalty under Section 4980H(a). If the employer does not to do so, the employer may be subject to a penalty under Section 4980H(a) in the amount of approximately $28,390 [(200-30) x $167] for the month, and $340,680 for the year, if the employer does not offer coverage as specified above for any month during the year (i.e., $100,000 more than for calendar year 2015). Similarly to 2015, the amount of the penalty in 2016 would be the same regardless of whether the employer offered (and even paid for) minimum essential coverage to (for) 189 of its fulltime employees or none of them. Not tax deductible Large employers should also keep in mind that they will not be permitted to deduct any penalties they pay under Section 4980H(a) from income for tax purposes. In view of the magnitude of potential penalties under Section 4980H(a), the impact of the lost tax benefit associated with the penalty (compared, for example, to tax incentives that may be available if the employer offers coverage) could be substantial. Aggregation rules The IRS will treat certain groups of employers (specifically, employers within a controlled group or affiliated service group, within the meaning of the Code) as a single employer. If the various employers within the group have 50 or more employees collectively, the IRS will treat each of them (regardless of whether the employer, by itself, has 50 or more employees) as a large employer. The employers within the group will be disaggregated, however, for penalty purposes, so that, for example, each employer within the group must offer minimum essential coverage to its full-time employees in 11 More specifically, the Final Rule permits a large employer to exclude from coverage up to 5 percent of its full-time employees, or five employees, whichever is greater, and not pay a penalty under Section 4980H(a). In other words, a large employer with fewer than 100 employees will not be subject to a penalty under Section 4980H(a) if it offers minimum essential coverage to all but 5 of its full-time employees, even if the result is that coverage is offered to less than 95 percent of the employers full-time employees. 12 The 95 percent safe harbor percentage will apply to all large employees for months during 2016, including large employers with fewer than 100 employees that qualify for transition relief that may postpone enforcement of the penalty provisions of Section 4980H until Likewise, except as noted herein in regard to large employers with non-calendar year health plans, all large employers must offer dependent coverage to avoid a Section 4980H(a) penalty in 2016 and thereafter; there is no transition relief beyond

7 compliance with the applicable safe harbor percentage of its full-time employees (i.e., 70 percent in 2015 and 95 percent in and later years) or pay the big penalty under Section 4980H(a). Moreover, in calculating a penalty under Section 4980H(a), the 80 fulltime employee reduction available in 2015 and the 30 full-time employee reduction available in later years 14 must be allocated pro rata (i.e., based on the employers number of full-time employees) among the employers within an aggregated group. 15 Conclusion As illustrated above, large employers must take into account a number of factors in assessing their potential exposure to the big penalty under Section 4980H(a). Many large employers already offer health coverage (i.e., that constitutes minimum essential coverage) to their full-time employees. For these employers, Section 4980H(a) essentially poses a compliance risk: the employer must be sure to implement systems that ensure it offers coverage to the applicable minimum safe harbor percentage of its full-time employees discussed above each month. On the other hand, large employers that have not historically offered health insurance coverage to certain of their employees that work substantial hours (i.e., 30 or more hours of service per week, under the ACA s new standard) may need to make significant business decisions as they prepare for the onset of Section 4980H. For example, such an employer that has more than 100 employees may opt to take a stepped approach to avoid the Section 4980H(a) penalty (that is, offer minimum essential coverage to 70 percent of their full-time employees, then 95 percent in 2016), or forego offering coverage, either in 2015 or altogether, in the event the employer concludes that the potential cost to offer coverage outweighs the potential Section 4980H(a) penalty. Also, as noted above, some large employers (and, in many cases, their employees) may benefit from implementing some type of low cost or high deductible plan (through the employer should take into account the potential penalty exposure under Section 4980H(b) before doing so). Giving consideration to these and many other factors, it is nearly impossible to generalize; each large employer must determine its own strategy with respect to Section 4980H(a) based on its own circumstances. This Client Alert obviously provides only an overview of some of the numerous issues a large employer may need to consider in regard to Section 4980H(a). Large employers that have questions or need assistance in regard to the application of Section 4980H(a) in their particular circumstances should consult appropriate legal counsel. This Client Alert is provided by Gilpin Givhan, P.C. for informational purposes only. It is not intended to constitute legal advice. For legal advice regarding particular matters, please contact Gilpin Givhan, P.C. or other appropriate legal counsel. 13 See note 9 above. 14 See note 9 above. 15 The aggregation rules are discussed in more detail in a separate Gilpin Givhan Client Alert