Small employers (fewer than 50 employees) who are in growth mode should familiarize themselves with the “Employer Shared Responsibility” (ESR) provisions in the Affordable Care Act (ACA) before they grow to be “applicable large employers” (ALEs) and are required to comply with them.
These rules – generally referred to as the “employer mandate” — can result in penalties on ALEs if at least one full-time employee qualifies for a subsidy and buys health insurance in the Marketplace. These penalties apply only if the employer was not offering health benefits to at least 95% of its full-time employees, or if the employer did offer coverage to at least 95% but for one or more full-time employees the coverage either was not “affordable” or did not provide “minimum value” as those terms are defined under the ACA.
This article explains the (fairly complicated) ESR provisions and details the two obligations of ALE’s:
- Offering coverage
- Reporting (after year-end) on coverage offered.
WHEN WILL A SMALL EMPLOYER BECOME AN “APPLICABLE LARGE EMPLOYER”?
The ACA ESR provisions apply to each “applicable large employer” (ALE), defined as an employer who employed on average at least 50 full-time employees (FT EEs) or “full-time equivalents” (FTEs) on business days in the prior calendar year. ALE status is determined on a controlled group basis; if the aggregated group is an ALE, then each employer member will be considered an ALE, even if each separate entity employed fewer than 50 FT EEs or FTEs in the prior year.
A small employer who grows and employs at least 50 FT EEs or FTEs does not immediately become an ALE subject to the ESR rules. However, it does become an ALE as of the January 1 following the calendar year in which it meets the 50-employee threshold. Thus, growing employers should keep track of this and determine before the end of the year whether or not they will be subject to these rules in the next calendar year and, if so, which employees should be offered coverage as of January 1. Small employers who grow into ALEs will not be subject to a penalty during the first three months (January – March) of the first year they are an ALE, if they are in compliance as of April 1st. This three-month period is called a “limited non-assessment period” (LNP).
Small employers who have off-calendar plan years should consider in advance whether they want to comply with the ESR rules as of the open enrollment period before the January 1st that they will be considered an ALE and the rules apply, or whether they want to have a special open enrollment period once they are an ALE, with coverage effective no later than April 1st of their first year as an ALE, when their LNP ends.
Additionally, small employers who grow into ALEs should plan to start tracking—as of January 1st—which full-time employees were offered coverage, which employees enrolled, and what the lowest-cost option was. This is because by the end of the following January they will have to do employer information reporting for the prior calendar year (i.e., furnish 1095-Cs to full-time employees and file 1094-Cs with the IRS). See below for details on information reporting obligations.
A word of warning: Employer shared responsibility and information reporting are two separate requirements, with two separate sets of penalties for non-compliance. Small employers are not subject to the employer mandate (employer shared responsibility) nor to penalties if they do not offer health coverage to any employees or do not offer coverage that meets affordability and minimum value requirements, but small employers may choose to offer coverage to some or all employees.
In contrast, small employers who offer self-funded health plans are subject to the information reporting requirements. This includes level funding, which is a form of self-funding. Small employers who offer only fully insured health plans are not subject to information reporting requirements.
WHAT ARE AN ALE’S OBLIGATIONS UNDER THE ESR RULES?
The ACA Employer Shared Responsibility (ESR) provisions are at Internal Revenue Code §4980H and are also known as the “Employer Mandate” or the “Play-or-Pay” rules. Under these rules, ALEs face potential penalties if at least one full-time employee qualifies for a subsidy and buys health insurance in the Health Insurance Marketplace.
Note: Don’t misunderstand recent news reports about the ACA! The Employer Shared Responsibility and Employer Mandate provisions and penalties continue to apply in 2019; only the Individual Mandate tax is reduced to zero as of January 1, 2019. Also, the December 14, 2018 district court decision in Texas v Azar (holding the individual mandate and the entire ACA unconstitutional) is not currently effective and will not change anything until and unless it is upheld by the U.S. Supreme Court, which many people doubt will happen.
Once a small employer becomes an ALE, its two obligations under the ESR provisions are:
- Offering coverage
- Reporting (after year-end) on coverage offered.
1- Offering coverage.
There are two separate coverage obligations and two alternative penalties that might apply. Note that an ALE will not be subject to both penalties. In fact, it will not be subject to either of the two potential penalties unless at least one full-time employee qualifies for a subsidy and buys health insurance in the Marketplace. The two potential penalties are referred to as the “A” and “B” penalties because they apply under Code § 4980H(a) or Code § 4980H(b).
- The “A” penalty applies if an ALE fails to offer “minimum essential coverage” (MEC) to at least 95% of “full-time” employees and their dependents. An ALE is not required to actually cover at least 95% of full-time employees, but only to offer coverage to them.
- The 2018 penalty calculation is: $193.33/month multiplied by (the total number of full-time employees minus 30). This equates to $2,320 per employee per year. This includes full-time employees who are enrolled in coverage. The “A” penalty is also known as the “sledgehammer” penalty.
- When the ESR first applied in 2015, the penalty amount was $177.33/month ($2,080 annually) with an offset of 80 full-time employees. For 2019, the “A” penalty is estimated to be $2,500 annually.
- The “B” penalty applies if an ALE does offer MEC to at least 95% of full-time employees, but for at least one of them the coverage is either not “affordable” (see definition later in this article) or does not provide “minimum value” (defined as at least 60% actuarial value).
- The 2018 penalty calculation is:$290/month multiplied by each full-time employee who qualifies for a subsidy and for whom the employer coverage offered was either not affordable or did not provide at least minimum value. This equates to $3,480 annually. An important difference from the “A” penalty is that the “B” penalty calculation does not include all full-time employees, but only those specific ones. The “B” penalty cannot be more than the “A” penalty would have been if it applied, so this indirectly takes into account the 30-employee offset when calculating the maximum “B” penalty. The “B” penalty is also known as the “tack hammer” penalty because it is usually much less than the “A” penalty.
- The original penalty amount in 2015 was $260/month for each full-time employee for whom coverage was either not affordable or did not provide at least minimum value. (12 x $260 = $3,120). For 2019, the “B” penalty is estimated to be $3,750 annually.
Since neither penalty is tax deductible (because penalties generally aren’t), the impact is much higher than just the face amount, especially since amounts the employer would have paid for employee health benefits (if the employer had “played” rather than “paid”) are tax-deductible.
2- Reporting on Coverage Offered
The ACA requires insurance companies, the Marketplace, large employers and self-insured small employers to annually file information returns with the IRS using forms 1094 and 1095, and also to annually furnish the 1095 forms to individuals. This is called ‘information reporting” because the forms provide specific information including but not limited to: who was offered coverage, who purchased coverage, the level of coverage, the cost of coverage, and who received a subsidy.
The IRS computers automatically match the information reporting required of the employer, the Marketplace and the insurance companies. This is not an “audit lottery,” where an employer might want to take a chance to see if it is audited. The IRS computers can quickly reconcile the information reported by employers, the Marketplace and insurance companies. If that match shows that a full-time employee of an ALE qualified for a subsidy and bought health insurance in the Marketplace, it will trigger an employer penalty of $290/month for that employee in 2018 ($3,480 for 12 months). This is the “B” penalty noted above. If the ALE did not offer at least “minimum essential coverage” to at least 95% of its full-time employees, the “sledgehammer” or “A” penalty will apply, which in 2018 is $193.33/month times the total number of full-time employees minus 30 employees.
For example, if an employer has 100 full-time employees and did not offer coverage to at least 95% of them for all 12 months, if even one full-time employee qualifies for a subsidy and buys health insurance in the Marketplace, the potential fine would be $162,400 annually ($2,320 x (100-30)). As noted above, the fine is calculated monthly so would be $193.33 x 70 employees for each month the employer did not offer coverage to at least 95% of full-time employees. If the employer was compliant for some months, the total penalty would be less than $162,400.
An employer may not realize until at least six months after the end of the year at issue that it was out of compliance during the prior year, for two reasons: 1) information reporting is not done until after the end of the year at issue, and 2) it takes several months before the IRS computers reconcile the information reports and the IRS sends proposed penalty assessments to employers (these are called “226J letters”). In fact, the first year the employer mandate applied was 2015, and the IRS did not send notices of proposed penalties for 2015 until November 2017. The lag time will not be that long for 2016 and later; by third quarter of 2018 the IRS was already sending out 226J letters for 2016, and it’s likely they will be sending letters for 2017 by early 2019.
In addition to the proposed penalty letters the IRS is currently sending, it is also sending separate letters to employers who have not filed any 1094-C and 1095-C forms but who are identified as potential ALEs. The IRS is currently sending these letters for the 2015 and 2016 calendar years. The IRS gleans enough information from the 1094 and 1095 forms filed by insurance companies and the Marketplace to identify employers it believes are large employers who should have filed.
The information above included a general description of the following terms, but here are some additional (important) details.
ALEs are defined as employers who employed on average at least 50 full-time employees and/or “full-time equivalent” employees on business days in the prior calendar year. The ACA regulations prescribe a specific method to calculate the average number of full-time employees during a calendar year, so employers must use this particular method in determining the average number of full-time employees. This method involves counting all full-time employees and full-time equivalents (part-time employees) in each month, summing the monthly totals, and dividing by 12. The ALE determination includes all employees in the control group and also includes contingent workers (i.e., from staffing companies) who fall under the legal definition of “common law” employee. Some additional special rules apply, which are summarized below in the next definition.
“Full-time” is defined for ESR purposes as working on average at least 30 hours per week or 130 hours per month over the prior calendar year. This applies slightly differently for two different purposes: 1) determining if an employer is an ALE, and 2) determining whether and when a particular employee of an ALE is considered to be “full-time.”
- For purposes of determining whether an employer is an ALE, the employer also must add all hours worked by non-full-time employees each month and then divide by 120 to calculate the total number of “full-time equivalent” employees in a month. Non-full-time employees include part-time employees as well as “variable hour” employees. The employer also must count “seasonal” workers, but in the final step may disregard those who worked full-time for fewer than four months if counting them is the reason the employer would be considered an ALE.
- For purposes of determining whether a particular employee of an ALE is considered to be “full-time,” an employer must track hours of service monthly for newly-hired full-time employees but for others can either track hours monthly or select a measurement period and track each employee’s hours of service during that period. For this purpose, an employee who has at least 780 hours of service during a six-month look-back period or 1,560 during a 12-month look-back period will be considered a “full-time” employee during the associated “stability period,” even if actual hours drop below 130 per month, so long as the employee is still employed by the employer.
Large employers are not required to offer coverage to employees who do not meet the above criteria, but they can offer coverage to part-time and seasonal employees if they wish.
AFFORDABILITY AND MINIMUM VALUE REQUIREMENTS
The coverage an ALE must offer to avoid the “A” penalty is defined under ACA as “minimum essential coverage” (MEC), and just about any health coverage is sufficient. The law does not specify what benefits or levels of coverage must be provided by MEC, except that “excepted” benefits will not be considered MEC. Examples of excepted benefits are limited scope dental and vision benefits, most health FSAs, and fixed indemnity insurance policies.
If an ALE wants to ensure it will not be subject to the “B” penalty described above, it must offer at least 95% of its full-time employees coverage that meets “Affordability” and “Minimum Value” (MV) requirements.
- The Affordability test is met if the employee cost for self-only coverage under the lowest-cost option offered to that employee is not more than 9.5% (indexed annually) of the employee’s “household income.” For 2019, the affordability percentage is 9.86%. Since employers generally will not know their employees’ household incomes, ACA regulations allow employers to use the following three “safe harbors” instead of actual household income. For employers who want to charge employees the maximum amount (or close to it), these exact percentage and numbers are critical.
- W-2 method: The employee’s W-2 (Box 1) income from the employer for the current This method is usually not recommended because the Box 1 amount will not be known until the end of the year, and by then it is too late to retroactively decrease the employee contribution amount. Box 1 does not include amounts the employee salary-reduced for 410(k) or 125 plan contributions.
- Rate of pay method: 130 multiplied by the lower of the employee’s hourly rate of pay as of the first day of the plan year or the hourly rate during any subsequent month. For salaried employees, use the monthly pay as of the first day of the plan year, not multiplied by 130.
- Federal poverty line: 100% of Federal Poverty Line (FPL) for an individual. For 2018, this is $12,140 (up from $12,060 in 2017). FPL tables are published in late January each year.
- The Minimum Value (MV) requirement is met if the plan pays on average at least 60% of the total cost of allowed benefits under the plan. This means that employee cost-sharing – deductibles, coinsurance, co-payments and out-of-pocket maximums – cannot exceed 40% of the average cost of benefits under the plan.
ACTION STEPS FOR SMALL EMPLOYERS
If you are growing, be sure to calculate your size during the year, using the ACA method described above, so you will know in advance if you will be considered an ALE for the next calendar year.
If you will be an ALE for the following year:
- If you have an off-calendar year plan, decide whether you will start complying with the ESR provisions as of the plan year starting before January 1, or by April 1st following it.
- Read about how and when the monthly and look-back measurement methods apply, decide which you will use, and determine before January 1 which current employees will be considered full-time as of January 1 and should be offered coverage. Make sure your payroll software and/or vendor will properly track employees’ hours of service and provide you the monthly reports you will need for compliance.
- Make sure you will offer at least “minimum essential coverage” (MEC) to at least 95% of your full-time employees, if you want to avoid the Code § 4980H(a) penalty.
- Make sure you will offer coverage that is affordable and provides at least minimum value if you want to avoid the Code § 4980H(b) penalty.
- If employees decline coverage, have them do so in writing (for online enrollment, keep electronic records), so you can document that you did offer coverage to at least 95% of full-time employees.
- Make sure employees are given enough time and information to make a decision and that you offer the option of coverage at least annually or provide that coverage will continue once it has been elected, unless an employee opts out (this is often called an “evergreen” election).
- Contact your Leavitt advisor and request a copy of the ACA “Four Steps” documentation — an easy-to-complete worksheet to document your compliance with the ACA ESR provisions. Keep a copy in your files and send one back to your advisor.
- Save this article and read it again before the date you will need to comply!