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Inside Compensation Developments in Employee Benefits & Executive Compensation

IRS Proposes Shared Responsibility Tax Rules for Employers

Posted in Health Plans, Welfare Plans

Starting in 2014, large employers will have to pay a “shared responsibility” excise tax up to $3,000 per employee if they fail to provide affordable health coverage to full-time employees and their dependents.  The Treasury Department and IRS have published a proposed regulation and frequently-asked questions that make important changes in prior guidance. 

Here are some highlights of the new rules.  For a closer look at the shared responsibility requirements, see our Advisory.

Which Employers Are Covered By The Requirement?

50-employee threshold.  The shared responsibility requirement applies to employers that had at least 50 full-time employees in the preceding calendar year.  The requirement will apply in 2014 to employers that had 50 full-time employees in 2013.

Controlled group rules.  The 50-employee threshold applies on a “controlled group” basis: related companies with 80% or more common ownership or control are treated as a single employer.  For example, if a company with 1,000 employees owns a subsidiary with 10 employees, the subsidiary is covered by the requirement because it is part of a controlled group with 50 full-time employees.

Which Employees Are “Full-Time Employees?”

An employer must count its full-time employees for three reasons: (1) to determine whether it meets the 50-employee threshold, (2) to identify the employees to whom it must provide affordable health coverage in order to avoid the excise tax, and (3) to satisfy a new IRS information reporting requirement.

Full-time employees.  A worker is a full-time employee if he or she is credited, on average, with at least 30 hours of service per week.  For employees who are not paid on an hourly basis, an employer may count actual hours of service or may use an equivalency that credits 8 hours for each day worked or 40 hours for each week worked.  Hours of paid leave count, without limit, as hours of service.

Part-time employees.  The proposed regulation requires employers to count part-time employees toward the 50-employee threshold on a full-time equivalent basis.  For example, two employees who work 15 hours per week on average are treated as one full-time equivalent employee.  (The regulation does not require the employer to provide affordable health coverage to part-time employees, however.)

Shared employees.  If an employee works for different companies in the same controlled group, the companies must aggregate working hours to determine whether the worker is a full-time employee.  For example, an employee who works 10 hours a week for Subsidiary A and 20 hours a week for Subsidiary B is a full-time employee of both companies.  If Subsidiary B provides health coverage to the employee and Subsidiary A does not, Subsidiary A might be subject to the excise tax, since the proposed regulation does not credit one controlled group member for group health coverage provided to a shared employee by another controlled group member.

Work Outside the U. S.  Employers do not have to count hours of service performed outside the United States, either by U. S. citizens or by foreign nationals.  “United States” means the 50 states and the District of Columbia.  Accordingly, hours worked in Puerto Rico, the U. S. Virgin Islands, and other U. S. territories don’t count, and employers do not have to offer affordable health coverage to workers in these locations.

Non-employees.  Only common-law employees count toward the 50-employee threshold: leased employees, independent contractors, sole proprietors, and S corporation shareholders are ignored.  It often is unclear whether a worker is a common-law employee, and this lack of clarity has led to a long history of disputes over “worker classification” issues.  The shared responsibility rules are likely to generate more conflicts among employers, workers, and the IRS over worker classification.

Workers With Variable Work Schedules.  One of the challenges employers face under the shared responsibility rules is to determine, month by month, whether a worker with a variable schedule works an average of 30 hours per week and must be offered affordable health coverage.  The proposed regulation provides an elaborate set of rules that an employer may use to determine whether a variable-hour or seasonal employee is a “full-time employee.”

The rules permit the employer to determine the employee’s status during a “look-back” measurement period: if the employee works an average of 30 hours per week during the measurement period, he must be treated as a full-time employee during a subsequent stability period, regardless of his actual working hours in the stability period.  For example, an employee who works an average of 30 hours a week during a 2013 measurement period would be treated as a full-time employee (regardless of hours worked) during a 2014 stability period.

An employer may not use the look-back measurement period and stability period to determine whether a worker must be counted toward the 50-employee threshold.  The proposed regulation does provide a special rule that allows an employer to ignore certain seasonal workers for purposes of the 50-employee threshold, however.  For example, if a small retailer exceeds the 50-employee threshold only because it hires extra workers during the holiday season, the special rule allows it to ignore the seasonal workers.

What Triggers The Excise Tax?

Starting in 2014, the “individual mandate” will require everyone to obtain a minimum level of health coverage or pay a tax.  An individual will be able to buy health coverage through an “Exchange,” which is a health insurance marketplace administered by a state or by the federal government.  Lower-income individuals will be eligible for a premium tax credit that helps make individual health coverage affordable.

Lower-income individuals will not qualify for the premium tax credit if they are eligible for affordable minimum-value health coverage from another source, such as an employer health plan.  An employer becomes subject to the shared responsibility excise tax only if at least one full-time employee purchases health coverage through an Exchange and qualifies for a premium tax credit.

Employers were concerned that they would have no way to know when an employee had purchased individual coverage and received a premium tax credit.  The proposed rule addresses this problem by providing that IRS will notify employers when their employees claim the premium tax credit and will give employers an opportunity to respond.

Which Tax Applies?

There are two levels of shared responsibility excise tax:

  • “A” Tax:  If a covered employer fails to offer its full-time employees (and their dependents) the opportunity to enroll in minimum essential coverage, the employer must pay an excise tax equal to 1/12 of $2,000 per month times the number of its full-time employees in excess of 30.
  • “B” Tax:  If a covered employer offers minimum essential coverage to its full-time employees (and their dependents), but the coverage is not affordable or not sufficiently valuable, the employer must pay an excise tax equal to 1/12 of $3,000 per month times the number of its full-time employees who receive a premium tax credit or cost-sharing reduction.

Although the “B” tax is a higher amount per employee, it usually will apply to fewer employees (only those who receive premium tax credits rather than all full-time employees).

How Do Employers Avoid the “A” Tax?

In order to avoid the “A” tax, a large employer must offer minimum essential coverage on every day of the month to:

  • At least 95 percent (or, if greater, five) of the employer’s full-time employees, and
  • The dependent children (up to age 26) of those full-time employees.

Future regulations will define “minimum essential coverage.”  Most employer group health plans (whether insured or self-insured) probably will qualify as minimum essential coverage unless they cover only “excepted benefits” such as dental or vision care (although it is not yet clear whether a limited reimbursement arrangement such as a stand-alone health reimbursement account will qualify as “minimum essential coverage”).

How Do Employers Avoid the “B” Tax?

Even if an employer offers minimum essential coverage to its full-time employees, the employer will be subject to the “B” tax if the coverage is not affordable or does not provide minimum value.

  • Coverage is affordable if an employee must pay no more than 9.5% of the employee’s annual household income for the lowest-cost self-only coverage that provides minimum value. The regulation provides safe harbors that allow employers to determine affordability based on employees’ W-2 wages or rate of pay (rather than household income), or to assume that employees earn no more than the federal poverty line.
  • Coverage provides minimum value if the coverage pays at least 60 percent of the total allowed costs of benefits provided under a typical large employer plan.  HHS and IRS will provide an on-line calculator and a series of design-based safe harbors to help employers satisfy this requirement.

Must Employers Cover Dependents?

One of the more controversial features of the proposed regulation is that it requires an employer to provide minimum essential coverage to the dependent children (up to age 26) of full-time employees in order to avoid the “A” tax.  The regulation defines “child” broadly to include natural and adopted children, stepchildren, and foster children.

On its face, the “B” tax also appears to require employers to cover dependents.  The “B” tax is based on the number of employees—not dependents—who qualify for the premium tax credit, however.  Accordingly, it appears that an employer will avoid the “B” tax if it offers affordable minimum-value coverage to all lower-income full-time employees, even if the employer offers only unaffordable coverage to their dependents.

An employer does not have to offer minimum essential coverage or affordable coverage to the spouses of full-time employees.

How Will the IRS Know Whether Employers Offer Affordable Coverage?

Starting in 2015 (for coverage provided in 2014), employers will be required to file annual reports with the IRS identifying each full-time employee and describing the coverage they offer to full-time employees and their dependents.  Employers must also provide a statement to each full-time employee with information about the coverage available to the employee.

When a lower-income person purchases individual coverage through an Exchange and claims a premium tax credit, the IRS will use the reported information to determine whether the person is eligible for affordable minimum-value coverage from his or her employer.  If the person has employer coverage, the person will not qualify for the premium tax credit.  If the person is a full-time employee and does not have employer coverage, the employer might owe the excise tax.

How Is the Excise Tax Calculated?

The excise tax applies separately to each member of a controlled group.  For example, if the full-time employee of one subsidiary in a large controlled group receives a premium tax credit, the credit will trigger the excise tax for that subsidiary, but not for other members of the controlled group.

The “A” tax does not apply to the first 30 full-time employees.  The 30-employee exclusion allowance applies to the “B” tax only to the extent that the “B” tax for any month cannot exceed the tax that would have applied if the employer were subject to the “A” tax.  The entire controlled group receives only one 30-employee exclusion allowance.  Each member of the controlled group receives an allocable share of the 30-employee exclusion based on the proportion of full-time employees employed by that member. If a member’s allocable share is less than one, the member is allocated credit for one full-time employee.

The shared responsibility excise tax is due only when the IRS notifies the employer that the tax is due and demands payment.  The tax is not deductible.

What Transition Relief Is Available?

A number of special transition rules apply during 2013 (when employers must start counting hours to identify full-time employees) and 2014 (when the shared responsibility rules become effective).  For example:

  • Employers will be considered to have satisfied the requirement to cover dependents of full-time employees in 2014 if they take steps towards offering coverage to dependents during the 2014 plan year.
  • Employers can use a 6-month period in 2013 (rather than the full calendar year) to determine whether they have at least 50 full-time employees.
  • Employers that wish to use the measurement period and stability period rules to identify full-time employees can use a 6-month measurement period in 2013 followed by a 12-month stability period in 2014.
  • Sponsors of fiscal year plans are not required to comply with the shared responsibility rules until the beginning of the plan year that starts in 2014.
  • Sponsors of fiscal year plans may offer special cafeteria plan elections that will permit employees to obtain group health coverage on January 1, 2014, when the individual mandate becomes effective.