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Digging Deeper Into Pay-or-Play Penalties

By: Timothy J. Tornga
Mika Myers Beckett & Jones, PLC.
Posted:  June 11, 2013

Following our earlier articles on Mandatory Coverage, we have had several questions about how/whether the pay-or-play penalty tax applies in various common scenarios.  See our previous Affordable Care Act (ACA) articles at  ACA - What Must A Small Employer Do? - Part 1 - Issues Affecting Employers of All SizesACA - What Must A Small Employer Do? Part 2 - Mandatory Coverage, and ACA – What Must a Small Employer Do? Part 3 – How Do You Count To 50?

Here is an example that illustrates several issues:  Employer X has 65 employees in 2013, but when it completes a temporary project in mid-2014, it will likely lay off six employees.  Of its 65 employees, 20 work only 15 hours/week and the rest (45) are conventional, full-time employees.

Employment is consistent throughout 2013.  Employer X has no variable hour or seasonal employees.  Will Employer X be subject to the pay-or-play penalty tax in 2014?

Step 1.  Is the employer an applicable large employer and therefore exposed to the penalty tax?

For Employer X, the 20 part-time employees work out to ten full-time equivalents (FTEs).  Together with the 45 employees working 120 hours or more per month, this employer has 55 full-time employees for this purpose.  Assume this is the case for all 12 months of 2013.  In the question above, this employer has 55 full-time employees for 2013 and is an applicable large employer for the entire 2014 year. This status (applicable large employer) does not change during the year due to payroll fluctuation.  The status in 2015 will depend on employment levels in 2014.

After we know that an employer is exposed to the penalty tax for all of 2014, we must then calculate the amount.  To calculate the amount of the penalty, we need to forget much of what we learned in step 1.

Step 2.  The “A” penalty tax of $2,000/full-time employee/year ($166.67/month) applies if the employer fails to offer coverage (affordable or not) to 95% or more of its full-time employees and at least one employee enrolls for subsidized exchange coverage.  For this purpose, the penalty tax provision allows a reduction of 30 full-time employees in calculating the penalty.  Determination of the full-time employees is critical.  We discussed this in more detail in our earlier Part 3 article.

Even though the exposure to the penalty tax is fixed for the entire year, the amount of the assessment will change by monthly variations in employee count.  As a result of the possibility of mid-year changes to the total count and mid-year gain or loss of compliance with the 95% test, this penalty tax must be calculated on a monthly basis.  Liability may also change in the year based on whether one or more “full-time” employees has enrolled for subsidized exchange coverage or whether all exchange enrollees have let their exchange coverage lapse.

Application of the penalty tax is based only on the employees who are full-time.  For the purpose of computing the amount of the penalty tax, Employer X can disregard the 20 part-time employees.  And because of a special rule, the permitted exclusion of 5% is expanded to the greater of 5% or five employees.  If Employer X offers coverage to at least 40 of the 45 full-time employees, it satisfies the 95% offer test and no “A” penalty tax is due.  If Employer X offers coverage to less than 40 of the 45 full-time employees and at least one of the employees purchases subsidized exchange coverage, then it owes a $166.67/month penalty tax on all 45 full-time employees, reduced by 30, or $2,500.05/month ((45 -30) X $166.67/month).

Next assume that six regular, full-time employees of Employer X are laid off June 30, 2014.  This drops the count to 49 employees on July 1 for purposes of the determination of the applicable large employer status; but that status does not change until January 1, 2015 at the earliest.  The number of fulltime employees for purposes of determining the amount of the “A” penalty tax for July is 39 (45 – 6 = 39).  Also, assume that at least one of the full-time employees was enrolled in subsidized exchange coverage in each month.   Under the 95% offer requirement, if Employer X offers coverage to 34 or more out of the 39 full-time employees in July, it is not subject to the “A” penalty tax in that month.  However, if Employer X offers coverage to less than 34 of the remaining 39 full-time employees in July, it must pay the “A” penalty tax.  The amount is based on 39 full-time employees less 30 employees x $166.66/month or $1,500.03/month

Observation:  An employer should make sure its eligibility standard is determined and carefully operated so that some coverage (affordable or not) is offered to all employees who satisfy the full-time employee test (or at least 95% of them).  This avoids the catastrophic “A” penalty tax applied to the entire workforce and allows the employer to “manage” the consequences of the “B” penalty tax.  However, the new discrimination rule for health insurance plans (and the old discrimination rule for self-insured health plans) must also be examined to make sure the employer has not managed its way into a new penalty by violating the discrimination rule while managing its way out of the “A” penalty tax.  The penalty for violating the discrimination rule that applies to insured plans of employers is potentially much greater than the pay-or-play penalty tax.  Note:  enforcement of the insured plan discrimination rule is delayed until regulations are published and the regulations must be examined carefully, when issued.

Step 3.  The “B” penalty tax of $3,000/full-time employee/year ($250/month) may apply even if the employer offers coverage to 95% or more of the full-time employees. The “B” penalty tax applies with respect to employees who are not offered coverage, or for whom coverage is not affordable or for whom the coverage fails the minimum value standard.  Full-time employees are determined in the same manner as for the “A” test.  However, the penalty tax is only assessed with respect to those full-time employees who are not offered affordable, minimum value coverage and who actually enroll in subsidized exchange coverage.  If a few employees fall between the cracks or the employer designs the subsidy so that some of this group are not eligible for affordable coverage, then the employer is exposed to some penalty; but this is offset by the money saved by not paying a larger premium subsidy that would be necessary to make the coverage "affordable."  Typically in a population of full-time employees who are permitted to enroll in subsidized exchange coverage, a significant percentage will not enroll, allowing the employer to avoid or reduce both the cost of the premium subsidy and the penalty tax.  Employers such as fast food franchisees may limit the work hours so that the number of full-time employees without affordable coverage is minimized.  However, some leakage in design and operation may occur.

Employer X is exposed to a possible penalty tax for each of the full-time employees who are not offered affordable, minimum value coverage.  Assuming two of the full-time employees enroll for subsidized exchange coverage in each month of the year, the employer must pay a penalty of $250/month x 2  or $500/ month for 12 months – a total of $6,000 for the year.  This is considerably less than the “A” penalty tax if coverage is not offered to 95% of its employees and probably less than the employer premium subsidy cost necessary to make the coverage affordable.

Observation:  Employers who are in the 50-employee range should study these rules carefully well in advance of January 1, 2013 as the staffing decisions in 2014 will affect the applicable large employer status in 2013.  For any staffing increase needs, consider whether to increase the number of hours of part-time employees, thus increasing exposure to applicable large employer status but reducing exposure to the “B” penalty tax.  Consider limiting the number of full-time employees to 30. While additional part-time employees may cause the employer to cross the 50 full time employee threshold, the 30 employee offset will protect the employer from the "A" penalty tax. A special rule limiting the "B" penalty tax to no more than the "A" tax will avoid payment of either tax. Alternatively, additional work can be assigned to someone who is already working 120 hours/month (for purposes of applicable large employer determination) or 130 hours/month (for purposes of the “B” penalty tax determination).  Hours in excess of 120/130 per month do not increase health insurance cost or penalty tax in lieu of health insurance.

Will employer X owe the A or B penalty tax in 2015?  If employment has dropped below 50 full-time employees on average over the 12 months of 2014, the employer is not exposed to either the “A” or the “B” penalty tax for any month in 2015.  If the average  number of employees over the 12 months of 2014 continues to be 50 or more, then the employer remains exposed to the possibility of an “A” or “B” penalty tax in 2015.  If Employer X’s workforce remains unchanged for the balance of 2014, then its average employment will remain at 50 or more for 2014 and will be exposed to the pay-or-play penalty tax in 2015 in the scenario described above.

There are many unaddressed details.

  • changes in employment duties and schedules
  • unpaid leave
  • dependent coverage (must be offered but need not be affordable or offered to spouses)
  • affordability determination using W-2 safe-harbor

We would like to address these details but we must turn to other issues.  In our next article, I will take a closer look at penalties other than the pay-or-play penalty tax.  If you would like information on these topics in advance or if you have questions about how the ACA will affect your business, contact Tim Tornga at (616) 632-8090 or or one of the labor attorneys at MMBJ.

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