Health care reform and the employer penalty – how will it affect your business? – Part 1

January 10, 2013|Terri Lillesand

As part of health care reform, effective January 1, 2014, large employers will be subject to a monthly penalty for not offering health insurance to their full-time employees and dependents or for failing to offer health insurance that is affordable or provides minimum value. The penalty for failure to offer health insurance is $2,000 a year per full-time employee, while the penalty for offering unaffordable or inadequate coverage is $3,000 a year per full-time employee. Both penalties, known as the “shared responsibility payment” are assessed on a monthly basis and will include both governmental and non-profit employers.

Only “large” employers will be subject to the penalties. How do you determine if your business is affected?

Are you “large”?

A large business is one who has employed an average of at least 50 full-time workers in the preceding calendar year, taking into account full-time equivalent (FTE) employees and full-time workers which are defined to be those who work on average at least 30 hours a week or 130 hours in the calendar month. Because this is a FTE computation, decreasing your number of employees does not necessarily reduce the FTE number when determining large employer status. Eliminating a full-time employee by replacing him with two part-timers who work 15 hours a week each still counts as one FTE; however, increasing service hours of full-time employees could lessen the number of FTEs. For example, eliminating one 30-hour a week employee and dividing those hours among three employees who each work a 30-hour week trims down the number of FTEs by one. While it may be somewhat difficult to stay out of the large employer category, strategies to reduce or eliminate the penalties for large employers will be discussed in a future article.

The monthly penalty is effective starting January 1, 2014, regardless of your tax year. Your employee count in the preceding calendar year is what determines if you are considered a large employer for the current year. So, for calendar year 2014, calendar year 2013 is used. Transitional relief is allowed for the 2014 calendar year only. For determining large employer status for 2014 only, you can choose to look at any 6 consecutive calendar months in 2013 rather than the entire 2013 calendar year. This may provide you some extra time to plan for the implementation of these new rules.

If you do not meet the definition of a large employer, you are free to make any choices regarding health insurance coverage without being subject to the penalty. If you meet the definition of a large employer, you may be subject to the penalty but not necessarily.

Addressing the finer points of the law

Many employers will be clearly under the 50 FTE threshold, and other employers will be definitively over the 50 FTE threshold. When it is not obvious or if there are special situations like seasonal employers, you will need to go through the computations as explained in the recently released proposed regulations and Revenue Procedure 2011-36:

Calculating your number of full-time employees

  1. Calculate the number of full-time employees for each calendar month in the preceding calendar year, which are those who on average work at least 30 hours per week or 130 hours per month.
  2. Calculate the number of FTE for all part-time employees for each calendar month in the preceding calendar year. In this step, calculate the aggregate number of service hours (but not more than 120 hours for any one employee) for all employees who were not considered full-time in step 1. Total the number of hours for the month for all part-time employees and divide by 120 hours. (NOTE: While the definition of full-time employees is based on 130 hours per month, the regulations and Revenue Procedure state that part-time employees are considered at 120 hours per month.)
  3. Add the number of full-time employees and the FTE of all part-time employees determined in steps 1 and 2 for each of the 12 months in the preceding calendar year.
  4. Add up the 12 monthly numbers determined in step 3 and divide the sum by 12. This is the average number of your FTEs in the preceding calendar year.
  5. If the number of FTE employees in step 4 is less than 50, you are not an applicable large employer for the current year.
  6. If the number of FTE employees in step 4 is 50 or more, determine whether the seasonal employee exception explained below applies. If the seasonal employee exception applies, you are not considered to be large for the current calendar year. If the seasonal employee exception does not apply, the employer is large for the current calendar year.

Determining hours of service

The hours of service performed by all employees during the preceding calendar year are used for the computation, which is done on a monthly basis. Hours of service include each hour for which an employee is paid, or entitled to be paid for both performance of duties for the employer or for vacation, holiday, illness, disability, layoff, jury duty, military duty or leave of absence.

For hourly paid employees, the actual number of hours of service for the employee is used. For non-hourly employees, you may use three different methods to determine hours of service:

  1. Actual hours of service. You may want to start tracking this.
  2. A days-worked equivalency whereby the employee is credited with eight hours of service for each day for which the employee would be credited for at least one hour of service using actual hours.
  3. A weeks-worked equivalency whereby the employee is credited with 40 hours of service for each week for which the employee would be credited for at least one hour of actual service.

You are not required to use the same method for all non-hourly employees but may apply different methods for different classifications of non-hourly employees, provided the classifications are reasonable and consistently applied. You may change the method used for each calendar year. Each member of a control group (see below) has some flexibility in choosing the method that they wish to use.

The number of service hours calculated using the days-worked and the weeks-worked equivalency must generally reflect the actual hours of service. An employer is not permitted to use the days-worked equivalency or the weeks-worked equivalency if the results substantially understate an employee’s hours of service to cause the employee to not be treated full-time. For example, an employer may not use a days-worked equivalency in the case of an employee who generally works three 10-hour days because the equivalency would substantially understate the employee’s hours of service as 24 hours of service per week, resulting in the employee being treated as not full-time.

The proposed regulations are very specific regarding rounding numbers. When determining the number of FTEs per month, fractions are taken into account, so there is no rounding up or down. When the average for the year is determined, fractions are ignored and the number is rounded down. For example, in a calendar month in which part-time employees work 1,260 hours, this equates to 10.5 FTE (1,260/120). However, after adding up the 12 monthly totals and dividing by 12, all fractions are disregarded. For example, 49.9 FTE employees for the preceding calendar year would be rounded down to 49 FTE employees.

Special situations addressed in the regulations

  • Seasonal employees, as defined by the Secretary of Labor, perform labor or services on a seasonal basis in agriculture and holiday retail. The IRS also will allow any other employment position that is similar, to be considered seasonal. If your workforce exceeds 50 FTE for 120 days or less during the calendar year and of those in excess of 50 employees, who during that period of no more than 120 days were seasonal employees, the employer would not be an applicable large employer. For this purpose, four calendar months would be treated as the equivalent of 120 days, whether or not they are consecutive. For purposes of determining a large employer, a seasonal employee can work more than 120 days and still be a seasonal employee.
  • If you are a new business that was not in existence for the entire preceding calendar year, you will be considered a large employer for the current calendar year if it is reasonable to expect your business to employ an average of at least 50 full-time workers in the current calendar year and it actually happens. That is all the guidance the proposed regulations provide, which may be clarified in the future.
  • Common ownership is also addressed in the proposed regulations. The regulations provide that all entities treated as a single employer under Internal Revenue Code section 414(b), (c), (m) or (o) are treated as a single employer. Thus all employees of a parent – subsidiary or brother-sister controlled group are to be taken into account in determining if the group is a large employer. If the controlled group is deemed to be a large employer, each member of the group is a large employer.
  • Excluded employees for any purpose of the employer penalty include the sole proprietor, a partner in a partnership and a 2 percent or more S-corporation shareholder. These individuals are not included when determining if an employer is considered large when computing the penalty.

Because the determination of large employer for 2014 is based on 2013, if it is borderline whether or not you will be a large employer, you will want to determine your FTE on a monthly basis starting in January 2013. Because of the transitional rules for 2014 only and because of the seasonal exception, you may be able to react accordingly and prevent yourself from being a large employer.

This article was updated and revised on February 27, 2013.

Terri Lillesand, CPA, tax shareholder, is a member of Schenck’s Health Care Reform Act Advisory team. She provides tax compliance and planning for corporate, individual, partnership, non-profit and fiduciary taxpayers.