Warning: Affordable Care Act Penalties Start This Year

The Affordable Care Act (ACA) remains a lightning rod for political and legal challenges. This year will be no exception, as new requirements are coming on line.

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Companies that want to wait and see how this will all shake out do so at their own risk. Here’s one reason why: Beginning this year, Internal Revenue Code (IRC) Section 4980H is requiring that certain “large employers” offer health coverage to their full-time employees or risk being subject to tax penalties. Two potential ones, affectionately termed (by lawyers) the “play or pay” penalties, can be assessed if no coverage is offered; or if coverage is offered that is either unaffordable or does not provide minimum value.

For 2015, employers must determine two critical factors: (a) whether they are a large employer; and (b) if coverage is required, how they can ensure that it is both affordable and provides minimum value. Here are six related questions -- and their answers.

1. Am I a large employer?

In general, “large employers” are those with 50 or more employees. The IRS has -- for 2015 only -- exempted employers with fewer than 100 employees from being subject to the penalties, but not the reporting requirements.

Determining “large employer” status requires looking back to the preceding calendar year to see if the organization employed an average of at least 50 full-time employees on business days during that year. A full-time employee is defined as any employee who provides 30 hours of service per week or 130 hours per month.

However, even employers with fewer than 50 full-time employees can meet the definition of a “large employer.” Section 4980H also requires that the hours of service performed by part-time employees be counted toward determining “full-time equivalents” (FTEs). Determining the number of FTEs is a simple fraction, calculated by counting the hours worked by part-time employees and dividing by 120.

2. What if I just started my business?

This circumstance is a bit tricky. The code and regulations merely provide that organizations that did not exist on any business day during a prior year may self-determine their status as applicable large employers upon opening for business. This must be based on the number of full-time employees and FTEs the employer reasonably expects to have during the current year.

Whether a new employer’s determination of its status is reasonable is open to interpretation, but the preamble to the final regulations states that a new employer’s determination may still be considered reasonable “even if subsequent events cause the actual number of full-time employees (including FTEs) to exceed that reasonable expectation.”

Related: Still Sorting Through Your Company's Healthcare Options? We Can Help

3. What if I’m involved with more than one business?

Many existing business enterprises involve multiple business entities or operations. The ACA mandates are designed via these aggregation rules to define a large employer in a manner not easily circumvented by superficial ownership and entity variations.

On the other hand, because some business enterprises could legitimately consist of separate business units that avoid the aggregation rules, business owners at formation or even post-formation should consider whether the aggregation rules render their enterprises a collective large employer and if there are business planning opportunities to legitimately allow separate business units with varying ownership patterns outside of the aggregation rules to have differing ACA obligations.

4. If I provide coverage: Is it affordable? Or, does it provide minimum value?

The Affordable Coverage Standard: The regulations provide three safe harbors for determining whether coverage is affordable. The first is the W-2 safe harbor that allows employers to rely on the total wages paid during the year to each employee, in comparison with that employee’s required contributions. This is permitted so long as an employee’s required contributions do not exceed 9.5 percent of the W-2 wages.

The second method is the rate-of-pay safe harbor that allows employers to deem coverage affordable so long as the employee’s required contributions in any month do not exceed 9.5 percent of an assumed monthly payment, determined by multiplying the lowest hourly rate of pay by 130 hours.

The third method is the federal poverty-line safe harbor that deems coverage affordable if an employee’s required contributions in any month do not exceed 9.5 percent of 1/12 of the applicable federal poverty line for that year.

The Minimum Value Standard: In general, a plan fails to provide minimum value if its share of the total allowed costs of benefits provided under the plan is less than 60 percent of those costs. The U.S. Department of Health and Human Services regulations provide multiple options for determining minimum value, including the MV Calculator tool. However, while this is still a useful tool, the IRS issued a notice last November warning employers that use of the MV Calculator is not sufficient for establishing that a plan provides minimum value if the plan excludes substantial coverage for in-patient hospitalization services or physician services.

5. If I want to pay rather than play, what’s my exposure?

Section 4980H(a) provides for a nondeductible penalty of $2,000 per full-time employee employed by the organization during the year if an employer does not offer substantially all (i.e., 95 percent) of its full-time employees (and their dependents) the opportunity to enroll in minimum essential coverage. If the penalty applies, every full-time employee is factored into the calculation regardless of whether he/she was offered coverage.

The $2,000 penalty amount is prorated by the number of months each individual was employed. For example, assume that a company does not provide coverage, has 50 employees who worked the entire year and 100 employees who worked only 3 months. The penalty in this circumstances would be $150,000.

For 2015 only, employers with 100 or more employees can avoid this penalty as long as they offer coverage to 70 percent or more of their employees. Also for 2015 only, the number of full-time employees counted for purposes of assessing the penalty will be reduced by 30, potentially lessening any penalty by as much as $60,000. Finally, no penalty will be assessed for a failure to provide coverage during the first three months of 2015.

6. What if the minimum essential coverage is either unaffordable or does not provide minimum value?

Section 4980H(b) provides for a lesser penalty in this scenario. The penalty is $3,000 per employee certified to the employer as qualifying and receiving an exchange subsidy. Like Section 4980H(a), this penalty is also nondeductible. Unlike Section 4980(a), this penalty is assessed only on an employee-by-employee basis.

For 2015 only, employers with more than 50 but fewer than 100 employees will not be subject to either penalty under section 4980H, but will be subject to these penalties beginning in 2016.

Business enterprises should evaluate ACA compliance requirements presently in place, and engage in business-planning analysis to explore how these requirements will affect IRS coverage mandate obligations. More important, business enterprises will benefit from understanding how large employers are defined and whether existing business structures present mitigation opportunities.

While ACA modification or replacement is certainly possible, it is unlikely that these basic mandate principles will entirely disappear. The wise course is to plan now for mandate-compliance management. The ACA is currently the law, and some form of it is likely to remain, in order to address the economic burdens imposed in a country with an inordinate number of citizens who lack healthcare coverage.

Related: What the Self-Employed Need to Know About Obamacare