The affordable care act's employer mandate: Part 3

Offers of Coverage and Avoiding Penalties

This article is Part 3 in a series intended to provide an overview of the Employer Shared Responsibility provisions (also known as the “employer mandate”) under the Affordable Care Act (ACA). The employer mandate generally requires applicable large employers (ALEs) offer affordable, minimum value medical coverage to its full-time employees in order to avoid potential employer mandate penalties. These employer mandate penalties are better known as “employer shared responsibility payments” or ESRPs.

We covered how to determine whether an employer is and ALE in Part 1, and how to determine ACA full-time employees (FTEs) in Part 2. This article addresses the ESRPs and how to avoid them through offers of coverage to FTEs.

Remember Why We Care

The employer mandate has two potential penalties, each indexed annually and assessed monthly on a pro-rated basis.

The Section 4980H(a) penalty (the “no offer” penalty) is triggered when an ALE fails to offer minimum essential coverage to at least 95% of its FTEs, and at least one FTE qualifies for a subsidy in the public health insurance exchange.

The Section 4980H(b) penalty (the “inadequate offer” penalty) is triggered when an ALE offers minimum essential coverage to at least 95% of its FTEs but fails to offer affordable, minimum value coverage to an FTE who qualifies for a subsidy in the public health insurance exchange.

Aggregated ALE Groups

ALE status is also determined in the aggregate for certain groups of related legal entities identified under the Internal Revenue Code, and each member employer of an aggregated ALE group is known as an “applicable large employer member” or ALEM. An ESRP triggered by one ALEM does not affect the other ALEMs within the aggregated ALE group. In other words, if one ALEM triggers a penalty it does not “poison the well” for the others.

Avoiding the No Offer Penalty

Coverage is shorthand for “minimum essential coverage” or MEC.  In general, MEC is any employer-sponsored medical plan, including the new individual coverage HRA (ICHRA).[1]

In order to avoid ESRPs, an offer of MEC must be made to FTEs at least annually. Active or passive enrollment can be used provided the FTEs have an effective opportunity to elect or decline coverage.[2] An ALE does not have to provide FTEs with the ability to decline coverage if the coverage provides minimum value and employee-only coverage is either 100% employer paid or the employee’s required contribution toward employee-only coverage meets the federal poverty level affordability safe harbor (addressed under Federal Poverty Level Safe Harbor later in this article).

The Offer Must be Made for the Entire Month to Most FTEs
An ALE only receives credit for offering coverage to an FTE for a given month if the offer of coverage includes every day of the month. For example, if coverage begins on the date of hire, FTEs who are hired on any day after the 1st of the month do not count as having received an offer for that month. This is relevant when determining if the ALE offered coverage to at least 95% of its FTEs for that particular month. 

Note: If an FTE is hired after the first of the month and is offered coverage effective as of the date of hire or is in a permitted waiting period before coverage is effective, the ALE may exclude the FTE from the 95% calculation for the applicable month or months. On the FTE’s corresponding IRS Form 1095-C for that year, the ALE would reflect Code 2D (limited non-assessment period) in Part II, Line #16. This would avoid a potential ESRP.

Similarly, an ALE may exclude an FTE who loses coverage mid-month from the 95% calculation. The Form 1094-C/1095-C instructions indicate an ALE should reflect Code 2B (not full-time) in Part II, Line #16 in this situation. This would also avoid a potential ESRP. 

Believe it or not, an ALE does not receive credit for making an offer of coverage to an FTE unless the FTE can also enroll his or her natural and adopted children up to age 26, if any. In other words, an ALE that limits its offers of coverage to employee-only coverage cannot meet the 95% offer standard. This special rule does not include spouses, stepchildren, or foster children.

Reminder: Within an aggregated ALE group, the 95% standard and any applicable ESRP penalties are determined on an ALEM-by-ALEM basis.

The Offer May be Made by Another Employer

1. Aggregated ALE Groups. If one ALEM makes an offer of coverage to an employee, that offer of coverage is considered to be made by every ALEM in the aggregated ALE group. If an individual is employed by two or more ALEMs, only one ALEM needs to offer coverage for all of the ALEMs to receive credit.
2. Professional Employer Organizations and Staffing Firms. Employers often use professional employer organizations (PEOs) and staffing agencies to outsource staffing, human resources, and payroll duties. The IRS allows the client-employer to take credit for an offer of coverage made to the worker by the PEO/staffing agency so long as the client-employer pays a higher fee in exchange for the PEO/staffing firm assuming the responsibility to provide health insurance. We recommend this be reflected as a line-item in the amount billed by the PEO/staffing agency and paid by the client-employer.
3. MEWAs. Multiple employer welfare arrangements (MEWAs) are formed when two or more unrelated employers join together to sponsor a health plan. Similar to the ALEMs above, an offer of coverage made to an employee by a MEWA will count as an offer of coverage made by the employer participating in the MEWA.

Calculating the No Offer Penalty

An ALE that fails to make an offer of coverage to 95% of its FTEs is vulnerable to the no offer penalty, which is triggered if a single FTE qualifies for subsidized coverage in the public health insurance exchange.

This no offer penalty amount is calculated by multiplying the applicable penalty amount by all of the ALE’s FTEs, but the ALE gets to subtract 30 FTEs from this total (“free FTEs”). This 30 free FTEs exclusion applies at the aggregated ALE group level, and each ALEM is assigned a share based on its proportion of all FTEs in the aggregated ALE group.

Example 1: This example uses the projected 2020 no offer penalty. Pro-rated monthly, the penalty is $215/month ($2,580 / 12).  

WiseCorp has 65 total employees, 50 of whom are FTEs for the year. WiseCorp fails to offer MEC to at least 95% of its FTEs (48 FTEs). Bob, an FTE, enrolls in coverage in the public health insurance exchange and receives a subsidy for 8 months during 2020.

WiseCorp’s no offer penalty is calculated as follows:

$215 x (50 FTEs – 30 “free FTEs”) = $4,300/month

$4,300 x 8 months = $34,400

Example 2: The same facts as in Example 1, except that WiseCorp is an ALEM in an aggregated ALE group with 300 total FTEs. 

WiseCorp may exclude 5 free FTEs from its no offer penalty calculation.

50 WiseCorp FTEs / 300 total FTEs = 16.67%

30 free FTEs x 16.67% = 5 free FTEs

WiseCorp’s no offer penalty is calculated as follows:

$215 x (50 FTEs – 5 “free FTEs”) = $9,675/month

$9,675 x 8 months = $77,400

Avoiding the Inadequate Offer Penalty

Just because an ALE makes an offer of coverage does not mean it has avoided all potential ESRPs. Even if an ALE offers MEC to at least 95% of its FTEs, an FTE can still trigger an inadequate offer penalty if the IRS finds that the offer of coverage does not provide minimum value AND/OR is unaffordable.

Minimum Value
Coverage is considered to provide minimum value (MV) if the plan covers at least 60% of the total allowed cost of covered services that are expected to be incurred by a standard population. The plan must also include coverage for hospital and physician services.[3] MV can be determined by an actuarial valuation or by using an MV calculator jointly developed by the IRS and Department of Health and Human Services.

Affordability
A plan is deemed affordable if the employee’s portion of the premium does not exceed an annually indexed amount of their household income.

Remember, the penalties are actually pro-rated monthly

Note: If wellness incentives can affect the employee’s contribution toward the cost of coverage, employees must be treated as satisfying any tobacco-related incentive and failing all other incentives no matter what the employee actually does.

Since it’s generally impossible for an employer to know an employee’s household income, the IRS created three affordability safe harbors. Each safe harbor is based on the employee’s required contribution toward the cost of employee-only coverage for the lowest cost, MV plan the employee could have elected for that plan year.  It doesn’t matter if the employee waived coverage, elected a more expensive plan option, or enrolled a spouse or dependent(s).

1. Form W-2 Safe Harbor. Under the Form W-2 safe harbor, coverage is deemed affordable if the employee’s share does not exceed 9.86% (9.78% in 2020) of wages reported in Box 1 of the employee’s W-2. Box 1 does not include pre-tax payroll deductions, such as 401(k) contributions and many other benefit elections. Employers can reasonably estimate employee W-2 earnings when pricing coverage, but affordability may not be certain until the end of the year. This safe harbor method cannot be combined with another safe harbor method during the same calendar reporting year. This might affect some employers with non-calendar year plans whose premiums change during the calendar year.
   
   
2. Rate of Pay Safe Harbor. The rate of pay safe harbor is a formula that operates differently for salaried and hourly employees:
   • For salaried employees, coverage is deemed affordable if it does not exceed 9.86% (9.78% in 2020) of the employee’s gross monthly salary as of the first day of the plan year.[4]
   • For hourly employees, coverage is deemed affordable if it does not exceed 9.86% (9.78% in 2020) of 130 paid hours multiplied by the lower of the employee’s rate of pay as of the first day of the plan year or the employee’s rate of pay at the beginning of a given month.
     
     
3. Federal Poverty Level Safe Harbor. Under the Federal Poverty Level (FPL) safe harbor, coverage will be deemed affordable if the employee’s share of the premium does not exceed 9.86% (9.78% in 2020) of the mainland FPL for a single individual. For 2019, the FPL safe harbor is $102.62 (($12,490 / 12) x 9.86%). This safe harbor ignores an employee’s actual compensation.This safe harbor does not exclude pre-tax benefit deductions, but it misses bonuses, commissions, and tips.

Calculating the Inadequate Offer Penalty

The inadequate offer penalty is triggered if the coverage offered doesn’t provide minimum value and/or was unaffordable, and an FTE qualifies for a subsidy in the public health insurance marketplace. The employer would be assessed an inadequate offer penalty for each FTE who receives a subsidy. For 2020, the maximum [projected] annual inadequate offer penalty is $3,870 per FTE. This penalty is pro-rated monthly.

Intentional Strategy

The inadequate offer penalty only applies to FTEs who waive coverage and actually receive a subsidy in the public health insurance exchange. For 2020, this penalty is approximately $322.50 per FTE per month, which may be less than the employer’s cost to offer affordable, minimum value coverage (and absorb additional claims experience). As a result, some employers might make a business decision to willingly accept potential inadequate offer penalties.

[1] MEC does not include HIPAA-excepted benefits, such as dental and/or vision only coverage, spending accounts (FSAs, HRAs) limited to dental and/or vision only coverage, and many types of fixed indemnity and supplemental coverage.

[2] Whatever election approach is used, we recommend employers maintain some sort of record in order to be able to demonstrate that the offer was made.

[3] This prevents many benefits from meeting the MV standard including “skinny” MEC plans, telemedicine, and onsite/offsite clinics.

[4] The rate of pay safe harbor cannot be used for an employee whose salary decreased during the year.