PPACA Tips and Best Practices: Penalties for Variable Employees

Posted February 13, 2013 by PHaynes in News | 0 comments

The Affordable Care Act (PPACA, aka Obamacare) has obligations and penalties that begin to take effect as early as January 1, 2014.  While the individual mandate and the employer mandate requirements will mean different fines/fees/taxes to different people, one thing is certain, and that is that we’ll all be affected.

Let’s consider some of your “contingent workers” – those independent contractors, leased employees and part-time employees that traditionally do not participate in your health and welfare benefit plans.  Some employers have even considered expanding their use of employees in these areas as a way or means of reducing their health care exposure.  This approach bears much scrutiny—there are risks, including potential monetary penalties that may dissuade many employers.

Under the Affordable Care Act (PPACA), individuals will be required to have healthcare coverage as of January 1, 2014 (the “individual mandate”). Individuals without employer-sponsored coverage will be able to satisfy the individual mandate by purchasing coverage through new health insurance exchanges (both a state exchange and a federal exchange purchased policy will satisfy this requirement). Individuals with incomes between 100 percent and 400 percent of the Federal Poverty Level (FPL) will be entitled to a “premium assistance” subsidy if they purchase coverage on an exchange.  Expectations are high in this regard and there are potentially millions of new customers.

Employers are not directly obligated to provide coverage to their employees. But if a “large” employer (one with 50 or more Full-Time Equivalent Employees (FTEs)) does not offer healthcare coverage to at least 95 percent of its Full-Time Employees, the employer faces a penalty under Internal Revenue Code Section 4980H(a). An employer that doesn’t cover at least 95 percent of employees would be hit with a penalty if any of its full-time employees without employer-provided coverage purchases coverage from an exchange and receives premium assistance.

The annual penalty under Section 4980H(a) can be severe: $2,000, multiplied by every full-time employee, minus the first 30 full-time employees. Note that all full-time employees count toward calculating the penalty, even the employees with employer-provided coverage.

Tip Number 1:  Part-Time Employees

The 4980H(a) penalty applies only with respect to full-time employees. An employer seeking to reduce its exposure could limit the hours of certain workers or create more part-time positions. A part-time employee generally means an employee averaging fewer than 30 hours per week (130 hours per month).

Although the failure to provide coverage to part-time employees will not subject an employer to PPACA penalties, part-time employees still count toward determining whether the employer meets the 50-employee threshold for a “large” employer.

Where can a Part-Time Strategy Go Wrong?

The Internal Revenue Service has issued detailed rules (Notices 2012-59 and 2012-17) for determining who is a part-time employee.  (See our prior article on this topic and our handy 2-page infographic).  An employer seeking to implement a part-time strategy will have to carefully consider these rules and closely monitor employees’ hours. A successful part-time strategy may require the employer to impose rigid restrictions on work schedules—which may, in turn, limit the employer’s ability to respond to changing business conditions and customer demands.

If an employer isn’t careful about monitoring employees’ hours, it might become subject to the Section 4980H(a) penalty. To use an extreme example, let’s say that an employer believes that it has:

  • 200 full-time employees, all with employer-provided coverage, and
  • 40 part-time employees, none with employer-provided coverage.

Because its entire full-time workforce appears to have employer-provided coverage, the employer believes that it has satisfied the 95 percent requirement and thus is not subject to the 4980H(a) penalty. But assume that twelve of the supposed part-time employees have amassed enough hours to be deemed full-time employees. The employer could then be subject to the penalty, because it actually has 212 full-time employees, and only 200 of them—94.3% have employer-provided coverage.

The annual penalty under Section 4980H(a) would be $364,000 (212 full-time employees, minus the first 30, multiplied by $2,000).

Tip Number 2: Independent Contractors

Under the Affordable Care Act, an “employee” means a common-law employee. Employers may be tempted to substitute independent contractors for common-law employees for a couple of reasons:

  • To stay under the 50-employee threshold.
  • To avoid offering healthcare coverage to a portion of its full-time workforce.

Some employers might view a successful independent contractor strategy as a double win: the business avoids both the cost of healthcare coverage for the independent contractors and the penalty that would apply for failing to offer coverage to full-time employees.

Where can an Independent Contractor Strategy Could Go Wrong?

Adopting a policy of using independent contractors in this way is a flawed strategy that has an immediate impediment, namely “worker misclassifications”. Determining whether a worker should be treated as an independent contractor, rather than an employee, can be complicated, if not impossible.

There hasn’t been a more public decision in this regard than 1999’s decision in the Vizcaino vs. Microsoft Corporation case.  Microsoft Corp discovered that classification without significant differences in treatment can result in severe penalties.  The IRS reclassified 483,000 workers, allowing the workers to sue for benefits.  A $751 million fine was also assessed.  Therefore, employers need to avoid making contingent workers into common law employees when attempting to avoid legal responsibilities of employers.

Many businesses moved to head-off similar claims by altering their benefit plans to make it clearer that misclassified workers were not entitled to benefits (they call this the “Microsoft fix”).  However, even with this fix, the employer could face PPACA penalties if the workers they exclude from health coverage are later deemed common-law employees.  (See the example above where the punitive penalty of $2,000 times all full-time employees (minus the first 30) is applied).    [Practical tip:  To read about Vice President Biden’s Middle Class Task Force and the Department of Labor’s Misclassification Initiative see details here].

Tip Number 3: Leased Employees

A leased or temporary employee is someone employed by a third-party, like a temp-agency, but they actually perform services/work on your behalf as a client of their employer.  Under the Affordable Care Act, if a leased employee/temp is actually a common-law employee of the leasing company/temp agency, and not a common-law employee of the client, then the temporary employee does not count toward determining whether the client is a “large” employer—and would not be considered a full-time employee of the client for purposes of the PPACA penalty.  [Practical tip:  The temp would still need to comply with PPACA’s individual mandate and the temp agency/leasing company may need to comply with PPACA’s employer mandate if they employ 50 or more employees].

Where can a “Use Temps” Strategy Could Go Wrong?

While the use of a third party (the temp agency/leasing company) is a great insulator and places the onus to comply on the individual and the temp agency (and not with the client-Employer), employee misclassification here should not be overlooked.  The goal is to ensure that you are not later deemed to be a joint-employer with the temp agency and that you could not be subject to PPACA’s penalties for denying them coverage.

Employers that use a “temp” label but do not engage/contract with a third party to provide these employees will find their efforts scrutinized by their state wage and hour/labor enforcement divisions as well as the US Department of Labor.

Tip Number 4: Separate Entities

A business/employer/plan sponsor can exclude up to 5% or its full-time employees from healthcare coverage without being subject to the 4980H(a) penalty. However, they’d probably run into IRC Section 125 problems and possibly IRC Section 105(h) discrimination problems for the disparate treatment, eligibility rules and payroll contributions.  But, could an employer create a separate entity to be the “employer” for the uncovered group?

For PPACA purposes only, the separate entity strategy could reduce, but not eliminate, the penalty. For example, assume that a business has 100 full-time employees. Seventy are employed by a subsidiary that has employer-provided coverage; the other 30 are employed by a subsidiary that does not have coverage. Both subsidiaries are at least 80 percent owned by a common parent (the control group analysis/test).  So, due to the common ownership/control, both subsidiaries are treated as a large employer. Since the first subsidiary has employer-provided coverage for its employees, it is not subject to the 4980H(a) penalty. The second subsidiary, however, is subject to a penalty of $42,000. The 30-employee exemption from the penalty is pro-rated between the two subsidiaries. Since the second subsidiary has 30% of the employees of the business, it has 9 exemptions. Thus, the penalty is $2,000 multiplied by 21 employees (30 minus 9).   By contrast, if all 100 employees were employed by the same entity, the penalty for failing to cover at least 95 percent of them would be $140,000.

Where can a “Create Separate Entities” Strategy Could Go Wrong?

There’s no clear path to fine avoidance here.  It isn’t clear, not in the least, that there’s any significant freedom to allocate employees to separate entities.  The IRS could require some significantly different business purpose to be in place (not merely for fine avoidance) or they may just treat all the entities as one common-joint-employer.

Finally, this doesn’t account for the discrimination requirement that would exist with a single control group for offering benefits under different eligibility and/or pricing terms (the Section 105(h) and 125 discrimination rules, a violation of each makes benefits taxable to owners, officers, the highly-compensated and in the case of Section 105(h) violations, to anyone in the top 25% of payroll too).

Carefully consider your worker classification programs and efforts with your in-house counsel, labor attorneys and your management team.  Also, consider testing your variable hour employee population to determine how many might meet the 30 hour/week (130 hours/month) threshold and thus expand your “healthcare eligible” population.

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