Overview of IRS Guidelines on Defining FTEs
October 2012 Issue 4
On August 31, 2012 the Internal Revenue Service ("IRS") issued guidance on how to determine if an employee is a "full-time" employee for purposes of complying with the employer shared responsibility (aka "pay or play") rules that take effect in 2014.
In this overview, we'll re-visit the shared responsibility rules, review the safe harbor methods offered by the IRS, and discuss how this impacts the operation of an employer sponsored group health plan.
Pay or Play
You will recall that effective January 1, 2014, employers with more than 50 full-time equivalent employees may be subject to penalties if they fail to either offer minimum essential health coverage or if they offer "unaffordable" coverage. These requirements, which are under the Affordable Care Act's employer responsibility section, beg the question of whether an employer would drop its health plan and pay the penalty/ tax (but still save money) or maintain the health plan. Hence, the term, "pay or play." The following summarizes the key provisions of the employer shared responsibility provisions:
• An employer with at least 50 full-time equivalent employees must offer all of its actual full-time employees ("FTEs") minimum essential health coverage. Otherwise, if at least one FTE receives a federal subsidy to buy coverage through the health insurance exchange, then the employer must pay an excise tax calculated as follows: # of actual FTEs (minus 30) x 1/12 of $2,000 for each month that such coverage is not offered.
– A FTE is defined as an employee who works on average at least 30 hours/week, or 130 hours/month.
– To determine whether the employer is subject to the penalty scheme, part-time employees are ggregated as "equivalent" FTEs (i.e., two part-time employees at 15 hours per week equal one full-time equivalent employee).
• An employer with at least 50 full-time equivalent employees that offers minmium essential coverage deemed "unaffordable," causing at least one FTE to receive a federal subsidy to buy coverage through the health insurance exchange must pay an excise tax calculated as follows: # FTEs who receive a premium subsidy x 1/12 of $3,000 for each month that such coverage is "unaffordable."
• Coverage is "unaffordable" if:
– The employee's required premium/contribution exceeds 9.5% of the employee's W-2 income; or
– The employer's share of covered expenses is less than 60%.
• Premium subsidies or credits are available to any employee whose household income is at least 100% of the Federal Poverty Level (FPL) but less than 400% of FPL.
– The Affordable Care Act authorizes these subsidies in connection with statebased health insurance exchanges.
Safe Harbor Methods
The "pay or play" rules apply on a month-to-month basis. With this guidance, the IRS offers safe harbor methods designed to mirror what they believe to be common employer eligibility and enrollment practices to reduce the burden on employers by eliminating the need for monthly eligibility determinations or frequent changes in eligibility for health benefits. If the safe harbors appear complicated, the IRS says that simply reflects the flexibility they were trying to provide employers, as opposed to mandating a particular way of complying with the shared responsibility requirements.
The IRS requested comments on their proposed guidance by September 30. Many employer advocacy groups, such as the American Benefits Council, submitted ideas to make the safe harbors more workable.
The first notable provision of the new guidance to assess FTE status is that there are different rules for on-going employees than for new employees. The details are:
1. To determine if an on-going employee is a FTE, the employer may use a "standard measurement period" and "stability period" safe harbor.
• The employer may use a standard measurement period consisting of the employee's prior work hours for a period of not less than 3 months and not more than 12 months (chosen at the option of the employer). If the on-going employee meets the FTE definition during the standard measurement period then he/she must be treated as a FTE during the subsequent stability period regardless of the hours worked in the stability period.
• Although the stability period must be at least 6 months, for practical purposes, employers will likely set their standard measurement and stability periods at equal lengths.
The following is an example of how the measurement and stability periods work together for on-going employees:
The Employer determines that its standard measurement period will be 3 months determined on a quarterly basis (January 1, April 1, July 1, October 1) during the calendar year. Employee John does not meet the definition of a FTE during the January 1 – March 30 standard measurement period because he worked less than an average of 30 hours per week. The Employer may treat John as a non-FTE during the stability period of April 1 through June 30, because the stability period may not exceed the duration of the standard measurement period for non-FTEs. Employee Bob meets the definition of a FTE during the same January 1 – March 30 standard measurement period. However, since Bob is determined to be a FTE, his stability period must be at least 6 months. To avoid tracking differing stability periods between employees such as John and Bob, the Employer will likely wish to set its standard measurement period to be at least 6 months or longer.
2. If a new employee is reasonably expected, as of his/her date of hire to work fulltime, and the employee is offered health benefits during his/her first 3 months of employment, the penalty/tax will not apply.
• For plan years beginning after December 31, 2013, both grandfathered and non-grandfathered plans cannot impose eligibility waiting periods greater than 90 days.
3. If on the date of hire the employer cannot determine whether a new employee is reasonably expected to work on average at least 30 hours/week, the employee is considered a "variable hour employee."
• New employees are employees who have not been employed for at least one full standard measurement period.
• New employees can be subject to a different measurement period called an "initial measurement period."
• The initial measurement period must also be at least 3 months but not more than 12 months (determined by the employer).
• If the variable hour employee does not meet the FTE definition during the initial measurement period, then he/she is deemed not to be FTE during the following stability period that must not be more than one month longer than the initial measurement period.
– During the stability period, the employer will not be subject to the pay or play penalty.
The following is an example of how the measurement and stability periods work together for new employees in conjunction with the 90-day eligibility waiting period:
Employer hires Nancy effective on March 1. The Employer has reasonably determined that Nancy will be a FTE as of the date of her hire. The Employer's group health plan includes an eligibility waiting period of the maximum permissible time of 90 days. Nancy is offered eligibility to enroll in the group health plan effective on June 1. Since Nancy was a new hire, and offered health benefits during her first three months of employment, the penalty/tax will not apply to her lack of coverage during the initial 3 months.
4. The IRS recognized employers need time between the initial or standard measurement period and the subsequent stability period to identify, notify, and enroll FTEs. Therefore, an "administrative period" of up to 90 days may be used.
• The administrative period begins at the end of the initial or standard measurement period and ends before the associated stability period begins.
• Ongoing employees who are eligible for coverage based on a prior measurement period must be offered coverage during the administrative period.
Here are two examples of how the administrative period integrates with the measurement and stability periods; one for an on-going employee and one for a new variable hour employee:
For purposes of this example, the Employer has set the standard measurement period as October 15 through October 14 of the following year. The Employer's chosen administrative period is October 15 through December 31 which is less than 90 days. The Employer's stability period is January 1 through December 31 of each year.
1. It is October 1, Employee John is an ongoing FTE. John is a FTE through the current applicable stability period that ends December 31. The applicable standard measurement period will end on October 14, and the Employer will have until December 31 (the administrative period of October 15 – December 31) to review the results of whether John will continue to be an FTE as of January 1, and enroll him in coverage. During the administrative period, John remains an FTE because it overlaps with the current stability period. Also during this time, the next standard measurement period has commenced.
2. It is May 1. The Employer hires Alex; however, the Employer reasonably is unable to determine whether Alex will work 30 or more hours per week on average. The Employer utilizes a 12 month initial measurement period, that commences on Alex's start date of May 1, and an administrative period of 90 days that commences at the end of the initial measurement period. On April 30 of the next year, the initial measurement period to determine whether to offer Alex coverage ends and the administrative period of 90 days begins. Thus, before July 29, the Employer must offer Alex coverage as a FTE if he satisfied the 30 or more average hours per week standard during the initial measurement period.
5. The employer may use different measurement and stability periods for different employee classifications, such as:
• Collectively bargained and non-collectively bargained employees;
• Salaried and hourly employees;
• Employees of different entities; or
• Employees in different states.
6. The IRS proposed a method to transition a new employee to an on-going employee.
• The employer must test the new employee at the end of the initial measurement period and after the first standard measurement period during which the employee is employed for the duration, even if there is an overlap between the initial and standard measurement periods.
The following is an example of how this works:
Using the previous example of the employee Alex. Alex is hired on May 1 and the Employer begins the initial measurement period, a 12 month period beginning on the date of hire (again, the length of the initial measurement period is optional: no less than 3 months but no longer than 12 months). The employer has also established an administrative period of 90 days at the end of the initial measurement period. For ongoing employees, the Employer uses an October 15 through October 14 standard measurement period and an October 15 – December 31 administrative period. While Alex is still in the initial measurement period, (May 1 year 1 through April 30 year 2), the Employer must also begin to measure Alex as an ongoing employee for FTE status with the standard measurement period that commences October 15 year 1 (about 5½ months into the initial measurement period). Assume Alex is determined to be a FTE at the end of the initial measurement period, Alex will be eligible for coverage during the stability period beginning July 30 year 2 at the end of the administrative period which follows his initial measurement period. That stability period would have to be for no less than 12 months and on these facts would end July 29 year 3. If Alex also was determined to be a FTE during the October 15 year 1 to October 14 year 2 standard measurement period, Alex will be eligible for coverage during the stability period beginning January 1 year 3 and ending December 31 year 3. If Alex was determined not to be a FTE during the standard measurement period ending October 14 year 2, Alex would not be eligible for coverage during the stability period beginning January 1 year 3. However, because Alex had met the FTE determination for initial measurement period, Alex will continue to be eligible until the end of the stability period related to the initial measurement period, i.e. the period ending July 29 year 3.
7. The IRS said employers may use reasonable good faith interpretation of the term "seasonal employee" to include retail employees employed during the holiday season, or agricultural workers. This means an employer may exclude seasonal employees from their health plan without consequence under the "pay or play" penalty scheme.
8. The IRS indicated an employer could rely on this guidance through 2014. The IRS also said the guidance applies to measurement and stability periods that begin in 2013 or 2014. That means if an employer with significant numbers of part-time employees is concerned about covering in 2014 only those employees they intended to classify as full-time and reducing any possible penalty, then the earliest a measurement period could commence is January 1, 2013.
Here is an example of such a measurement period working together with an administrative period and stability period:
The potential for a penalty/tax commences in 2014; thus, technically, if coverage is not offered prior to such date, there is no consequence to the Employer. The employer desires to have maximum certainty on excluding its part-time employees from coverage, but still desires an administrative period of at least one month to implement any necessary enrollments. The Employer sets its initial standard measurement period for 11 months starting on January 1, 2013 and ending on November 30, 2013. The initial stability period will commence on January 1, 2014, after a one month administrative period in December of 2013. Perhaps odd, but the employer could designate the stability period as the 11 months through the end of November 30, 2014 based on making the stability period equal to the initial measurement period. Prior to the end of 2013, the Employer implements a new standard measurement period of October 15, 2013 to October 14, 2014, and establishes a different longer administrative period for 2014 and beyond of October 15 to December 31 (assuming the guidance is extended). The new stability period would then be January 1 to December 31, the first new stability period being calendar year 2015. In this example, the employee could end coverage at December 1, 2014 for an employee who was determined not to be a FTE during the overlapping standard measurement period ending October 14, 2014.