Written by Alden J. Bianchi
The Employer Shared Responsibility provisions of the Affordable Care Act (“ACA”) generally require “applicable large employers” (i.e., employers who employed at least 50 full-time and full-time equivalent employees on business days during the preceding calendar year) to offer group health plan coverage or face the prospect of having to pay an assessable payment. The McNamara-O'Hara Service Contract Act of 1965—a/k/a the “Service Contract Act” or “SCA”— generally applies to Federal contracts. Contractors subject to the SCA must pay prevailing wage rates and fringe benefits to service employees employed on contracts to provide services to the federal government. The latter fringe benefit obligation may, however, be discharged by paying cash in lieu of fringe benefits. Under the SCA, fringe benefit payments required by Federal or state law (“mandated benefits”) may not be used to satisfy the employer’s fringe benefit obligations.
The Wage and Hour Division of the U.S. Department of Labor, in a June 11, 2012 memorandum, determined that “employer contributions that are made to satisfy the employers’ obligations under the Hawaii-mandated prepaid Health Care Act may not be credited toward meeting the contractor’s obligations under SCA.” The Wage and Hour Division has not yet opined on whether offers of group health plan coverage are “mandated benefits.”
The answer to that question has important consequences to Federal contractors and subcontractors that are subject to the SCA. Should the Wage and Hour Division determine that the ACA is a benefit mandate, group health plan coverage provided to employees to reduce or eliminate exposure under Code § 4980H would not count toward the $3.71/hour fringe benefit obligation.
Contractors (and subcontractors) subject to the SCA generally have the right to choose how they satisfy the fringe benefit requirements, although the choice may be constrained in the case of employers with collectively bargained employees. The contractor may choose to provide bona fide fringe benefits in kind, e.g., group health benefits, additional sick leave days, or pension/retirement benefits. Alternatively, contractors may discharge their fringe benefit obligations through payment of additional cash wages “in lieu of” benefits.
Most contractors prefer to satisfy the fringe benefit portion of the SCA wage with non-taxable fringe benefits, thereby reducing the marginal payroll tax burden. This is not always possible, however. For example, workers may prefer to receive, and may have the leverage to demand, cash. Nor is it uncommon for employers to provide, or organized workers to negotiate, a choice of non-taxable fringe benefits or cash under a Code § 125 cafeteria plan. But all other things being equal, the contractor paying a bona fide fringe benefit enjoys a competitive advantage over a contractor that pays cash in lieu of benefits.
The Wage and Hour Division explains the particulars of the SCA statutory and regulatory scheme in a suite of resources available here. While comprehensive and well written, nothing in these materials furnishes any clues about how the SCA will coordinate with the ACA’s Employer Shared Responsibility provisions. Nor does it give the reader any sense of the contours of the industry. Employers that compete for Federal contracts and subcontracts, and that are therefore subject to the SCA, fall into three broad categories:
- Large, publicly held contractors, typically though not always in the defense sector;
- Medium and large, closely held employers that are subject to the ACA’s employer shared responsibility provisions; and
- Small companies that often have less than 50 full-time and full-time equivalent employees (i.e., not subject to the ACA’s employer shared responsibility provisions).
What the Wage and Hour Division decides on the matter of benefit mandates will affect the balance of the competitive advantages enjoyed by each of these groups of companies.
The Wage and Hour Determination
If an offer of group health plan coverage for ACA purposes is determined to be a benefits mandate
If an offer of group health plan coverage for ACA purposes is determined to be a benefits mandate, then, as noted above, the coverage would not count toward the SCA’s $3.71/hour fringe benefit requirement. Small employers that are not subject to the ACA’s employer shared responsibility requirements will have a competitive advantage over the other two employer cohorts, since they will have no Code § 4980H exposure.
Large and medium-sized employers—i.e., applicable large employers for ACA purposes—might choose to offer a skinny (or “MEC”) plan on a contributory basis as a way to avoid exposure under Code § 4980H(a). They would, of course, remain liable under Code § 4980H(b). (For an explanation of skinny plans, please see our June 16, 2014 entry.)
There is one final consequence of “mandated benefit” determination: It leaves the Treasury Department and IRS with little to do. The rules governing the application of Code § 4980H as set out in final regulations issued February 12 of this year include comprehensive rules governing offers of coverage. These rules would apply in the SCA context as they would to any other employer. While an offer of group health plan coverage would affect their exposure under Code § 4980H, it would not qualify as a bona fide fringe benefit for SCA purposes.
If an offer of group health plan coverage for ACA purposes is determined not to be a benefits mandate
If an offer of group health plan coverage for ACA purposes is determined not to be a benefits mandate, then, at a minimum, group health plan coverage would count toward the $3.71/hour fringe benefit requirement. Here, the competitive advantage shifts to the larger employers who are best able to leverage their size to limit the cost of coverage.
The Affordability Determination
Should the Wage and Hour Division find that the ACA does not impose a benefits mandate, the focus shifts to the tax rules. Specifically, the Treasury Department and IRS will need to tell us how to treat the fringe benefit portion of the SCA wage when establishing whether an offer of group health plan coverage is affordable. (Under the statute and the final Code § 4980H regulations, if an employee’s share of the premium for employer-provided coverage costs the employee 9.5% or less of the employee’s annual household income, the coverage is considered affordable. Because employers generally will not know their employees’ household incomes, the final regulations provide three optional affordability safe harbors that are based on the employee’s Form W-2 wages or the employee’s rate of pay.)
Exclusive offer of group health plan coverage that provides minimum value
Assume that an employer chooses to satisfy the SCA fringe benefit requirement by offering only group health plan coverage that provides minimum value. Assume further that the cost of self-only coverage is less than or equal to the specified fringe benefit value of $3.71/hour. Since the employer is providing the coverage, and there are no other options, it would appear under these circumstances that the employer has no Code § 4980H exposure. The employees in this instance are “firewalled” from premium subsidies, which means that the employer cannot be subject to any assessable payments. Importantly, this conclusion assumes that the premium cost is being paid by the employer despite the fact that the employer has an obligation, rooted in the SCA, to provide fringe benefits or cash.
There are, of course, variations on this theme. For an employee working full-time for an entire year, $3.71/hour would translate into more than $7,000 of annual premiums. This would equal or exceed the cost of self-only coverage in most instances. He or she might have the excess of the fringe benefit wage over the premium cost paid to him or her in cash. Conversely, an employee whose hours are intermittent might have to make up a portion of the premium. In either case, the tax principle remains the same: the SCA fringe benefit wage paid toward premiums is treated as though provided by the employer—which it is, or certainly appears to be.
Choice between group health plan coverage or cash
As noted above, the choice between group health plan coverage or cash in the context of the SCA fringe benefit rules is, for tax purposes, the choice between cash and a non-taxable (or qualified) benefit that is subject to Code § 125. Here, we suspect that the result will be quite different, since amounts contributed to group health plan premiums are treated as employee contributions for employer shared responsibility purposes. The amounts paid toward group health plan coverage are treated as being paid by the employee in this instance. As a consequence, the coverage may or may not be affordable. In this case, the employer will not be subject to assessable payments under Code § 4980H(a), but may incur exposure under Code § 4980H(b).
There is, to be sure, something deeply troubling about this result. Why is it that, when an employer offers only group health plan coverage as the SCA bona fide fringe benefit, the contribution is treated as being provided by the employer, but where a similarly situated employee is offered a choice between group health plan coverage and cash, the contribution is treated as being provided by the employee? While this result is consistent with the underlying tax rules, it’s difficult to justify, as a practical matter, in the SCA context.