Compliance with the Affordable Care Act’s (ACA) employer shared responsibility rules requires that applicable large employers identify their full-time employees. A “full-time employee” for this purpose is an employee who works on average 30 hours per week or 130 hours per month. “Hours of service” includes both hours for which an employee is paid for the performance of services, as well as hours for which an employee is paid for a period during which no duties are performed—including short- and long-term disability leave. Including paid hours for which no work is performed poses some unique reporting challenges, principally due to the need to make adjustments to compensation that affect affordability and the lingering question of the period of time for which hours must be attributed in the case of individuals on long-term disability. This post examines these challenges.
Background—hours of service
The final Code § 4980H regulations define the term “full-time employee” to mean, “with respect to a calendar month, an employee who is employed an average of at least 30 hours of service per week with an employer.” For convenience, the regulation further provides that, “130 hours of service in a calendar month is treated as the monthly equivalent of at least 30 hours of service per week.” “Hours of service” for this purpose is defined as follows:
The term hour of service means each hour for which an employee is paid, or entitled to payment, for the performance of duties for the employer; and each hour for which an employee is paid, or entitled to payment by the employer for a period of time during which no duties are performed due to vacation, holiday, illness, incapacity (including disability), layoff, jury duty, military duty or leave of absence (as defined in 29 CFR 2530.200b–2(a)).
As a consequence, an otherwise full-time employee who ceases active employment and is placed on paid short- or long-term disability leave continues to accrue hours of service.
The effect on affordability
Form 1095-C, part II, Lines 15 and 16 solicit information relating to the employee cost of coverage and whether the coverage is deemed to be affordable. This information allows the Internal Revenue Service to determine whether the employee is prevented from receiving premium subsidies for coverage through a public insurance exchange or marketplace. This occurs where the employee either fails to offer coverage to substantially all of its full-time employees, or where the offered coverage either fails to provide minimum value (i.e., major medical coverage) or is unaffordable. Where an employee is so barred or “firewalled,” the employer will not incur an excise tax penalty with respect to that employee.
Employer-provided coverage is affordable if the employee’s share of the premium for self-only coverage is less than 9.5% of the employee’s annual household income. Recognizing that employers don’t necessarily know their employees’ household income, the final regulations establish the following three affordability safe harbors:
- The Form W-2 wages safe harbor
The Form W-2 wages safe harbor generally is based on the amount of wages paid to the employee that are reported in Box 1 of that employee’s Form W-2.
- The rate of pay safe harbor
The rate of pay safe harbor generally is based on the employee’s rate of pay at the beginning of the coverage period, with adjustments permitted for an hourly employee if the rate of pay is decreased (but not if the rate of pay is increased).
- The federal poverty line (or “FPL”) safe harbor
The federal poverty line safe harbor generally treats coverage as affordable if the employee contribution for the year does not exceed 9.5% of the federal poverty line for a single individual for the applicable calendar year.
An employer is free to choose one or more of these safe harbors for all of its employees or for any reasonable category of employees, provided it does so on a uniform and consistent basis for all employees in a category.
In the ordinary course, short-term disability benefits simply continue paying wages for a specified period of time, e.g. 13 or 26 weeks. In this instance, the reporting of a full-time employee will not change. But long-term disability benefits usually result in some reduction in pay. It is common, for example, for long-term disability benefits to be paid at the rate of 60 percent or 70 percent of an employee’s regular pay. Complicating matters is that, while almost all short-term disability benefits are paid in after-tax dollars, long-term disability benefits may be paid after-tax (i.e., where the benefit is entirely employer-paid) or pre-tax (where the benefit is employee paid). Where long-term disability benefits are paid pre-tax, there might be no net reduction. This would occur, for example, in the case of an executive with long-term disability benefits of 70 percent of regular salary who is in the 30 percent tax bracket.
Where an active full-time employee is covered under his or her employer’s group health plan for a portion of the year and then goes on disability, he or she continues to accrue hours of service. An employer that is applying the W-2 safe harbor or the FPL safe harbor will not make any adjustments to Form 1095-C, Line 15. In the case of the W-2 safe harbor, the final 2015 regulations provide that the W-2 compensation for the year is averaged across working months. Similarly, no adjustments would be required in the case of the FPL safe harbor.
Where the rate of pay safe harbor is concerned, there are separate rules for hourly and non-hourly employees.
- Hourly employees
For an hourly employee, the rate of pay safe harbor is based on the employee’s rate of pay at the beginning of the coverage period. Where the rate of pay decreases, the affordability calculus changes, however. The result for reporting purposes will appear in Line 16. By way of example, if an employee is paid at the rate of $25 per hour on January 1, which is the first day of the plan year, coverage will be affordable if the employee cost of coverage is less than $308.75 per month. (($25 x 130 hours) x 9.5% = $308.75). If the employer charges $300 per month for coverage, the proper Line 16 indicator code for the month is 2H (section 4980H affordability rate of pay safe harbor) indicating that the coverage is affordable based on the rate of pay safe harbor. If the employee goes on short-term disability commencing on February 1 for 13 weeks, then the coding for Lines 15 and 16 does not change for February, March and April. If the employee then qualifies for long-term disability commencing May 1, at which time his pay is reduced to $20 per hour, then coverage becomes unaffordable. (($20 x 130 hours) x 9.5% = $247). In that case, assuming no adjustment to the employer subsidy, Line 16 would be left blank, indicating that the employer may face exposure for an assessable payment under Code § 4980H(b).
NOTE: These examples assume that hours must be imputed during the entire period of disability. The reason for this assumption, and the controversy that it has engendered, is discussed below.
- Non-hourly (salaried) employees
In the case of a non-hourly or salaried employee, the rate of pay safe harbor is satisfied if the employee portion of the premium for self-only coverage does not exceed 9.5 percent of the employee’s monthly salary, as of the first day of the coverage period. But where a salaried employee experiences a reduction in compensation, the rate of pay safe harbor is not available. Here is the rule:
An applicable large employer member satisfies the rate of pay safe harbor with respect to a non-hourly employee for a calendar month if the employee’s required contribution for the calendar month for the applicable large employer member’s lowest cost self-only coverage that provides minimum value does not exceed 9.5 percent of the employee’s monthly salary, as of the first day of the coverage period (instead of 130 multiplied by the hourly rate of pay); provided that if the monthly salary is reduced, including due to a reduction in work hours, the safe harbor is not available . . . . (Emphasis added).
Though this result seems harsh, the reason for the rule is not difficult to discern; the employer could set an employee’s salary at some unreasonably high amount on the first day of the coverage period, then reduce it immediately thereafter. But a reduction in the case of long-term disability is hardly abusive. So it would seem that an exception might be in order. Absent an exception, the employer would need to rely on one of the other safe harbors. In that case, the instructions for Form 1095-C admonish that, “[i]f an employer uses this [W-2] safe harbor for an employee, it must be used for all months of the calendar year for which the employee is offered health coverage.” Presumably, “employees on disability” is a reasonable category of employees.
Period during which hours must be imputed due to disability
Readers familiar with the regulation of tax-qualified retirement plans will immediately recognize the treatment of hours of service for which pay is received but no services are performed as a rule that has applied to retirement plans since 1978. While the rule appears straightforward on its face, it is worth examining the Department of Labor regulation—i.e., 29 CFR 2530.200b–2(a)—cited in the definition of “hours of service” set out above. It reads, in relevant part:
(a) General rule. An hour of service which must, as a minimum, be counted for the purposes of determining a year of service, a year of participation for benefit accrual, a break in service and employment commencement date (or reemployment commencement date) under sections 202, 203 and 204 of the Act and sections 410 and 411 of the Code, is an hour of service as defined in paragraphs (a)(1), (2) and (3) of this section. The employer may round up hours at the end of a computation period or more frequently.
(1) An hour of service is each hour for which an employee is paid, or entitled to payment, for the performance of duties for the employer during the applicable computation period.
(2) An hour of service is each hour for which an employee is paid, or entitled to payment, by the employer on account of a period of time during which no duties are performed (irrespective of whether the employment relationship has terminated) due to vacation, holiday, illness, incapacity (including disability), layoff, jury duty, military duty or leave of absence. Notwithstanding the preceding sentence,
(i) No more than 501 hours of service are required to be credited under this paragraph (a)(2) to an employee on account of any single continuous period during which the employee performs no duties (whether or not such period occurs in a single computation period);
(ii) An hour for which an employee is directly or indirectly paid, or entitled to payment, on account of a period during which no duties are performed is not required to be credited to the employee if such payment is made or due under a plan maintained solely for the purpose of complying with applicable workmen's compensation, or unemployment compensation or disability insurance laws; and
(iii) Hours of service are not required to be credited for a payment which solely reimburses an employee for medical or medically related expenses incurred by the employee.
In a notice issued in 2011, the IRS described a potential rule under which, for any single continuous period during which the employee was paid or entitled to payment but performed no duties, no more than 160 hours of service would be counted as hours of service. Thus, in the above examples, this would have the effect of crediting no further hours of service after a little more than a month. But in response to criticism, this rule was modified in the proposed regulations. The preamble to the proposed regulations provided the following explanation for the modification (78 Fed. Reg. 218, 223 (proposed Jan. 2, 2013):
A number of commenters on Notice 2011–36 requested that the 160-hour limit be removed because they viewed it as restrictive, and expressed concern about the potential negative impact on employees who are on longer paid leaves, such as maternity or paternity leave. In response, these proposed regulations remove the 160-hour limit on paid leave, so that all periods of paid leave must be taken into account. (Emphasis added).
While this rule was carried over in the final regulations, it does not appear that it is being uniformly followed. Noting that 29 CFR 2530.200b–2(a)(2)(ii) imposes a 501 hour cap, some argue that there is a limit, i.e., 501 hours. To be sure, it is less than clear what the reference to “29 CFR 2530.200b–2(a)” modifies in the definition of hours of service. So this argument is not without merit. But it is clear that the Treasury Department and the IRS do not read the rule this way. Fortunately, in most cases, the penalties on an employer that imposes a 501 hour cap would in the vast majority of cases be inconsequential, since the cohort of employees on disability at any given time is likely to be very small in comparison to the applicable large employer’s workforce.