As the ACA audit era approaches, many employers are wondering: what will happen? What sorts of documentation will the IRS request? What industries will be targeted? And what can employers do to prepare? In this post, I discuss what employers might expect based on my experience with audits under the Massachusetts Fair Share law, and provide some tips for audit preparation and troubleshooting.
The first year of the Affordable Care Act’s employer mandate is behind us. Employers nationwide have rearranged plan designs, identified full-time employees, made offers of coverage, and submitted a formidable pile of data to the IRS. Meanwhile, US citizens have filed or are finishing up their personal tax filings and, in some cases, have requested health care subsidies. Now it’s the IRS’ turn to review all of this information, root out noncompliance, and enforce the ACA.
Earlier this decade, Massachusetts employers were chin-deep in audits under the state’s “Fair Share” law. While not identical to the ACA’s employer mandate, the Fair Share law bore many similarities to the ACA. Each law requires that an “offer” of employer coverage be made within a certain timeframe following hire, sets forth a full-time standard, and puts parameters around the employee’s share of the premium cost. Specifically, the Fair Share law’s so-called “secondary test” required employers to make an offer of group health coverage to all full-time employees within 90 days of hire, and make a 33% employer premium contribution towards the coverage. The ACA, in turn, requires employers to make an offer of minimum value group health coverage to all full-time employees within the first three full months of employment, and charge those employees no more than 9.5% of income. For an in-depth comparison of the two laws, click here, and for a more in-depth look at the ACA, see our coverage here.
Mintz Levin handled Massachusetts Fair Share audits for employers of all sizes and from all industries, and saw our clients confront a variety of issues and challenges. The Fair Share law was enforced aggressively starting on the law’s effective date by the Massachusetts Division of Unemployment Assistance (DUA). It is hard to know at this point exactly how the IRS will approach ACA audits. On the one hand, we have every reason to believe that the IRS will be merciful in its enforcement of the 2015 compliance year, at least with respect to those employers who made good-faith efforts to comply. On the other hand, the IRS delayed the ACA’s implementation for a year (from ’14 to ‘15), and provided employers, well in advance of the January 1, 2015 compliance date, with plenty of regulations and other guidance to help with compliance. Employers should not expect unlimited and perpetual lenience.
Given the likelihood of some serious IRS ACA auditing, possibly as early as this fall, employers should be thinking of the practical steps they can take to prepare. Here are some of the lessons we learned from our Massachusetts Fair Share audits that are likely to be valuable to any employer potentially subject to the IRS’s enforcement activities.
Document The Offer Of Coverage
In Massachusetts, the outcome of audits depended heavily on whether employers could prove that they had made “offers” of coverage to all full-time employees within 90 days of hire. When enforcing the Fair Share Law, the DUA generally required that employers produce a signed, dated waiver of coverage from each full-time employee who had not elected coverage. Employers who could not produce waivers for an overwhelming percentage of applicable employees tended to fail audits. It is notable that the Fair Share Law did not specifically require employers to obtain “waivers” in order document offers of coverage.
Similarly, the IRS has not indicated exactly how employers should document an offer of coverage under the ACA. Drawing on our experience in Massachusetts, the most ironclad practice would be to get a waiver from every full-time employee who is offered coverage and declines. Where that is simply impracticable, employers are advised to communicate the offer of coverage to each applicable employee and keep careful records of what communication was sent, to whom and when. Employers who rely on managers to distribute offers should document the chain of command and train and monitor managers. Employers who distribute communications electronically are advised to follow ERISA’s electronic disclosure safe harbor whenever possible.
Document “Full-Time” Status
In Massachusetts, an employee was generally considered to be “full-time” (and eligible for an offer) if he or she worked 35 hours or more per week. Audited employers were required to produce detailed spreadsheets showing a variety of payroll data for employees including hire and termination dates and hours worked. Unfortunately for employers, the DUA did not provide clear guidance as to how to determine the “full-time” status of employees with flexible schedules, varying hours, leaves of absence, and other unusual employment scenarios, and employers were left to interpret the rules as best as they could (often with disastrous consequences on audit).
Under the ACA, an employee is considered to be “full-time” if he or she works, on average, 30 hours of service or more per week. For better or for worse, the IRS (unlike the DUA) has produced a tome of guidance explaining how to identify “full-time” employees in a broad swath of employment settings. More on that guidance here. During an audit, the IRS will likely want to see similar information to that requested by Massachusetts auditors – hours worked, start dates, and termination dates. The IRS will also likely want to know which methodology an employer used to identify “full-time” employees and calculations showing application of that methodology. Employers are advised to consider how to best present their “full-time” analysis to the IRS in the event of an audit.
Employers audited in Massachusetts needed to prove that employers offered to pay at least 33% of the cost of coverage. These details could generally be proven though payroll records showing employee premium deductions coupled with evidence of the total cost of coverage provided by the carrier or TPA.
Under the ACA, audited employers will be required to prove that coverage is “affordable” – i.e. that the coverage costs the employee no more than 9.5% of the employee’s income. Employers will thus be required to produce documentation of employees’ premium costs, and will likely need to show evidence of W-2 compensation or rate of pay (depending on the affordability safe harbor in use). For more information on the affordability safe harbors, click here.
While this data-gathering exercise may seem somewhat rote, that is not always the case. Large employers with complex organizational structures may need to obtain different data elements from different sources. For example, payroll might have compensation information, but premium information might be housed at HR. Different divisions of the company may have different payroll providers or departments, using different codes and methods. Employers are advised to determine how affordability will be shown in the event of an audit.
Staffing Firms and Restaurants Beware
In Massachusetts, much of the DUA’s audits targeted industries with large cohorts of employees with uncertain or fluctuating hours (generally, the employees known under the ACA as “variable hour”). Restaurants, staffing firms, and similarly situated companies with variable hour workers (hotels, cleaning services, and home health, to name a few) tended to struggle with audits primarily because, in spite of best efforts, they could not document “offers of coverage” in a manner sufficient to the DUA. More specifically, employees tended not to return signed, dated “waivers” of coverage as requested by the employer.
At this time, it is unclear where the IRS will focus its audits. To the extent the IRS takes a hard line on the documentation of “offers of coverage” and requires waivers (or other substantial evidence of the offer) from every employee who declines an offer of coverage, staffing firms, restaurants and their brethren may find themselves in the audit hot seat once again.
Keep Addresses Up to Date, and Alert the Mailroom
The IRS tends to kick off audits with a letter to the employer. The letter will likely be addressed to the individual named on the 1094-C form, but it may be addressed to the employer generally at the address on file with the IRS. Therefore, it is important the IRS has a current employer address, and that mailroom employees know what to do with correspondence from the IRS (or any governmental entity for that matter).
While this particular piece of advice may seem dismissible, I witnessed a surprising number of employers struggle with Fair Share audits in Massachusetts simply because they did not receive the audit letter in time (or never received it). In some cases, the company had moved and the letter went to an old address. In other cases, the letter was not addressed to a specific person and bounced around the company unnoticed. If the IRS sends letters to specific addressees, cases may arise where the addressee has left the company. At a minimum, failure to timely to respond to an audit letter will get the audited company off on the wrong foot with the auditor; at worst, it could lead to an automatic audit failure.
As the ACA audit era approaches, employers are advised to prepare now. Based on our experience in Massachusetts, employers should make sure they are documenting offers of coverage. Employers should also consider how they will gather and present the payroll data that supports the “affordability” standard and the identification of “full-time” employees. Finally, employers should make sure that all IRS correspondence is properly routed, and that the IRS has up-to-date addresses. Restaurants and staffing firms are advised to be particularly vigilant.