Free Rider Penalty (Employer Mandate)
Under Internal Revenue Code (Code) Section 4980H, large employers that do not offer health coverage to full-time employees and their dependent children, or offer coverage that is “inadequate” or “unaffordable,” and have at least one employee enroll in exchange (Marketplace) coverage and qualify for a federal premium tax credit or cost-sharing reduction, must pay a non-deductible penalty. While generally effective January 1, 2015, the final regulations provide transition relief for non-calendar year plans in existence on December 27, 2012: for any employee for whom the employer offers “adequate” and “affordable” coverage by the first day of the plan year beginning in 2015, no penalty will be due prior to the beginning of the plan year beginning in 2015. Note that an employer is not eligible for this transition if it modified its plan year after December 27, 2012 to begin at a later date.
Large Employers Subject to the Penalty
The Free Rider Penalty (or employer mandate) only applies to large employers. A large employer generally is one that employed an average of at least 50 full-time equivalent employees on business days during the preceding year. However, employers with 50-99 full-time equivalent employees will not be subject to the penalty until the first day of the plan year that begins on or after January 1, 2016. An employer’s number of full-time employees is based on actual hours of service in the prior year. However, for purposes of determining whether an employer is a large employer in 2015, an employer may use a period of at least six consecutive calendar months, chosen by the employer, in the 2014 calendar year (rather than having to use the entire 2014 calendar year).
There are two penalties that could apply:
If the employer does not offer coverage to substantially all full-time employees and their dependent children, and at least one employee enrolls in exchange coverage and qualifies for a premium tax credit, the monthly penalty imposed under Code Section 4980H(a) is 1/12th times $2,000 per employee after the first 30 employees. A transition rule for 2015 increases this number to 80 employees. For the 2015 plan year, an employer will have satisfied the requirement to offer coverage to “substantially all” employees if it offers coverage to 70% of the employees (decreased from 95% from the proposed regulations) who are considered full-time under the law. Beginning in 2016, the substantially all threshold increases to 95%.
A second penalty applies if the employer’s provided coverage is considered “inadequate” or “unaffordable.” This penalty could also be triggered for any full-time employee who is not offered coverage in the situation where the employer satisfies the “substantially all” requirements (70% in 2015 and 95% in 2016) but the employee is not offered coverage and thus falls in the gap (30% for 2015 and 5% for 2016). The amount of this penalty is 1/12th x $3,000 per month per full-time employee who enrolls in exchange coverage and qualifies for a federal premium tax credit. The amount of the penalty is capped at the amount the employer would have had to pay for not offering coverage at all under 4980H(a).
Free Rider Penalty Hot Topics & FAQs
- Final Free Rider Penalty Regulations
On Monday, February 10th the Internal Revenue Service (IRS) released long-awaited final regulations implementing the Employer Shared Responsibility provision (the Free Rider Penalty or employer mandate) under Health Care Reform. Our white paper provides a recap of the general rules, describes the changes and key clarifications provided by the final regulations, and highlights some of the questions that remain unanswered.
- New Guidance on Who Qualifies as a Full-Time Employee for the Free Rider Penalty
The proposed regulations describe a safe harbor employers may use to determine whether an existing or newly hired employee is considered a full-time employee for purposes of the Free Rider Penalty. In general, full-time status is determined for each month, and an employee who averages 30+ hours of service per week is considered a full-time employee. Employers may use an optional lookback period (of between 3 and 12 calendar months) to determine whether an employee averaged 30+ hours of service per week. If an employee was considered full-time during this “measurement period”, the employee must be treated as a full-time employee for benefits purposes for a subsequent “stability period” regardless of the employee’s number of hours worked during the stability period, so long as the individual remains an employee. If the employee was considered part-time during the measurement period, the employee may be treated as part-time for benefits purposes throughout the stability period. The stability period must be at least as long as the measurement period, and not shorter than six months.
These rules may be used for new employees who will work variable hours if, based on the facts and circumstances at the date of hire, it cannot be determined that the employee is reasonably expected to work an average of at least 30 hours per week. The rules may also be used for ongoing employees who have worked for at least one complete measurement period.
The employer has the flexibility to determine the months in which the measurement period starts and ends, which must be applied consistently for all employees in the same category (e.g., collectively bargained employees, hourly employees, or employees who work for different entities or at different locations). An employer may also utilize an administrative period of up to 90 days following the measurement period, but together the measurement and administrative periods may not extend longer than 13 months from the employee’s start date, plus the time remaining until the first day of the next calendar month (if the employee’s start date is not the first day of a calendar month). The proposed regulations include a number of examples illustrating the application of these rules and may be relied upon at least through 2014.
- Safe Harbor Definition of Income For Free Rider Penalty
Coverage is affordable, for purposes of the Free Rider Penalty, if the employee does not have to pay more than 9.5% of household income in order to receive employee-only coverage. The reference to “household income” raised concern for employers who do not have access to information about the employee’s household income. To address this concern, the proposed regulations provide three safe harbors. The safe harbors allow employers to determine “household income” in one of three ways: (1) the employees’ current Box 1 W-2 wages from the employer; (2) the employee’s current monthly rate of pay, which is the monthly salary for a salaried employee and the hourly rate of pay X 130 for an hourly employee; or (3) the federal poverty level for a single individual. An employer may choose to use one or more of these safe harbors for all or any reasonable category of employees as long as they are used on a uniform and consistent basis for all employees in a category. Coverage will be considered affordable if the coverage is otherwise adequate and the employee portion of the employee-only premium for the employer’s lowest cost coverage option does not exceed 9.5% of the safe harbor “household income” substitute selected by the employer. For purposes of the premium tax credit, an employee will be considered to have access to affordable employer-sponsored coverage (and therefore would not qualify for a premium tax credit) if the employee has to pay less than 9.5% of their household income for employee-only coverage.
- Will grandfathered plans be subject to the Free Rider Penalty?
Answer: Employers, not plans themselves, are subject to the Free Rider Penalty. There is no exemption for sponsors of grandfathered plans. Thus, if the grandfathered coverage is inadequate or unaffordable, the employer may owe a penalty.
- Does a high deductible health plan provide adequate coverage?
The plan sponsor would need to perform the calculation to determine whether the plan's actuarial equivalence is at least 60%. However, as a rule of thumb, high deductible health plan coverage offered in connection with a Health Savings Account often has an actuarial value of approximately 65%.
- How much is 400% of the Federal Poverty Level?
Click here to link to the latest Federal Poverty Levels as established by the federal government. The following are examples of 400% of the Federal Poverty Level in 2013:
- Individual: $ 45,960
- Family of 2: $ 62,040
- Family of 4: $ 94,200
- Family of 6: $ 126,360
What do you do with your health plan now?
To determine which employees may have unaffordable coverage today
Additional information about the availability of a premium tax credit
Link to the latest levels as established by the federal government
Free Rider Penalty Flowchart
See if your plan is likely to trigger a Free Rider Penalty
- Free Rider Penalty Proposed Regulations
Guidance to determine whether employees working variable hours are considered full-time
- Minimum Value Calculator
Calculate whether an employer's coverage is "adequate"
American Fidelity Assurance Company does not provide tax or legal advice.