Free Rider Penalty
Orginally effective January 1, 2014, if large employers do not offer "adequate" and "affordable" health coverage to their full time (30+ hours per week) employees (and their dependent children), they may be subject to a Free Rider Penalty. In Notice 2013-45, the IRS announced a one-year delay in the reports that most employers will be required to submit to the IRS. In addition, the IRS will not assess a Free Rider Penalty in 2014.
The Notice does not indicate when the Free Rider Penalty will apply to non-calendar year plans. In the proposed Free Rider Penalty regulations issued earlier this year, transitional relief was available for certain non-calendar year plans, which effectively delayed the Free Rider Penalty until the first day of the plan year beginning in 2014 for these plans. The Notice does not address non-caledar year plans. This could mean that a non-calendar year plan could be assessed a Free Rider Penalty as early as January 1, 2015. Plan sponsors of non-calendar year plans that hope to avoid triggering a Free Rider Penalty may want to offer adequate/affordable coverage to substantially all full time employees by the beginning of their 2014 plan year to avoid making mid-year changes and holding a second open enrollment before January 1, 2015. Further guidance is needed in this and a variety of other areas.
A "large employer" is defined as one having an average of 50 or more full-time (or full-time equivalent) employees during business days of the previous calendar year. To determine the number full-time equivalent employees for a given month, the employer would add:
- Number of full-time employees working 30+ hours per week (or 130 per month), plus,
- Hours worked by part-time employees (up to 120 hours per employee) during the month divided by 120.
The result is the number of full-time equivalent employees. Certain seasonal workers may be excluded from the calculation.
The law will exact a monthly penalty on the employer in either of the following circumstances:
- Employer does not offer any coverage
One penalty applies if the employer does not offer health coverage to at least 95% of full-time employees (30+ hours per week or 130 hours per month) and their dependent children to age 26 and at least one full-time employee qualifies to receive a premium tax credit to purchase coverage through an Exchange. (Certain employees with household income of up to 400% of the Federal Poverty Level are eligible for a premium tax credit.) This monthly penalty is 1/12 times $2,000 times the number of full-time employees. The first 30 employees are excluded from the calculation of the penalty.
- Employer's coverage is "inadequate" or "unaffordable"
A penalty applies if the employer does offer health coverage to full-time employees (30+ hours per week or 130 hours per month) and their dependent children to age 26, but the coverage is either inadequate or unaffordable and one or more full-time employees qualifies to receive a premium tax credit to purchase coverage through an Exchange. Coverage is considered inadequate if the plan pays less than 60% of the allowable costs covered by the plan. Coverage is considered unaffordable if the premium contribution to participate in employee-only coverage in at least one plan option offered by the employer costs the employee more than 9.5% of household income. This monthly penalty is 1/12 times $3,000 times the number of full-time employees receiving a premium tax credit, capped at the maximum penalty the employer would pay if it did not offer coverage.
Free Rider Penalty Hot Topics & FAQs
- 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.