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New Pay or Play Regulation Makes Significant Changes, Offers Some Relief

Employee Benefits Law Alert John L. Barlament

On Friday, December 28, 2012, the Internal Revenue Service ("IRS") released a proposed Pay or Play Rule regulation. The regulation retains many of the same concepts from prior IRS guidance on the Pay or Play Rule while introducing several brand-new rules. In addition, the new regulation answers many common questions and provides important - although somewhat complicated - transitional relief. The IRS also released a series of questions and answers on the new regulation.

Effective Date of Regulations. The new regulation is effective immediately. Although it is only proposed (not final), employers can rely upon it.

Transition Rules. The regulation provides various transition rules, including two provisions, described immediately below, for when the Pay or Play Rule applies to fiscal year (i.e., not calendar year) plans.

  • Effective Date: Transition Relief for Those Eligible on December 27, 2012. For any employees who are eligible to participate in a fiscal year plan under its terms as of December 27, 2012 (whether or not they take the coverage), the employer will not be subject to a potential Pay or Play Rule penalty until the first day of the fiscal plan year starting in 2014.

  • Effective Date: Additional Relief. The second transitional rule seems to be designed to allow a fiscal year plan additional time to expand its eligibility provisions and offer coverage to those who were not previously eligible for coverage. Under the second transitional rule, if (1) the fiscal year plan was offered to at least one-third of the employer's employees (full-time and part-time) at the most recent open enrollment period; or (2) the fiscal year plan covered at least one-quarter of the employer's employees, then the employer also will not be subject to the Pay or Play Rule penalty until the first day of the fiscal plan year starting in 2014, provided that those full-time employees are offered affordable coverage that provides minimum value no later than that first day.

    For example, if during the most recent open season preceding December 27, 2012, an employer offered coverage under a fiscal year plan with a plan year starting on July 1, 2013 to at least one-third of its employees (meeting the threshold for the additional relief), the employer could avoid liability for a Pay or Play Rule penalty if, by July 1, 2014, it expanded the plan to offer coverage satisfying the Pay or Play Rule provisions to the full-time employees who had not been offered coverage.

    For purposes of determining whether the plan covers at least one-third (or one-quarter) of the employer's employees, an employer may look at any day between October 31, 2012 and December 27, 2012. The regulation also provides a related transitional rule for cafeteria plan changes (e.g., if an employee wishes to drop employer-provided health plan coverage and enroll in an Exchange).

  • Measurement Period Relief. The IRS noted that employers who wish to adopt a 12-month measurement period and a 12-month stability period will have "time constraints" due to the regulation just being released now. The transition rule allows an employer to adopt a shorter measurement period (such as six months) but keep the longer stability period (such as 12 months). To rely on this transition rule, the transition measurement period must be at least six months long, must begin no later than July 1, 2013 and must end no earlier than 90 days before the first day of the plan year beginning on or after January 1, 2014.
  • Large Employer Determination Relief. Some employers will be close to 50 full-time (and full-time equivalent) employees. These employers may need extra time to determine if they are subject to the Pay or Play Rule. The IRS has provided a transition rule for these employers. The transition rule allows an employer the option to determine its "large employer" status with respect to a period of at least six consecutive calendar months in the 2013 calendar year (rather than the entire 2013 calendar year). This will be very helpful for such employers.

De Minimis Rule. Employers have long been concerned that they could face a large penalty if they accidentally fail to cover just one full-time employee. The new regulation provides helpful guidance on this point. An employer will not face a Pay or Play Rule penalty if it fails to offer coverage to five percent or less of its full-time employees. (For small employers, the standard is five employees, rather than five percent.)

Penalty Does Not Apply on Controlled Group Basis. The Pay or Play Rule requires that all employees of all employers within a single controlled group be added when determining if any employer is subject to the Pay or Play Rule. Thus, all related employers are aggregated in determining whether the Pay or Play Rule applies at all. However, the new regulation provides that the Pay or Play Rule penalty is not determined on an aggregated basis - each employer is considered separately. This is very helpful for related employers and private equity firms. These entities had been concerned that a small company's failure to offer coverage would lead to a penalty based on all full-time employees of other, larger companies in the same controlled group.

Clarification of Affected Employers. The regulation clarifies that all common law employers are subject to the Pay or Play Rule, even government entities (such as federal, state, local or Indian tribal government entities) and churches.

Foreign Employees and Foreign Employers. Under the new guidance, employees who work overseas are generally not counted for Pay or Play Rule purposes. For employees who work both in the United States and overseas, "hours worked" for determining full-time employee status includes only United States-based hours.

Special Rule for Teachers and Employees on Unpaid Leave. One difficult question under the Pay or Play Rule had been how to determine an employee's hours of service when an employee was on unpaid leave (such as FMLA or USERRA leave) or when an employee worked for only a portion of the calendar year (such as a teacher who does not work during the summer). The regulation provides a special rule which is favorable for employees. Under this rule, an employer may ignore the period of the unpaid leave when averaging the hours, or, alternatively, provide a "credit" for hours worked during that time (even though no hours were, in fact, worked).

For example, suppose Client Co. generally uses a 12-month measurement period when determining whether an employee averaged 130 hours of service per month. Employee C, an employee of Client Co., takes a two-month FMLA leave. Client Co. would determine C's hours worked over ten months, not twelve months (as it does for other employees).  

Educational institutions are subject to this general rule and an additional, special rule. When such institutions have an "employment break period" lasting at least four consecutive weeks (such as summer vacation), that period is ignored when determining an employee's hours of service. The IRS is still considering whether employers other than educational institutions may be subject to a similar rule.

Change in Employment Status. A new variable hour employee or new seasonal employee may sometimes have a change in employment status during the initial measurement period. For example, a seasonal employee may be "promoted" to full-time status. If so, the employer generally must treat the employee as a full-time employee by the first day of the fourth month following that change in status. Although this rule may not seem difficult, it likely will increase administrative complexity for employers. Now, employers (especially those with operations in multiple states and far-flung human resource departments) must regularly monitor each variable hour or seasonal employee's current status to determine if the status has changed to "full-time."

Rehired Employees. Many employers will hire an employee, have them work for a few months, terminate the employee, then rehire that employee a few weeks or months later. Does each rehire create a separate, new initial measurement period for that employee? 

Under the new regulation, the answer is generally no, unless one of two exceptions apply. First, the employer can treat the rehired employee as a "new" employee if the person had a break in service of at least 26 weeks. Second, the employer may apply a "rule of parity" for a break which is less than 26 weeks. Under this rule of parity, an employee may be treated as a new employee if the employee's period of time with no credited service is at least four weeks long and is longer than the employee's immediately preceding period of employment. For example, suppose Employee B works for Client Co. for three weeks, then terminates employment. B is rehired 10 weeks later. Client Co. can treat B as a new employee because the 10-week period with no credited hours of service: (1) is at least four weeks long; and (2) is longer than the immediately preceding three-week period of employment. If a rehired employee cannot be treated as a "new" employee, the employee must be offered health plan coverage as soon as administratively practicable.

Anti-Abuse Rules. In a few places, the regulation imposes new "anti-abuse" rules. For example, an employer may not use an equivalency method for determining hours worked by an employee if the method would "substantially understate" an employee's hours of service. Similarly, the IRS specifically notes that an employer cannot have a single employee work 20 hours per week as the employer's "employee" and an additional 20 hours per week as the "employee" of a temporary staffing agency. The effect of such an arrangement, if it had been allowed, is that the employee would have been working "full-time" hours (40 hours per week) but would not have been any employer's "full-time" employee.

No Need to Offer Spousal Coverage. In order to avoid a Pay or Play Rule penalty, an employer must offer coverage to full-time employees and their "dependents." The regulation requires that coverage be offered to an employee's child who has not yet attained age 26. However, "dependent" does not include a spouse or, presumably, a domestic partner. Under a special transition rule, an employer does not need to offer dependent coverage in 2014, as long as it "takes steps" in 2014 to provide such coverage for the 2015 plan year.

How to "Offer" Coverage. To avoid the Pay or Play Rule, an employer generally must "offer" coverage to a full-time employee (and the employee's dependents). The regulation clarifies that an "offer" will exist if an employee has an effective opportunity to elect to enroll (or decline to enroll) at least once per year. This would effectively seem to prevent certain plan designs (such as a permanent, multiyear waiver of benefits in exchange for higher wages). The regulation also clarifies that certain recordkeeping requirements should be followed to demonstrate that an offer of coverage was made by the employer to the employee and the dependent.

Expanded "Affordability" Safe Harbor. In order to avoid all Pay or Play Rule penalties, an employer must provide self-only health plan coverage which is "affordable." (Family coverage does not need to be "affordable" under the Pay or Play Rule.)  The regulation continues to allow an employer to use an employee's Form W-2 wages in determining whether the self-only premium for the employer's lowest-cost, minimum value plan is "affordable." In a new provision, the IRS allows an employer to adjust Form W-2 wages if the employee was full-time for only a portion of the year (a change which is designed to assist employers).

The regulation also provides two new ways to measure "affordability." The first involves a "rate of pay" safe harbor which calculates an employee's maximum monthly contribution. The second is a "Federal poverty line safe harbor" (the "FPL safe harbor"). Under the FPL safe harbor, coverage will be affordable if the employee's cost for self-only coverage does not exceed 9.5 percent of the federal poverty line for a single individual. The FPL safe harbor would seem to be very helpful for employers and may significantly reduce the administrative burden of conducting an employee-by-employee analysis of "affordability."

Penalty Procedures. The regulation does not provide complete guidance on how the IRS will impose Pay or Play Rule penalties against an employer. However, they do offer some hints about the procedure. The procedure will ensure that employers receive a notice of the possible penalty and are provided an opportunity to respond before the IRS demands payment.

Multiemployer Plans. The regulation requests comments on how the Pay or Play Rule should apply to multiemployer plans and employers who contribute to these plans. The regulation does provide a transition rule for these plans and employers. To rely upon this relief, the plan must be offered to full-time employees and their dependents. The coverage also must be affordable and provide minimum value. An employer likely should examine its current multiemployer plan coverage to determine if it can verify this information.

Many Concepts Remain Same. Many of the concepts previously provided by the IRS remain the same (or very similar). For example, "full-time" employee status is still determined by using 130 hours of service in a month. Also, the familiar concepts of an "initial measurement period," "standard measurement period," "stability period" and "administrative period" remain. The IRS does provide some clarifications to these terms. For example, the IRS states that an employer may change its standard measurement period and stability period in a future year but generally may not change it during the current year. Also, the IRS clarified that, starting in 2015, a "variable hour" employee must be presumed to be employed through at least the end of that employee's initial measurement period.

Other Items Remain "Open." Although the new regulation addresses many topics, a number of related items remain unaddressed. Open items which are raised - but not answered - in the new regulation include: what type of coverage constitutes "minimum essential coverage"; how to determine "minimum value"; how the rules apply to "successor" employers; the exact definition of a "seasonal" employee; whether special rules should be created for "short-term" employees or "high-turnover" positions; whether special rules should apply for temporary staffing agencies; how exactly the Pay or Play Rule applies to employers who contribute to multiemployer plans; reporting requirements on the employer's health plan coverage; and how hours of service are calculated for certain industries (e.g., airline pilots and for colleges that pay professors based on course credits taught, not on hours worked).

Links to Further Guidance. The regulation can be found here. In addition, the IRS questions and answers can be found here.

For more information contact the author of this alert, John Barlament, at (414) 277-5727 / You may also contact any of the following Quarles & Brady employee benefits attorneys: Marla Anderson at (414) 277-5453 /; Amy Ciepluch at (414) 277-5585 /; Sarah Fowles, at (414) 277-5287 /; David Olson at (414) 277-5671 /; Robert Rothacker at (414) 277-5643 / or your Quarles & Brady attorney.