IRS Issues More “Play or Pay” Guidance

Benefits in Brief reports:

“Shortly before 2012 came to an end, the IRS issued proposed regulations and Frequently Asked Questions concerning the employer “play or pay” provisions of the Affordable Care Act (“ACA”). More formally known as the employer “shared responsibility” requirement, these provisions require that large employers either “play” (by offering health coverage to their full-time employees) or “pay” (in the form of a substantial excise tax). The proposed regulations largely codify guidance provided through four separate Notices issued during 2011 and 2012, though with some important clarifications and modifications.


As explained in our November 2012 article, starting in 2014 a large employer (generally defined as an employer having 50 or more full-time employees during the prior calendar year) could face an annual penalty of $2,000 per full-time employee (in excess of 30) if it fails to offer such employees at least a minimal level of health coverage. Because this penalty would be assessed under Section 4980H(a) of the Tax Code, these regulations refer to it as the “4980H(a) penalty.”

Although an employer may avoid this 4980H(a) penalty by offering health coverage to substantially all of its full-time employees, it may still face an annual penalty of $3,000 for any full-time employee who is eligible for a federal tax credit (or other subsidy) to purchase coverage through an Affordable Health Exchange and elects to decline the employer’s coverage in favor of that Exchange-provided coverage. Because this penalty would be assessed under Code Section 4980H(b), these regulations refer to it as the “4980H(b) penalty.” An employer may avoid this 4980H(b) penalty by ensuring that the coverage it offers is “affordable” by each full-time employee and provides at least “minimum value.”


Counting Full-Time Employees (and FTEs)

In general, an employer is considered “large” for this purpose if it averaged 50 or more full-time employees on business days during the prior calendar year, with “full-time” defined as working 30 or more hours per week. Even hours worked by employees who averaged fewer than 30 hours per week must be counted − and then divided by 120 per month − to determine the number of “full-time equivalent” employees. These full-time equivalents are then added to the actual full-time employee count. Thus, an employer with 45 full-time employees and 10 employees who averaged 15 hours per week would be treated as having 50 full-time employees – and therefore subject to the play or pay mandate.

As is typically the case in the benefit-plan context, the “employer” for this purpose is defined to include all members of a “controlled group” or “affiliated service group.” This is true even for governmental and church employers, though the regulations do allow such employers to apply a good-faith interpretation of the employer aggregation rules. The proposed regulations also require that predecessor and successor employers be considered when applying this 50-employee threshold. (As explained below, a contrary rule applies when determining which member of an employer group might actually owe a 4980H penalty.)

Defining “Employees” and “Hours of Service”

The proposed regulations also provide greater clarity on the proper definition of “employee” and permissible methods of counting “hours of service.” As proposed in Notice 2011-36, the IRS will apply the common-law definition of “employee.” In general, this definition focuses on a service recipient’s ability to control the manner in which an individual performs services. The Preamble to these regulations notes that, under this common-law definition, individuals who are characterized as employees of a staffing agency may in fact be employed by the agency’s clients.

“Hours of service” will be defined, in general, under the definition developed by the Department of Labor in administering ERISA. There are some key modifications, however, as well as special rules applicable to certain types of employers or employees.

For instance, rather than counting the actual hours worked by salaried employees, an employer may apply a daily or weekly “equivalency rule.” Under these rules, employees must be credited with 8 hours of service for each day, or 40 hours of service for each week, during which they complete any hours of service. These two equivalencies are slightly lower than the ERISA equivalencies of 9 hours per day or 45 hours per week.

On the other hand, the regulations make clear that these daily or weekly equivalency rules may not be used if they would substantially understate an employee’s hours of service in a manner that would cause the employee not to be treated as full-time. For instance, an employer could not use the daily equivalency rule for an employee who generally works three 10-hour days per week. Doing so would substantially understate the employee’s hours of service as only 24 hours per week, thereby resulting in the employee not being treated as a full-time employee. There is no similar restriction on the use of the ERISA equivalency rules.

The Preamble also concedes that there are various categories of employees who are simply not compensated on the basis of hours worked. Examples include commissioned sales persons, airline pilots, and adjunct faculty. The IRS continues to request comments on possible rules for counting such employees’ hours of service. In the meantime, employers of such employees must use “a reasonable method for crediting hours of service that is consistent with the purposes of Section 4980H.” The Preamble notes that a method of crediting hours would not be reasonable if it took into account only some of an employee’s hours of service, with the effect of treating as other than full-time a position that traditionally involves more than 30 hours of service per week.

“Seasonal Worker” Exception

The regulations also attempt to clarify a statutory exception from the “large employer” definition for employers utilizing certain “seasonal workers.” (“Seasonal workers” should not be confused with “seasonal employees,” a group to whom a large employer may apply a “look-back/stability period safe harbor” to determine whether an employee’s average weekly work hours equal or exceed 30.) Under this seasonal worker exception, an employer whose work force exceeded 50 full-time employees on 120 or fewer days during the prior calendar year need not comply with these play or pay rules if the only reason the number of full-time employees exceeded 50 was due to seasonal workers.

Rather than applying this seasonal worker exception on the basis of 120 days, the regulations allow an employer to use 4 months. And regardless of whether an employer looks at 120 days or 4 months, the days or months need not be consecutive.

Despite the 120-day (or 4-month) aspect of this seasonal worker exception, the Preamble to the proposed regulations makes clear that even employees working more than 120 days (or 4 months) during a calendar year may still be considered “seasonal.” According to the Preamble, “labor is performed on a seasonal basis where, ordinarily, the employment pertains to or is of the kind exclusively performed at certain seasons or periods of the year and which, from its nature, may not be continuous or carried on throughout the year.” Pending further guidance, employers may apply any reasonable, good-faith interpretation of this definition.

Treatment of Employer Groups

Although all employers within the same controlled or affiliated service group must be aggregated when determining whether the employer group has 50 or more full-time employees, the regulations make clear that the actual play or pay mandate applies separately to each employer within the group. Thus, if one subsidiary offers health coverage to its employees but another subsidiary does not, only the non-offering subsidiary would be liable for the 4980H(a) penalty. Similarly, only a subsidiary employing one or more full-time employees who receive subsidized coverage through an Exchange could be liable for the 4980H(b) penalty. This employer-by-employer approach is a significant exception to the rule generally applied in the benefit-plan context.

This approach also makes it necessary to determine which of the employers within a group will be entitled to the benefit of the 30-employee offset when calculating any 4980H(a) penalty. The regulations provide that this offset amount is to be allocated among all employers within such a group in proportion to each employer’s total number of full-time employees. Each member employer is entitled to claim at least one of these 30 employees, even if it employs fewer than 1/30th of the group’s total full-time workforce. The regulations concede that the effect of this rule could be to give the entire group an offset of more than 30 employees.


The earlier Notices (and particularly Notice 2012-58) had developed a fairly detailed set of “safe-harbor” rules by which an employer could determine which “variable-hour” or “seasonal” employees should be considered full-time under the 30-hour standard. Subject to a number of variations, all of these safe harbors incorporate a look-back period (also called a “measurement period”) and a succeeding “stability period” (during which an employee’s status as either full-time or not full-time would remain in effect). An employer may also insert an intervening “administrative period” of up to three months. These safe-harbor rules were described in greater detail in our September 2012 article. The proposed regulations modify these rules in a number of key respects.

Short-Term Employees

For instance, unless an employee can be characterized (in good faith) as a “seasonal employee,” an employer will not be allowed to assume that he or she will terminate employment before the end of the initial measurement period. Thus, an employee hired into even a short-term position that is expected to involve 30 or more hours of service per week must be immediately treated as a full-time employee, rather than being subjected to a measurement period of up to 12 months during which his or her average weekly hours are determined.

Because this rule did not explicitly appear in Notice 2012-58, it will not apply until 2015. Even during 2014, however, an employer will be able to avoid treating such an employee as full-time only if the employer can point to “objective facts and circumstances specific to the newly hired employee at the start date demonstrating that the individual employee’s employment is reasonably expected to be of limited duration within the initial measurement period.”

Special Rules for Educational Employees

In addition to “variable-hour employees,” the look-back/stability period safe harbors may be applied to “seasonal employees.” The proposed regulations do not even attempt to define this phrase (other than by inserting the word “[Reserved]”). Accordingly, employers are free to adopt a good-faith interpretation of the phrase. However, educational employers should note the following sentence from the regulations’ Preamble: “It is not a reasonable good-faith interpretation of the term seasonal employee to treat an employee of an educational organization, who works during the active portions of the academic year, as a seasonal employee.”

In a related rule, the regulations require that an educational employer continue to treat an employee as working his or her average weekly hours during any “employment break period” of 4 weeks or longer (up to a total of 501 hours per calendar year). An example set forth in the regulations confirms that this rule will effectively preclude the use of a look-back/stability period safe-harbor to characterize an educational employee as less than full-time simply because his or her actual average hours over the course of a 12-month measurement period fall below the 30-hour weekly threshold.

Treatment of “Special Unpaid Leaves”

The regulations also provide similar rules for three types of “special unpaid leaves.” These are unpaid leaves of absence taken under the Family and Medical Leave Act (“FMLA”), the Uniformed Services Employment and Reemployment Rights Act (“USERRA”), or for purposes of jury duty. During any such leave, an employer must treat an employee as continuing to work the average weekly hours the employee actually worked during the remainder of that measurement period. The effect, of course, will be to increase the likelihood of such an employee averaging the 30 or more hours per week needed to have full-time status.

Changes in Employment Status

A number of questions had arisen concerning the application of the safe-harbor rules to employees who experience either a change in employment status during a measurement period (such as by moving between part-time and full-time positions) or a significant period of time with no hours of service. The regulations answer many of these questions.

For instance, if an employee has been hired into a variable-hour position (because it cannot be determined that the employee is reasonably expected to work an average of 30 or more hours per week), but is then transferred or promoted into a position where he or she is reasonably expected to work an average of 30 or more hours per week, the employee must be treated as full-time as of the first day of the fourth month following the change in employment status. (Of course, if the employee actually averages 30 or more hours of service per week during the initial measurement period, the characterization of the employee as a full-time employee must occur by the usual deadline – even if that is prior to the fourth month after the change in status.)

Note that this employment-change rule applies only to new employees. If an ongoing employee experiences a change in employment status during the course of a standard measurement period, an employer may disregard that change (although any increase in the employee’s weekly hours may well affect his or her status during the following stability period).

Treatment of Breaks in Service

The proposed regulations also introduce a “break-in-service” concept to the look-back/stability period safe harbors. If an employee has no hours of service for a period of 26 weeks or more, and then returns to active employment, he or she may be treated as a new employee under the safe-harbor provisions. This means the employee could then be forced to begin a new initial measurement period.

Moreover, an employer may elect to apply a “rule of parity” to any employee who has no hours of service for a period of 4 to 26 weeks. Under this rule, an employee could be treated as a new employee if the period of the break in service exceeds the employee’s period of employment with that employer immediately before the break began. For instance, this rule of parity would allow an employee who had 6 weeks of service, followed by a 10-week break, to be treated as a new employee upon returning to active duty.

The corollary of these break-in-service rules is that any employee whose break does not exceed 26 weeks (or fall within the optional rule of parity) must be treated upon rehire as though he or she had not had any break in service. For instance, if an employee returns to service during a stability period for which the employee had already earned full-time status, he or she must be treated as a full-time employee immediately upon rehire and through the end of that stability period. Such an employee will be treated as having received an offer of coverage upon resumption of service if that coverage is made available as soon as administratively practicable after he or she completes an hour of service.

Special Categories of Employees

The IRS continues to request comments on certain other categories of employees. These include employees hired into positions that, although requiring more than 30 hours of service per week, are either high-turnover in nature or expected to be of only short-term duration. As noted above, however − and solely for 2014 − an employer may take into account a specific employee’s likely short-term employment.

The IRS has also requested further comments on the proper treatment of employees of temporary staffing agencies. The IRS cautions, however, that they are referring only to staffing agencies that are truly the common-law employers of employees placed with the agencies’ employer clients.

Moreover, the IRS has developed certain “anti-abuse rules” designed to prevent employers from circumventing the 30-hour full-time threshold by utilizing two or more staffing agencies to provide the services of the same individual. In effect, all of an individual’s hours of service with one or more staffing agencies and the employer for which the services are ultimately provided would have to be aggregated when applying the 30-hour threshold.


To avoid the 4980H(a) penalty, a large employer must offer health coverage to its full-time employees and their dependents. The proposed regulations offer guidance on a number of aspects of this requirement – sometimes in rather surprising ways.

Dependent Coverage

After confirming that this coverage offer must indeed be made to dependents (despite commenters’ arguments to the contrary), the regulations define a dependent as an employee’s “child” (as defined in Code Section 152(f)(1)) who has not yet attained his or her 26th birthday. In general, Section 152(f)(1) refers to all natural, step, adopted, and foster children. Thus, an employer may not condition a coverage offer on a child’s residency, dependency, or full-time student status. The regulations do allow an employer to rely on an employee’s representations concerning his or her dependents and their ages.

Importantly, the term “dependent” does not include an employee’s spouse. Plans that condition spousal coverage on proof that no other coverage is available to the spouse will thus be free to continue that practice.

If a plan already offers dependent coverage, this requirement will apply without modification as of the 2014 plan year. However, any plan that does not yet offer coverage to employees’ children will have one additional year to come into full compliance − so long as the plan’s sponsor takes steps during the 2014 plan year to begin satisfying this requirement.

Freedom to Accept or Decline Coverage

The regulations also shed some light on the precise meaning of the phrase “offer coverage.” Essentially, the rules developed in connection with Section 401(k) plans will apply here. Thus, for instance, the offer must actually be communicated to employees (which may be done electronically), and the employer must maintain adequate documentation of the offer.

In addition to having an effective opportunity to accept coverage, an employee must have an effective opportunity to decline any offer of coverage that either is not “affordable” or fails to meet the “minimum value” requirement. This means an employer may not cause an employee to be ineligible for a tax credit to purchase coverage through an Exchange − thereby insulating the employer from liability for any 4980H penalty − simply by forcing the employee to accept health coverage that fails to provide minimum value.

“Substantially All” Means 95%

The regulations also adopt a bright-line test for what it means to offer coverage to “substantially all” of an employer’s full-time employees. (The statute actually suggests that all full-time employees must be offered coverage. The more lenient “substantially all” standard was proposed by the IRS in Notice 2011-36.) So long as an employer offers coverage to at least 95% of its full-time employees, it will satisfy this requirement. This is true even if the failure to offer coverage to certain employees was intentional, rather than inadvertent.

An alternative rule would allow an employer to exclude up to 5 employees, even if these would constitute more than 5% of the employer’s full-time work force. Because these rules apply separately to each member of an employer group (some of whom could have fewer than 50 full-time employees), this 5-employee alternative could have broader application than one might at first assume.

Nonpayment of Premiums

The regulations even address the question of whether an employer may terminate an employee’s coverage for nonpayment of premiums − and still be treated as having “offered coverage” to that employee. Coverage may indeed be terminated for nonpayment of premiums, though only after jumping through the same hoops that apply to the termination of COBRA coverage. These include advance notice of the termination, along with special rules for premium payments that fall short by only an “insignificant” amount. Moreover, even after an employee’s coverage has been properly terminated for nonpayment of premiums, that employee must be offered the opportunity to reenroll as of the first day of the next plan year.


In order to avoid the 4980H(b) penalty, a large employer must offer health coverage that provides “minimum value” and is “affordable.” The minimum value rules are within the purview of the Department of Health and Human Services, which issued proposed regulations in this area on November 26, 2012. These IRS regulations are therefore largely silent on that topic. However, the IRS regulations do speak to the affordability requirement.

In general, coverage is “affordable” if an employee’s share of the premium for employee-only coverage does not exceed 9.5% of his or her household income. Recognizing the difficulty – if not impossibility – of an employer determining an employee’s household income, Notice 2011-73 had proposed a “safe harbor” under which an employer could meet this affordability requirement by limiting an employee’s premium to 9.5% of the employee’s W-2 income. These proposed regulations preserve and clarify that safe harbor, while adding two additional safe harbors.

W-2 Safe Harbor

For instance, the W-2 safe harbor must be based solely on the amount reported in Box 1 of an employee’s W-2. An employer may not increase this amount by any pre-tax contributions made under a cafeteria plan or pre-tax salary deferrals made under a 401(k), 403(b), or 457(b) plan.

Moreover, any employer wishing to rely on this W-2 safe harbor on a prospective basis must ensure that an employee’s contribution does not exceed 9.5% of that employee’s projected Box 1 wages for the year, assuming no increase in pay over the course of the year. There are also monthly proration rules if an employee terminates employment during the year.

Rate-of-Pay Safe Harbor

One of the two new safe harbors for satisfying the affordability requirement is a “rate-of-pay” safe harbor. To rely on this safe harbor, an employer would multiply an hourly employee’s rate of pay as of the first day of the plan year by 130 hours (the ACA threshold for full-time status) and then cap the employee’s monthly premium at 9.5% of that amount. In the case of a salaried employee, the cap would simply be 9.5% of the employee’s monthly salary.

If an hourly employee actually works more than 130 hours during a month, this cap could be well below 9.5% of the employee’s W-2 pay. For instance, an hourly employee might average 176 hours per month (8 hours for each of 22 business days), but this safe harbor would allow an employer to consider only 130 of those hours. For an employee earning $10 per hour, this would make the difference between a premium cap of $167.20 (176 x $10 x 9.5%) and $123.50 (130 x $10 x 9.5%).

Note that the regulations allow the use of this rate-of-pay safe harbor only if an employer does not reduce the hourly wages or monthly salary of an employee during the plan year.

Federal Poverty Line Safe Harbor

The other new option for measuring affordability is a “federal poverty line” safe harbor. This safe harbor relies on the fact that only individuals having a household income of 100% to 400% of the federal poverty level (“FPL”) may be eligible to receive a federal subsidy to purchase coverage through an Exchange. Thus, any employee who is required to pay no more than 9.5% of the FPL should be ineligible to receive a premium subsidy. To rely on this safe harbor, an employer would cap an employee’s share of the monthly health premium at 9.5% of the FPL for a single individual.

For 2012, the FPL for a single individual (in the 48 contiguous states and the District of Columbia) is $11,170. On a monthly basis, this converts to $930.83. So disregarding any inflation adjustment, this safe harbor would require that an employee’s monthly premium for single coverage be capped at $88.43.


Answering a number of questions concerning the mechanics by which any 4980H penalty would be paid, the regulations make clear that no such penalty is payable until it is actually assessed by the IRS. That is, unlike many other penalties in the health care arena (including those addressed in our March 2010 article), employers will have no obligation to self-report and pay this penalty.

Any IRS assessment would occur after the close of a calendar year, and would include an opportunity for the employer to challenge the assessment. As a part of the assessment process, employers will receive a certification that one or more of their employees have received a premium tax credit to purchase coverage through an Exchange.

Consistent with the rule that each member of an employer group is separately responsible for complying with this play or pay mandate, any penalty would be assessed only against the applicable group member, and only that member would be liable for payment of the penalty. Of course, any 4980H penalty would not be tax deductible.


In addition to the transition rules noted above, these regulations (or their Preamble) include the following modifications to the general rules:

  • Although the play or pay mandate is generally effective as of January 1, 2014, employers that sponsored non-calendar-year plans as of December 27, 2012, may not be subject to these penalty assessments until the first day of the plan year beginning in 2014. This relief applies at least to employees who would have been eligible to participate in such a plan (based on the eligibility terms in effect on December 27, 2012). It will also apply to the employer’s other employees – so long as a significant percentage of that employer’s workforce was eligible to participate in the non-calendar-year plan on December 27, 2012.
  • Becoming eligible to enroll in Exchange-provided coverage may not be a permissible basis for allowing mid-year election changes under a cafeteria plan. The proposed regulations therefore create additional election-change opportunities under non-calendar-year cafeteria plans. An employer sponsoring such a plan may amend the plan to allow for a mid-year election change to add, drop, or modify health coverage as of January 1, 2014. Any such amendment must be adopted by the end of the 2014 calendar year.
  • Another transition rule would allow an employer to adopt a 12-month stability period for the 2014 plan year (under a look-back/stability period safe harbor) without also adopting a 12-month measurement period for that year. This is an exception to the usual rule that a stability period may be no longer than the preceding measurement period. Under this transition rule, an employer may adopt a measurement period of as few as 6 months (and still have a 12-month stability period), so long as that measurement period (i) begins no later than July 1, 2013, (ii) includes 6 or more consecutive months, and (iii) ends no more than 90 days before the first day of the plan year beginning in 2014. Employers that are not yet counting hours of service by their variable-hour or seasonal employees may wish to take advantage of this transition rule in order to retain the right to use a 12-month stability period in 2014.
  • A similar transition rule allows an employer to determine whether it meets the 50-employee threshold for a “large employer” during 2014 by reference to any consecutive 6-month period during 2013. Without this transition relief, the entirety of calendar-year 2013 would have to be considered when determining whether an employer is subject to the play or pay mandate for 2014.


Although these regulations are only proposed, employers may rely on them pending the issuance of final regulations. Any such regulations will be only prospectively effective, and they will provide employers with sufficient time to come into compliance. Accordingly, employers should not wait for those final regulations before taking the following steps:

  • Determine whether the employer (including all affiliates) meets the 50-employee threshold for a “large employer,” to which the play or pay rules apply.
  • Assuming the rules do apply, decide whether to “play” or “pay.” Note that this decision may require input from a number of parties – including legal counsel, accountants, and insurance brokers.
  • Also determine which, if any, of the transition rules should be relied upon.
  • If planning to take advantage of a look-back/stability period safe harbor, select measurement, stability, and administrative periods for both new and ongoing employees.
  • Determine the approach to be followed in counting each employee’s hours of service, and then begin counting those hours for the applicable measurement periods.
  • Coordinate with any insurer or third-party administrator to verify that they can support the desired approach for complying with this play or pay mandate.
  • Determine whether each health plan satisfies the “minimum value” requirement, as well as which of the three affordability safe harbors would make most sense for the employer’s work force.
  • Stay tuned for further guidance from the IRS and other federal agencies.”