2013-Issue 25—The Affordable Care Act, which became law in 2010, radically changes how U.S. companies will provide healthcare benefits to employees. The Act is designed to phase in changes over time, with many of the major changes, including the Play or Pay rules and Individual Mandate becoming effective in 2014.
This edition of Tax Advisor Weekly describes, in plain English and with multiple examples, a few ways the new Play or Pay rules and Individual Mandate will affect employers and employees in 2014. Specific terms are defined at the end of the article.
The Play or Pay rules require large employers to pay a penalty tax if they do not offer qualified healthcare coverage to a sufficient number of full-time employees. The Individual Mandate requires individuals to pay a penalty tax if they fail to obtain health insurance.
The following examples show the interplay between these rules.
Example 1: No Employer-Provided Coverage
Douglas Company has 100 full-time employees, including Jack and Sarah. Douglas Company does not intend to offer health insurance in 2014. Jack earns $50,000 per year and is single. Sarah earns $30,000 per year and is single.
Application of Play or Pay Rules to Douglas Company
Because Douglas Company is a large employer that does not offer minimum essential coverage to employees, it will be subject to potential penalty taxes. If one or more full-time employees receive subsidized coverage through an "exchange" (an online marketplace — see definition below) during 2014, Douglas Company will be subject to a nondeductible IRC Section 4980H(a) Penalty Tax of $140,000 [$2,000 x (100 full-time employees - 30) = $140,000]. The IRS will notify Douglas Company when the penalty tax applies. The tax is not paid when the company's tax return is filed but is instead paid when assessed by the IRS.
Application of Individual Mandate to Jack
The Individual Mandate requires that Jack obtain health insurance. Jack can purchase health insurance through an exchange. As Jack's compensation is greater than four times the federal poverty level, he will not be entitled to a premium subsidy. Jack will pay the full premium. Alternatively, he may choose to purchase his health insurance outside the exchange.
If Jack chooses to forgo health insurance in 2014, he will be subject to a $400 penalty tax. His penalty tax will be the greater of $95 or 1 percent of household income over the income tax filing threshold for a single person. The penalty is computed as follows: $50,000 less $10,000 (an approximation of the 2014 filing threshold for a single person) = $40,000 times 1 percent = $400. He will pay this tax when he files his 2014 personal tax return. Jack may avoid this tax if he is otherwise covered under a parent's insurance, TRICARE, Medicare or Medicaid.
Application of Individual Mandate to Sarah
Sarah has the same options as Jack. At her current salary of $30,000, Sarah is eligible to receive a premium subsidy through the exchange because her income is less than four times the federal poverty level. The subsidy will reduce her premium for silver coverage to about 8 percent of her salary (about $200 per month). Sarah's subsidy is recalculated annually and may increase or decrease each year based on Sarah's future income. Sarah's subsidy is an advance tax credit that is paid directly to the insurance company. The subsidy effectively reduces Sarah's monthly medical premiums during 2014.
If Sarah chooses to forgo health insurance, Sarah will pay a penalty of $200 ($30,000 - $10,000 = $20,000 x 1 percent = $200).
Example 2: Employer Provides Health Insurance Coverage
Allis & Sons, Inc. has 200 full-time employees, including Don and Reba. Allis & Sons, Inc. offers qualified healthcare coverage to all full-time employees. Don, a full-time employee, earns $28,000 annually and is married without children. Reba, a full-time employee, earns $52,000 annually and is single.
Application of Play or Pay Rules to Allis & Sons, Inc.
Because Allis & Sons, Inc. offers qualified healthcare coverage to more than 95 percent of the full-time employees, no Play or Pay penalty tax applies.
Application of Individual Mandate to Don and Reba
Don and Reba can purchase the qualified healthcare coverage offered by Allis & Sons, Inc. Alternatively, both could purchase health insurance through an exchange or outside an exchange, but if they do, they will have to pay the entire premium. Reba is not eligible for a premium subsidy because her income is greater than four times the federal poverty level and she has access to qualified healthcare coverage through her employer. Don is not eligible for a subsidy even though his compensation is less than four times the federal poverty level because his employer is offering qualified healthcare coverage.
If Don or Reba decides to forgo health insurance, they will be subject to a penalty tax equal to 1 percent of their household income over the applicable income tax filing threshold unless they are covered under another policy, such as a parent's or spouse's policy, TRICARE, Medicare or Medicaid. The penalty tax will be reported on their 2014 personal tax return. The penalty tax will increase in future years as shown below:
Penalty Tax Phase-In
2014: Greater of 1 percent of household income above the filing threshold or $95
2015: Greater of 2 percent of household income above the filing threshold or $325
2016: Greater of 2.5 percent of household income above the filing threshold or $695
2017 and beyond: Indexed for inflation from $695
Example 3: Controlled Group Provides Coverage to Some Employees
RobCo has 40 full-time employees, does not sponsor a health plan and owns 100 percent of Casburn, Inc. Casburn, Inc. has 35 full-time employees and sponsors a health plan that offers qualified healthcare coverage to all full-time employees. During 2014, RobCo receives notice that at least one full-time employee has obtained subsidized health insurance through an exchange during 2014.
Application of Play or Pay Rules to RobCo and Casburn, Inc.
RobCo and Casburn, Inc. are members of a controlled group that has more than 50 full-time employees. As a result, the two companies are considered large employers subject to the Play or Pay rules. However, the Play or Pay penalty tax is applied separately to each of the companies. When calculating the penalty tax, the 30-employee reduction is allocated pro-rata between members of a controlled group. RobCo will therefore reduce its full-time employee count by 16 and will be subject to a $48,000 Play or Pay penalty tax. Because Casburn, Inc. offers qualified healthcare coverage to 95 percent of its full-time employees, the Play or Pay penalty tax will not apply.
Application of Individual Mandate to Employees of RobCo and Casburn, Inc.
Employees of RobCo, although not afforded the opportunity to purchase health insurance through their employer, are still required to obtain health insurance. RobCo employees can obtain their health insurance through an exchange or outside an exchange. If otherwise eligible for a subsidy, employees of RobCo who obtain health insurance through an exchange will receive a subsidy.
Full-time employees of Casburn, Inc. are not eligible for a subsidy because they are being offered employer-sponsored qualified healthcare coverage. These employees can still choose to forgo their employer-sponsored health insurance and purchase their own coverage through an exchange or outside an exchange. If they do, they will have to pay the entire premium themselves.
Employees of RobCo and Casburn, Inc. who choose to forgo insurance coverage entirely in 2014 will be subject to the Individual Mandate penalty tax equal to the greater of $95 or 1 percent of household income over their income tax filing threshold.
This article addresses only one of the two penalty taxes that are applicable to large employers under the Play or Pay rules. Large employers that offer health insurance that qualifies as minimum essential coverage but fails to satisfy minimum value standards or affordability requirements will be subject to the IRC Section 4980H(b) Penalty Tax, an alternative penalty tax.
Alvarez & Marsal Taxand Says:
- Although compliance responsibility for the Affordable Care Act requirements usually resides in a company's human resource department, tax directors should understand their company's healthcare strategy, the tax and accounting ramifications, the potential compliance failures, and business practices that introduce unnecessary risk.
- It is time to make sure you identify all employees who could cause your company to run afoul of the Affordable Care Act Play or Pay rules. An analysis of your company's control group status is critical to avoiding unexpected penalties.
- Companies that use independent contractors are receiving additional scrutiny from the IRS because some companies will attempt to avoid the Play or Pay penalty tax by classifying employees as independent contractors.
- The opportunity to plan for 2014 is quickly slipping away. The 2014 open enrollment for exchanges begins October 1, 2013.
Affordable Care Act:
Also known as the Patient Protection and Affordable Care Act. The Affordable Care Act is a United States federal statute signed into law on March 23, 2010. The Affordable Care Act represents the largest government overhaul of the healthcare system since the passage of Medicare and Medicaid in 1965.
An online marketplace for health insurance operated by the state (or federal government in states that do not have a marketplace) where individuals or small businesses can purchase qualified healthcare coverage.
Federal Poverty Level:
A measure of income level issued annually by the Department of Health and Human Services. An employee may be eligible for a subsidy if the household income is less than four times the federal poverty level. The federal poverty level in 2013 for a one-person household in the contiguous U.S. is $11,490, with an additional $4,020 added for each additional member of the household.
Full Time Employee:
Generally, an employee who works on average, 30 or more hours per week.
Beginning in 2014, individuals are required to obtain health insurance or they are subject to a penalty. In 2014, the penalty is the greater of $95 or 1 percent of household income in excess of the income tax filing threshold. Note that the penalty tax is actually computed in monthly increments. The penalty tax will be paid when the individual files his or her 2014 personal income tax return.
IRC Section 4980H(a) Penalty Tax:
This penalty applies if a large employer fails to offer minimum essential coverage to 95 percent of full-time employees and their dependents and one or more full-time employees receives a subsidy. To compute the penalty, you take the total number of full-time employees, reduce that number by 30, and multiply by $2,000. Note that the penalty tax is actually computed in monthly increments.
IRC Section 4980H(b) Penalty Tax:
This penalty applies if a large employer offers minimum essential coverage to 95 percent or more full-time employees but the plan does not satisfy the minimum valuation or affordability requirements of the Affordable Care Act. The minimum valuation requirement is satisfied if the plan pays at least 60 percent of the cost of covered benefits for the standard plan participant. The affordability requirements are satisfied if the employee's share of the premiums for employer-sponsored insurance does not exceed 9.5 percent of household income. To calculate the penalty amount, multiply the number of full-time employees who receive a subsidy during 2014 times $3,000. Note that this penalty tax is actually computed in monthly increments.
Generally, any organization that employs 50 or more full-time employees or equivalents. Note that controlled and affiliated service groups are aggregated for purposes of determining whether a company or group of companies is a large employer.
Minimum Essential Coverage:
Generally, the following benefits must be provided with no annual limits: ambulatory services, emergency services, hospitalization, maternity and newborn care, mental health and substance abuse services, prescription drugs, laboratory services, pediatric services including oral and vision care, preventative and wellness services, and chronic disease management.
Play or Pay:
Beginning in 2014, large employers that fail to offer qualified healthcare coverage to at least 95 percent of their full-time employees will be subject to a penalty under Internal Revenue Code sections 4980H(a) or (b).
Qualified Healthcare Coverage:
Healthcare coverage that satisfies the Affordable Care Act requirements pertaining to minimum essential coverage, minimum value standards and affordability requirements.
Silver coverage is an insurance plan offered through an exchange that provides the minimum essential coverage and has an actuarial value of 70 percent. A 70 percent actuarial value means that on average the plan pays 70 percent of the cost of covered benefits for a standard population of enrollees. Exchanges will offer four levels of coverage, each that provides a different level of actuarial value. Bronze will offer 60 percent, silver 70 percent, gold 80 percent, and platinum 90 percent.
A tax credit available to eligible individuals who have earnings between 100 and 400 percent of the federal poverty level and who purchase their health insurance through the exchange. The tax credit is paid directly to the insurance provider and effectively reduces monthly premiums.
Senior Director, Dallas
+1 214 438 1017
Jack Raksnis, Associate, contributed to this article.
For More Information
Managing Director, Dallas
+1 214 438 1013
Managing Director, Dallas
+1 214 438 1028
Senior Director, Dallas
+1 214 438 1037
+1 212 763 1878
+1 214 438 1032
As provided in Treasury Department Circular 230, this publication is not intended or written by Alvarez & Marsal Taxand, LLC, (or any Taxand member firm) to be used, and cannot be used, by a client or any other person or entity for the purpose of avoiding tax penalties that may be imposed on any taxpayer.
The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisors. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisors before determining if any information contained herein remains applicable to their facts and circumstances.
About Alvarez & Marsal Taxand
Alvarez & Marsal Taxand, an affiliate of Alvarez & Marsal (A&M), a leading global professional services firm, is an independent tax group made up of experienced tax professionals dedicated to providing customized tax advice to clients and investors across a broad range of industries. Its professionals extend A&M's commitment to offering clients a choice in advisors who are free from audit-based conflicts of interest, and bring an unyielding commitment to delivering responsive client service. A&M Taxand has offices in major metropolitan markets throughout the U.S., and serves the U.K. from its base in London.
Alvarez & Marsal Taxand is a founder of Taxand, the world's largest independent tax organization, which provides high quality, integrated tax advice worldwide. Taxand professionals, including almost 400 partners and more than 2,000 advisors in 50 countries, grasp both the fine points of tax and the broader strategic implications, helping you mitigate risk, manage your tax burden and drive the performance of your business.