In 2014, employers will first become responsible for payments for “shared responsibility” for health care coverage, or what is increasingly being called the “Employer Shared Responsibility Tax” (ESRT), as a part of the PPACA legislation, under the new IRC Section 4980H. The ESRT is also known as the “play or pay” tax, as it effectively requires employers to either “play” by offering employee health care, or pay a tax for failing to do so. The ESRT will apply to so-called "large employers" with more than 50 full-time (equivalent) employees.
What's significant about the ESRT, though, is the fact that while it does represent a potential new tax to manage or avoid, the reality is that for many employers the penalty tax may be less expensive than sharing in the cost of employee health care... which means over time, employers may increasingly choose to just pay the penalty and let their employees get their own coverage. While in the past this wasn't feasible - simply because health insurance was often viewed as a "mandatory" employee benefit, especially for highly competitive job markets or positions - the reality is that employees (and non-employees) will be able to get guaranteed issue insurance for standard policy types and rates without any limitations on pre-existing conditions beginning in 2014. Which means, simply put, that employees will no longer need to rely on employers for health insurance, at the same time that employers may find its cheaper to just pay the penalty and stop offering coverage to employees.
In the meantime, though, the transition may be challenging for employers, which must make a decision by the end of the year whether to change their approach to health insurance in 2014, and make some significant decisions with big economic ramifications (not to mention simply ensuring they properly comply with the rules so they don't offer health insurance to employees AND pay a penalty!). Nonetheless, the onset of the ESRT may mark the beginning of the end of health insurance being tied to employment, where employers instead just pay employees a little more (or not), and let them make their own health insurance choices. And although this may be a difficult transition for employees as well, in the long run many individuals may actually enjoy the greater flexibility to change jobs, start businesses, or just retire early, in a world where employment is simply no longer a requirement to get access to health insurance.
Employers Subject to ESRT
The new ESRT will apply to “large employers,” which are defined as those who have 50 or more full-time-equivalent (FTE) employees in the prior year.
To determine whether an employer has a total of 50 FTE employee, anyone who works for at least 30 hours per week is deemed “full time”. For part-time employees, the employer is required to add up all of their hours worked for the month, and divide by 120; thus, an employer that had 10 employees who worked half-time at 15 hours per week would have a total 600 hours of part-time employees, which divided by 120 would equal 5 FTE employees. The calculation is done for each month of the year, and if the average FTE employee count across all 12 months adds up to more than 50 employees, the employer is subject to the ESRT rules. Exceptions apply for seasonal workers, or if the employer is only above the 50-FTE count for fewer than 4 months (120 days) of the year.
Employers with fewer than 50 full-time equivalent employees would not be subject to the ESRT rules.
The preceding test to measure whether the business is an “applicable large employer” is simply to determine if the company may be potentially subject to an ESRT liability. Whether the tax is actually triggered or not depends on whether either the employer fails to offer “minimum essential health care” coverage to all full-time employees (working more than 30 hours per week) and their dependents, or offers “unaffordable” coverage to full-time employees and their dependents. Coverage will be deemed unaffordable if the cost for employee-only coverage exceeds 9.5% of the employee’s compensation (which, notably, means the total cost of spouse and family coverage may still exceed this threshold). Notably, there are also minimum requirements for what the plan must offer, although in practice all health care coverage will likely be adjusted to ensure it meets those “minimum essential health care” and “minimum value” plan requirements.
Notably, in the case of triggering the ESRT for an employer not offering coverage at all, the tax is technically only triggered if coverage is not offered to all full-time employees and at least one of those full-time employees enrolls in health insurance through an insurance exchange and that employee is eligible for a cost-sharing subsidy. Thus, even for applicable large employers, if the only employees not covered either: 1) don’t buy their own health insurance (for instance, because they’re covered through a spouse); or 2) buy their health insurance through an exchange but have enough income to be ineligible for the premium assistance tax credit or other subsidies, then the ESRT will not apply. On the other hand, it’s important to note that it only takes one employee not offered coverage who enrolls for his/her own health insurance with premium assistance to trigger the tax.
In the context of triggering the ESR due to coverage being offered by unaffordable, again the ESRT is not actually triggered until at least one full-time employee actually enrolls in health insurance through an exchange and receives a cost-sharing subsidy. However, employees who are offered employer-sponsored coverage are initially ineligible for any cost-sharing subsidies on the exchange by default, and can only receive assistance by obtaining an “affordability waiver” from the exchange (by showing that the employer coverage is “unaffordable” because the employee-only portion of the coverage costs more than 9.5% of the employee’s compensation or fails to provide minimum essential health care coverage). Thus, in practice, for the “unaffordable coverage” trigger to occur, the employee must get coverage through the employer, find that it’s unaffordable (or fails to cover the required essentials), document to the insurance exchange that it’s unaffordable, receive an affordability waiver, and then actually be eligible for cost-sharing subsidies from the exchange itself under the normal rules. If at least one full-time employee of an applicable large employer goes through this process and receives insurance from the exchange along with premium assistance tax credits, the ESRT will be triggered.
Calculating The ESRT
The rules for calculating the actual amount of the ESRT vary depending on whether the employer failed to offer coverage at all, or offered coverage that was deemed unaffordable.
ESRT For Failure To Offer Coverage
If a full-time employee enrolls for health insurance on an exchange and qualifies for premium assistance after not being offered health insurance by the employer at all, the ESRT penalty is applied monthly and is calculated as $166.67 multiplied by the total number of full-time employees (reduced by a flat 30 employees). Only full-time employees who work more than 30 hours/week are counted (i.e., the penalty is based on the actual number of full-time employees, not full-time equivalents).
Thus, for instance, if the firm had 100 full-time employees and 20 part-time employees working half time (110 full-time equivalent employees), the monthly penalty would be 100 (actual full time employees) – 30 (flat reduction amount) = 70 x $166.67 = $11,666.90/month.
Notably, the penalty applies based on all full-time employees, even if only one employee isn’t covered and gets coverage through an exchange; as a result, employers will likely either go all-or-none in offering coverage to full-time employees (or will have to be very careful to ensure that any full-time employees who aren’t covered won’t need to get it from the exchange and be eligible for cost-sharing subsidies).
ESRT For Offering Unaffordable Coverage
If “unaffordable” coverage is offered, the monthly ESRT penalty is equal to $250 multiplied by the number of full-time employees who actually received coverage, with premium assistance tax credits or other cost-sharing subsidies, through a health insurance exchange. Thus, unlike the ESRT penalty for failing to offer coverage, the unaffordability penalty is triggered only for the actual number of employees impacted, not all full-time employees. The ESRT penalty for unaffordable coverage is capped at the maximum penalty that could have applied if coverage wasn’t offered at all; thus, applicable large employers essentially pay the lesser of either $250 multiplied by the number of affected full-time employees, or $166.67 multiplied by the total number of full-time employees (reduced by 30).
Strategies For Planning Around ESRT
The bottom line for managing the ESRT is that applicable large employers can avoid the tax by offering coverage to employees, and ensuring that the employer covers enough of the cost that the employee’s share of employee-only costs will not exceed 9.5% of the employee’s compensation (and assuming the coverage offered meets the minimum value requirements in the first place). And of course, if the employer doesn’t have enough ongoing full-time equivalent employees to be characterized as an applicable large employer, they’re not potentially subject to the ESRT in the first place.
However, the reality is that for many employers, avoiding the ESRT may not actually be the preferred route. After all, offering health insurance to employees can be very expensive, especially if employers must effectively cap the employee-only premiums at 9.5% of their compensation and pay any excess on behalf of employees to avoid having coverage deemed “unaffordable”. Given that the penalty is “only” $250/month per employee for offering unaffordable coverage, or $166.67/month per employee for simply not offering coverage at all, many firms may simply choose to pay the penalty as a cheaper alternative to subsidizing health insurance premiums and offering benefits to employees directly. Notably, the ESRT penalty is not tax deductible, while health insurance premiums are deductible, so employers need to have a significant amount of cash flow savings by paying the ESRT to make the choice worthwhile; nonetheless, given the high and rising costs of health care, this may indeed be an appealing course of action for many employers. And given that the $166.67/month and $250/month ESRT penalty amounts are not indexed for inflation, as health insurance rises over time – and the potential share employers must pay along with it – there is an increasing likelihood that at some point, most employers will simply choose to pay the “penalty” tax as a cost of doing business, rather than offering health insurance directly.
In the past, employers dropping coverage was not an option, as having access to health insurance through an employer was vital to employees obtaining coverage, at reasonable rates, and without exclusions for pre-existing conditions. But with the rise of health insurance exchanges, with uniform pricing, guaranteed issuance, and no limitations for pre-existing conditions, access to health insurance through an employer will simply no longer be a necessity; it will simply be a choice. Employees can get coverage through an employer, or via a health insurance exchange, with what should be roughly similar pricing, features and benefits, and no restrictions. The only benefit of getting coverage through an employer will be the possibility that the employer subsidizes enough of the cost to make it more affordable.
Accordingly, some employers may even choose to provide some of the savings back to employees for “just” paying the penalty instead of health insurance itself. For instance, if the employer was paying 80% of the cost of family coverage, which might have been $4,000/year for the employer for a $5,000/year policy, and the ESRT penalty is only $166/month x 12 months = $2,000/year, the employer might decide to share some of the $2,000/year savings with employees; for instance, eliminating health insurance, but giving all employees a $1,500/year raise to help them afford their own coverage. The net cost to the employer might be similar (given the difference in tax treatment between insurance payments and paying the penalty), and employees might be better or worse off, depending on what kind of coverage they bought… but at least the choice would be theirs.
In the transition process, some employees may be unhappy with such a change, especially if the immediate result is that the cost for their own coverage – even with some compensation raise from the employer – is more than the employee was previously used to paying. To say the least, employers looking to transition to the ESRT will face significant communication challenges with employees. But on the other hand, employees that obtain their own coverage through the health insurance exchange can also be comforted by the fact that choosing to change jobs will have no impact on their health insurance coverage! In other words, the upside of separating insurance from employment and just letting employees buy their own is that employees gain the flexibility and freedom to make decisions about where to work, what company to work for, what job to take, etc., regardless of the availability of health insurance because they’ll already have it directly through an exchange! In point of fact, this may make some clients more willing to change jobs, start businesses, or simply retire early, knowing that they will have guaranteed access to health insurance at standard rates with no limitations for pre-existing conditions, regardless of their employment.
In the long run, it actually appears quite likely that the ESRT penalty will be the beginning of the end of getting health insurance through employers at all. As the cost of coverage increases over time, while the penalty remains level, employers will simply find it’s more and more affordable to just pay employees a little more, and let them get their own health insurance directly, and employees will simply judge the value of working for various employers by the total cash compensation they receive, not by the often-poorly-understood value of their health insurance benefits.