Editor’s note: This is part 1 of a two-part post by Timothy Jost describing the Internal Revenue Service’s final rule implementing the Affordable Care Act’s employer responsbility requirement. Part 2 will appear later today or tomorrow.

It is arguable that as of early February 2014, the most important missing piece of the 2014 Affordable Care Act implementation puzzle was the final employer responsibility rule.  The ACA’s market reform, premium tax credit, qualified health plan, and exchange provisions have been in effect, more or less, since the beginning of January, and, although new guidance continues to emerge, the basic rules for these programs have been in place for months.  The individual responsibility rule is also in effect, although individuals covered by the rule still have until March 31 to get coverage and those who fail to comply will not pay the penalty until 2015.  But the employer responsibility requirement, which was delayed until 2015 in July, has remained in limbo.

On February 10, 2014, the Internal Revenue Service released the final employer responsibility rule, together with a fact sheet and a series of questions and answers about the rule.  The rule finalizes rules proposed late in December 2012 and analyzed at that time.

The employer mandate plays a vital but secondary rule in the Affordable Care Act scheme.  Our current health care financing system is overwhelmingly employment based.  171 million Americans are currently covered by employment-based coverage, compared to only 11 to 13 million in the individual market.  Virtually all (99 percent) of large firms (200 plus workers) offer health insurance to their employees.

The primary goal of the ACA is to extend the individual market through premium tax credit subsidies, the individual responsibility provision, guaranteed issue and the elimination of underwriting for preexisting conditions, and the exchanges, with the goal of  reducing the number of Americans who are uninsured (currently around 48 million). But if employers who now offer health insurance to their workers would decide to cease doing so, essentially making their employees go to the exchanges and purchase health insurance using federal premium tax credits, the cost of the ACA would expand dramatically and many Americans would see their coverage disrupted.

The ACA’s employer responsibility provisions, are intended therefore to keep large employers in the game — to require them to pay a penalty if they do not offer affordable and adequate coverage to their full-time employees.  Small employers, who are less likely to offer coverage (only 45 percent of employers with fewer than 10 employees offer coverage) face no penalties for not offering coverage.  Also, no employer is required to offer coverage to part-time workers.

Contrasting the employer responsibility and individual responsibility requirements.  It is important to realize, however, that the employer mandate is only a marginal incentive.  Employers have overwhelmingly offered health coverage heretofore not because they were legally required to do so, but because health insurance is an expected employee benefit in the United States and is heavily subsidized by the federal and state governments.  Employers offer health insurance primarily for employee recruitment and retention.  Employee health benefits are also not subject to federal or state income or payroll taxes, making a dollar spent on health benefits much more valuable than a dollar spent on wages.   Health coverage also increases productivity and decreases absenteeism.

Even without the employer responsibility penalty, therefore, most large employers would in the short run continue to offer coverage.  A year or two delay in the imposition of the mandate, therefore, is likely to have a trivial effect on insurance offer rates, as the Congressional Budget Office noted after the July postponement.  A total repeal of the requirement, however, would have a much larger effect over time.

The employer responsibility provision is very different from the individual responsibility provision in this respect.  The employer mandate is there simply to discourage employers from dropping coverage, which they would probably continue in any event.  The individual mandate is necessary to convince Americans who can afford coverage but would otherwise not buy it to take the affirmative step of purchasing coverage.  Delay of the individual mandate would have a much greater effect on coverage.

The employer mandate requires large employers to offer affordable and adequate insurance coverage to their full-time employees and their employee’s dependents or pay a penalty.  The law actually imposes two different penalties.  Under the statute, large employers that fail to offer “minimum essential coverage” to their full-time employees and dependents must pay a $2,000 penalty for every one of their full-time employees over the first 30 if any employee receives premium tax credits through the exchange (the 4980H(a) penalty).  Large employers that fail to offer full-time employees coverage that is affordable (costs no more than 9.5 percent of an employee’s household gross income) and adequate (covering 60 percent or more of medical costs on average) face a $3,000 penalty for each individual employee who obtains premium tax credits (the 4980H(b) penalty).  Small employers — employers with fewer than 50 full-time and full-time equivalent employees — are not required to offer coverage and are not subject to these penalties.

Employees who are offered affordable and adequate coverage by their employees are ineligible for premium tax credits.  Employees who accept an offer of employee coverage, even if it is not affordable or adequate, are also ineligible.  Employees who are not offered coverage, or who are offered coverage that is not affordable or adequate, may be eligible for premium tax credits if their household income is between 100 and 400 percent of the poverty level and they are not eligible for public insurance coverage.  Employees whose income is below 138 percent of poverty in states that have expanded Medicaid are eligible for Medicaid, even if their employer offers coverage.  Employers are not penalized for employees who receive Medicaid coverage.

What’s in the rule?  The final rule addresses four major issues that must be resolved for the employer responsibility provision, as described above, to be implemented.  The first is how to determine whether an employer is a large employer subject to the requirement or a small employer that need not offer coverage. The second issue is how to determine whether an employee is full-time and thus must be offered coverage, or part-time and not covered by the mandate.  Third, the rule describes the circumstances under which the $2,000 and $3,000 penalties will be applied.  Fourth, the rule lays out various transition provisions intended to smooth the implementation of the coverage requirement in situations where it might be particularly disruptive.  Throughout, the rule is attentive to very specific situations — such as those of seasonal workers, volunteer fire fighters, adjunct instructors, airline pilots, or home care workers — where employees do not work in traditional employer-employee relationships and 40 hour a week settings.

Controversy over transitional provisions.  Coverage of the rule in the media is focusing on the final issue, transition.  Although the rule contains a number of transition provisions described further below, three provisions are the most dramatic.  First, the rule postpones until 2016 the application of the mandate for employers with between 50 and 99 employees, as long as employers do not intentionally reduce their workforce to avoid the rule.  Second, the rule extends for a year transition relief originally available for 2014, allowing employers who have not heretofore offered affordable and adequate dependent coverage an additional year until 2016 in which to add it.  Third, the rule will not penalize large employers that cover at least 70 percent of their full-time employees for 2015, giving them until 2016 to cover 95 percent of their full-time workers.  Other transition rules, discussed below, affect new employers and employers with non-calendar year benefit plans.

Questions will undoubtedly be raised again as to the legality of these delays.  The Treasury Department has long claimed that it has authority under its rulemaking power to adopt transitional provisions to relieve the burden of transitions — authority that has been invoked by earlier administrations, Republican and Democratic.  A lawsuit challenging the delay of the employer mandate was dismissed in January, although the dismissal was based on the fact that the plaintiff had not been injured by the delay, not on the IRS’s authority to delay the mandate.

The transitional provisions are obviously a response to concerns raised by employers and no doubt take into account the difficult political circumstances of moderate Democrats in the mid-term elections.  But they will also benefit employees and consumers.  The transition provisions, as well as the definitions of part-time work, will result in fewer reductions in hours for employees currently working less than 40 but more than 30 hours a week.  The delay in the dependent coverage requirement will soften at least temporarily the effects of the “family glitch” which bars families from getting premium tax credits in situations where sole-employee coverage is affordable but family coverage is not.  Dependents not offered coverage will be eligible for premium tax credits even if the employed member of a family is not.

Determining whether an employer is a large employer.  The first question addressed by the rules is when is an employer a large employer.  Although generally under the ACA, a large employer is an employer with 100 or more employees (50 or more prior to 2016 in most states), for purposes of the employer responsibility provision, a large employer is an employer with at least 50 full-time or full-time-equivalent employees.  Thus, an employer with 40 full-time employees and 20 half time employees would be a large employer.

The number of full-time and FTE employees is calculated for each month and averaged across the year to determine whether an employer is a large employer for the following year.  If an employer exceeded 50 employees for 120 days or fewer during a year, and if the excess employees during that 120 days were seasonal workers (workers who perform work on a seasonal bases or retail workers during a holiday season), the employer will not be considered a large employer. Employers may apply a reasonable, good faith interpretation of “seasonal worker.”  The size of employers not in existence in a prior year will be determined based on its reasonable expectations as to number of employees for the first year of existence.  Employers who were small employers in one year and become a large employer the next year will not be penalized if they fail to offer coverage for the first three months of the year that they become large employers if they offer coverage by the fourth month.

For purposes of determining large employer status, full-time employees are determined by the monthly measurement method, described below.  Employers may not use the look-back method, described below, which can be used for determining whether an employee is a full-time employee for purposes of the coverage requirement.  Employees who work 30 hours a week or 130 hours a month are considered full-time employees.

The number of an employer’s full-time equivalent employees is determined by adding the total number of hours worked by part-time employees in a month (up to 120) and dividing by 120 (not 130, the number used for determining full-time employment).  Hours are counted during which an employee is on paid leave, such as vacation or sick leave, but not for unpaid breaks in service.  Employees who work on a non-hourly basis, such as salaried employees, can be credited for actual hours worked or with eight hours of service for each day in which they work and are paid for at least one hour of work, or forty hours of service for each week in which they are paid for at least one hour of work.  Equivalency methods cannot be used if they would result in a substantial undercounting of hours worked for a particular employee (for example, counting 40 hours a week where the employee was in fact working 50 hours a week) or in undercounting for a substantial number of employees.   Different counting methods can be used for different categories of employees as long as the categories are reasonable.

Special rules are applied for counting the hours of particular employees.  Hours of service are not counted for “bona fide volunteers” who are not compensated for their services, even though they receive expense reimbursement, contributions to employee benefit plans, or nominal wages. This exception covers volunteer firefighters and emergency responders, but also volunteers for non-profit organizations.  Hours of work-study students are not counted, although hours of other student employees are.  Hours of student interns and externs are not counted if they are not paid for their time, but are otherwise counted.  Hours of members of a religious order subject to a vow of poverty are not counted when they are performing duties of members of the order.

Particular categories of employees have posed special difficulties for the hour counting rules.  These include adjunct faculty, employees (such as airline pilots) with layover hours, employees who have on-call duty, and commissioned salespeople.  In general, employers must use a reasonable method for counting employees.  Employers of adjunct faculty may count hours by crediting adjuncts with 75 minutes of preparation for every hour of class time, adding to that amount time required to be spent in office hours or meetings.  Employees with layover-hours should be credited for hours for which they are paid, and for at least 8 hours for every day they must stay away from home.  On-call employees should be credited for on-call hours for which they are paid or for which their non-work activities are substantially restricted.

Companies that are owned by a common owner or are otherwise related are treated as a single firm for determining employer size. Employers cannot simply evade the requirement by forming multiple companies.  If an employee works for more than one related employee, hours of service are totaled across all related employers to determine full-time employment.  Penalties, however, are determined separately for each “applicable large employer member,” however, as will be discussed later.  The final rule does not resolve how the aggregation rule will apply to churches or government entities.  Successor employers are considered continuations of predecessor employers.

The employer responsibility requirement applies to non-profit as well as for-profit employers and to federal, state, local, and Indian tribal employers.  In determining large employer status, all employees are counted, even though they may be eligible for Medicare, Medicaid, or coverage under a spouse’s insurance.  Such employees, however, would in most instances not be eligible for premium tax credits, and thus the failure to offer coverage to such employees would not cause the employer to have to pay the employer responsibility penalty (although they would be counted in determining the $2,000 per employee 4980H(a) penalty if an employer fails to offer any minimum essential coverage).

Employees are counted toward the 50 employee threshold even though they are individuals who are not subject to the individual responsibility provision, for example because of the religious conscience or health care sharing ministry exceptions or because they are Indians.  Employees who work outside the United States, including U.S. citizens employed abroad, are not usually counted.

Determining whether an employee is a full-time employee.  An employer determined to be a large employer must offer minimum essential coverage to its full-time employees to avoid the $2,000 per full-time employee penalty (assuming one or more employees gets a premium tax credit)  and affordable and adequate coverage to its full-time employees to avoid the $3,000 per employee penalty for each employee who receives a premium tax credit.  It thus becomes necessary to determine which employees are full-time.

Two different approaches are offered for determining full-time employee status: the monthly measurement and the look-back methods.  Under the monthly measurement method, employees are treated as full-time if they actually work full-time during a particular month, that is 130 hours for a month, or alternatively, 120 hours for a four-week month and 150 hours for a five-week month.  Because the ACA allows a three-month waiting period before coverage begins, employers need not provide coverage until the day after three months have elapsed.  If an employee leaves an employer and then returns, a new three-month waiting period cannot be imposed unless the employee has been absent for at least 13 weeks (26 weeks for an educational institution).

The basic idea of the look-back method is that if an employee is hired as a full-time employee, the employee must be offered coverage after the three-month waiting period, but if it is not known whether an employee will be full- or part-time, the employer can wait and see.  Whether or not an employee is reasonably expected to be full-time is based on the facts and circumstances of the hire, including how the job was advertised and whether employees in comparable positions are full time.  Educational institutions cannot take into account employment-break periods in determining whether an employee is full-time.

If it is uncertain when an employee is hired whether the employee will be full-time or part-time, the employee is considered a variable hour employee.  Variable hour employees (and seasonal employees) may be excluded from coverage until it is established that they are in fact a full-time employees.  Hours of a variable hour employee can be tracked during a measurement period lasting from three to twelve months.  The measurement period can be followed by an administrative period lasting up to 90 days (reduced by any time the employee was employed prior to the beginning of the measurement period).

Upon the expiration of the measuring period and administrative period, a stability period begins, which must last at least as long as the measuring period or six months, whichever is shorter.  If during the measuring period, the employee averaged fewer than 30 hours a week, the employee can be treated as a part-time employee for the duration of the stability period.  If the employee averaged 30 hours a week or more during the measuring period, the employee must be considered full-time for the duration of the stability period.  A new measurement period can be imposed during the stability period, and coverage during a subsequent stability period be based on experience during the new measuring period.

Different measurement and stability periods can be used for hourly and salaried employees, employees in different states, employees subject to collective bargaining and those not subject to collective bargaining, and for different collective bargaining units.  Employers cannot generally, however, switch back and forth and must apply the rules uniformly within categories.  The look-back approach can also be used for determining whether seasonal employees (employees expected to be employed for six months or less but who are rehired annually for the same period of time) are full- or part-time employees.

Special considerations apply for temporary staffing agencies, although they are basically held to the same rules.  In particular, employers cannot hire employees part time who are also placed with the employer part time through a temporary staffing agency or use employees working part time for two or more temporary staffing agencies.  Special rules also apply for measuring time during the measuring unit for employees on special unpaid leave (such as family leave, military leave, or jury duty) and for breaks in employment for educational institutions.   No special treatment is provided, however, for short-term and high-turnover employees, beyond the general three-month waiting period provision.

If a seasonal or variable hour employee is upgraded to full time, coverage must begin after a three month waiting period.  If a full-time employee becomes part-time, coverage may be terminated after three months of actual part-time work.

Ordinarily, an employee who leaves employment will not be treated as a new hire if the employee is rehired within 13 weeks (26 weeks for educational institutions).  Under a rule of parity, however, a rehired employee can be treated as a new employee if the employee is rehired after 4 weeks if the period during which the employee was previously employed is shorter than the period between leaving and returning to employment.

This is again only a basic description of the rules governing determination of full-time employment and does not begin to capture their full complexity.  Large employers that do not intend to offer coverage to all employees will need to study the rules for distinguishing between full and part-time employees in much greater detail.