Controlled Group Liability – The Play or Pay Mandate

Controlled Group Rules Add a Layer of Complexity for Private Equity Funds Analyzing the Play or Pay Mandate

The purpose of this paper is to discuss the implications of the Affordable Care Act on private equity funds.  While the paper contains a complete discussion of the major tax issues relevant for a private equity fund, an attorney should be consulted when planning strategies for business implementation.

Initially the Affordable Care Act did not have a large impact on employers.  However, that will soon change.  In 2014 employers will need to begin to make strategic decisions as the Play or Pay Mandate (the Mandate) associated with the Affordable Care Act takes effect.

The Mandate only applies to Large Employers.  A Large Employer is defined as an employer who on average employed at least 50 full-time employees during the preceding calendar year.  A full-time employee is defined as an employee who works an average of 30 hours or more per week.  However, all the hours of the employees not covered by the full-time employee definition are aggregated together on a monthly basis and divided by 120 to give the employer a number to count as full-time equivalent employees. If the number of full-time employees plus the number of full-time equivalent employees is 50 or greater, the employer will be considered a Large Employer and the Mandate will apply.  It is important to understand that full-time equivalent employees are only relevant for determining if an employer is a Large Employer.  Full-time equivalent employees are not considered when calculating either of the taxes discussed below.

If an employer is a Large Employer, two taxes will need to be considered before making strategic decisions regarding healthcare plans for its workforce.   The first tax applies to Large Employers who fail to offer their full-time employees (and their dependents) the opportunity to enroll in an eligible employer plan that offers minimum essential coverage.  The proposed Treasury regulations, which employers may rely on pending the issuance of the final regulations, interpret the phrase, “and their dependents,” to require the employer to offer coverage to a full-time employee’s children who have not reached the age of 26.  Interestingly, the proposed regulations do not require the employer to offer coverage to a full-time employee’s spouse.  For the tax to apply one full-time employee or one of the full-time employee’s dependents must enroll in a health plan offered through an Exchange (which will be setup by the States or the Federal government if a State opts out) and also qualify for a premium tax credit or cost-sharing subsidy.  The premium tax credit and cost-sharing subsidy are available to individuals with a household income of at least 100 percent but not more than 400 percent of the federal poverty line.

In 2012 the federal poverty line for an individual living in the continental United States was approximately $11,170. Therefore, if an individual’s household income is between $11,170 and $44,680, the individual will be eligible for the premium tax credit and cost-sharing subsidy.  For a family of four living in the continental United States the federal poverty line in 2012 was approximately $23,050.  Therefore, if a family of four has a household income between $23,050 and $92,200 the family will be eligible for the premium tax credit and cost-sharing subsidy.

If an employer does not offer minimum essential coverage and the conditions discussed above are met for one full-time employee or one of the full-time employee’s dependents, the employer must pay $2,000 per year for each employee over 30 employees regardless of whether the full-time employee received minimum essential coverage from the employer or was eligible for the premium tax credit or cost-sharing subsidy.  Put simply, the equation for the tax involves all full-time employees of the employer.  The $2,000 annual tax will be adjusted in future years to mimic the rising price of health insurance premiums.

Even if an employer provides minimum essential coverage, an employer could still be subject to the second tax associated with the Mandate.  The tax applies to Large Employers who provide minimum essential coverage to their full-time employees (and their dependents), but the coverage provided is not “affordable” or does not provide “minimum value.”  The tax only applies to full-time employees eligible for a premium tax credit or cost-sharing subsidy.

To be considered affordable the cost of the insurance to the employee must not exceed 9.5 percent of the employee’s household income.  The proposed regulations provide three safe harbor methods to test the affordability of minimum essential coverage that will be discussed in a future publication.  However, it is beneficial for employers to know that only the self-only coverage is required to meet the 9.5 percent affordability test.  The proposed regulations make it clear coverage options that are not self-only coverage, such as family coverage, are not subject to the 9.5 percent affordability test.

For the coverage to provide minimum value the plan’s share of the total allowed costs of benefits provided under the plan must be greater than or equal to 60 percent of such cost.  Regulations are still forthcoming that will clarify the meaning of “minimum value.”  When the regulations are finalized or there is greater clarity on the subject, Moulder Law will publish a paper explaining the nuances of the “minimum value” test.

If the coverage provided to employees eligible for a premium tax credit or cost-sharing subsidy is not “affordable” or does not provide “minimum value” and the employee enrolls in a health plan through an Exchange, an annual $3,000 tax would apply for each such employee.  The second tax is capped at the amount of a hypothetical first tax which is calculated by assuming the employer did not offer minimum essential coverage to its full-time employees.  The $3,000 annual tax will be adjusted in future years to mimic the rising price of health insurance premiums.  Unfortunately, and importantly, both taxes associated with the Mandate are not deductible for employers.

While the taxes discussed above only apply to Large Employers, the number of employees is tested on a controlled group basis.  A private equity fund needs to be aware of the rules for a parent-subsidiary controlled group.  According to the Internal Revenue Code (the Code) and the Treasury regulations interpreting the Code there are two requirements for a parent-subsidiary controlled group to exist: (1) there must be one or more chains of organizations conducting “trades or businesses” and (2) those “trades or businesses” must be connected through ownership of at least 80 percent.

Understanding the two aspects of a parent-subsidiary controlled group is important to understanding one of the issues private equity funds will face with the Mandate.  The Treasury regulations make it clear each entity in the controlled group must be a “trade or business,” but do not require the “trades or businesses” to have any nexus to be considered part of the same controlled group.  Consider the following hypothetical which illustrates why the question of whether a private equity fund is considered a “trade or business” is critical for the private equity industry.

Fund A, a private equity fund, owns 100 percent of employer B and employer C.  Employer B employs 40 full-time employees in each calendar month of 2015.  Employer C employs 60 full-time employees in each calendar month of 2015.  Employer B and employer C have no full-time equivalent employees in 2015.  For 2015, assume the applicable payment amount for the first tax associated with the Mandate is $2,000.  Employer B does not sponsor an eligible employer-sponsored plan for any calendar month in 2015, and receives proper notice that at least one full-time employee enrolled in a health plan offered through an Exchange and was eligible for a premium tax credit or cost-sharing subsidy.  Employer C sponsors an eligible employer-sponsored plan under which all of its full-time employees are eligible for minimum essential coverage that is both “affordable” and which provides “minimum value.”

If fund A is not considered a “trade or business,” then fund A, employer B, and employer C would not be part of a controlled group as both prongs of the test for a parent-subsidiary controlled group would not exist.  Employer B would not be considered a Large Employer as it employed less than 50 full-time employees per month on average in 2015.  Therefore, the Mandate would not apply to employer B.  Employer C would be a Large Employer as it employed 50 or more full-time employees per month on average in 2015.  However, employer C sponsored an eligible employer-sponsored plan which would satisfy the obligations of the Mandate.

If fund A is considered a “trade or business,” then fund A, employer B, and employer C would be members of a parent-subsidiary controlled group.  Fund A, employer B, and employer C would all be considered a Large Employer for the purpose of the Mandate as the controlled group members employed 50 or more full-time employees per month on average in 2015.  The proposed regulations require Large Employer members to allocate the 30-employee offset associated with the first tax of the Mandate.  The proposed regulations require the allocation to be based on the number of full-time employees employed by each Large Employer member during the calendar year.  Employer B did not sponsor an eligible employer-sponsored plan for any calendar month in 2015 and at least one full-time employee enrolled in a health plan offered through an Exchange and was eligible for a premium tax credit or cost-sharing subsidy.  Consequently, employer B would owe $2,000 for each full-time employee reduced by its allocable share of the 30-employee offset.  Employer B’s assessable payment under the Mandate for 2015 would be $56,000, which is equal to 28 x $2,000 (40 full-time employees reduced by 12 (its allocable share of the 30-employee offset ((40/100) x 30 = 12)) and then multiplied by $2,000).  Employer C would not be subject to the Mandate as it offers its full-time employees an eligible employer-sponsored plan that would satisfy the Mandate.

The hypothetical above illustrates some of the advantageous of a private equity fund not being considered a “trade or business.”  First, a portion of the companies the fund owns may not have the requisite number of employees to be considered a Large Employer.  If a company is not a Large Employer, the Mandate would not apply to that company.  Additionally, even if all of the companies the fund owns are Large Employers, the fund could use the 30-employee offset for each company when calculating the first tax associated with the Mandate.  This would result in additional savings for each company the fund owns.

Whether a private equity fund is a “trade or business” is far from clear.  The long standing belief in the industry is a private equity fund is not a “trade or business.”  Consequently, the controlled group rules would not aggregate any of the companies a private equity fund owns.  This was the widely held belief among industry insiders until 2008.

In 2008 the Pension Benefit Guarantee Corporation (PBGC), a quasi-government agency that insures a portion of the benefits of almost all defined benefit plans, held that a private equity fund was a “trade or business.”  The regulations the PBGC interpreted in the decision required the PBGC to interpret the phrase “trade or business” consistent and coextensive with the interpretation of the Code and Treasury regulations.  As a result, the decision created uncertainty and confusion in the industry.

While the official positions of the IRS and Treasury are not entirely clear, there is Supreme Court precedent supporting the position a private equity fund is not a “trade or business.”  There are other tax reasons the IRS and Treasury would not view a private equity fund as a “trade or business,” but with the PBGC decision lurking there is uncertainty.  In a recent case from the United States District Court in Massachusetts, the court dismissed the PBGC’s interpretation of the phrase “trade or business” and held the private equity fund itself was not a “trade or business.”  The recent case along with the Supreme Court precedent should allow private equity funds to not aggregate the companies the fund owns for the Mandate so long as the fund follows proper structural formalities.

To ensure the proper structural protections are in place to prevent aggregation, it would be wise to consult with counsel.  An attorney at Moulder Law should also be consulted to discuss the nuances associated with the Affordable Care Act that are beyond the scope of this paper.
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