Nondiscrimination Rules Could Pose Problem for Employers

Like many, I was surprised to see the penalties imposed by section 4980H of the Code will be applied on a member by member basis of a controlled group as opposed to counting the controlled group as one employer.  This was a generous concession by the IRS and Treasury which opens the door to potential planning opportunities.  However, these opportunities could be closed when the IRS and Treasury release regulations regarding the nondiscrimination rules associated with the ACA.

Consider the following hypothetical to illustrate the concept.  Suppose Employer A owns 100 percent of Employer B.  A parent-subsidiary controlled group would exist between Employer A and Employer B.  Employer A employs 100 full-time employees in 2015, but has no part-time employees.  Employer B also employs 100 full-time employees in 2015 and also has no part-time employees.  After carefully analyzing the situation Employer A determines it will offer all of its full-time employees and their dependents health coverage that meets the minimum essential coverage requirements of the ACA.  However, Employer B determines it will not offer any health coverage to its full-time employees.

Employer A would not be subject to the tax under section 4980H of the Code because the tax under section 4980H is tested on a member by member basis of the controlled group.  As a result of Employer A offering its employees minimum essential coverage, Employer A would have satisfied the Play or Pay Mandate associated with the ACA.

Employer B would be subject to the tax under section 4980H of the Code because it did not offer its employees minimum essential coverage.  Employer B would owe $170,000 (100 full-time employees reduced by 15 (its allocable share of the 30-employee offset ((100/200) x 30 = 15) and then multiplied by $2,000).

The proposed regulations are generous to allow this member by member look at a controlled group for section 4980H purposes.  However, employers need to keep in mind the nondiscrimination rules associated with the ACA when putting together their action plan.  The ACA for the first time will impose nondiscrimination rules on insured group health plans that discriminate in favor of highly compensated individuals (HCI).  An HCI means an individual who is (1) one of the five highest paid officers; (2) a shareholder who owns 10 percent or more in the value of the employer stock; or (3) among the highest paid 25 percent of all employees.  The ACA provision on the nondiscrimination clause is vague only disclosing the rules will be similar to section 105(h) of the Code.  This should concern employers as section 105(h) of the Code is tested taking into account all members of the controlled group as one single employer.

According to Notice 2011-1 employers will not be obligated to comply with the nondiscrimination provision of the ACA until the proposed regulations are released.  This will likely not be until the early summer of 2013.  Until then employers are forced to use the limited information that is known about the nondiscrimination rules under the ACA when putting together their action plan.

Unlike section 105(h), which penalizes the highly compensated individuals, the employer will be liable for the penalties associated with a failure to comply with the nondiscrimination test under the ACA.  If the employer fails to meet the nondiscrimination rules, one penalty it could be subject to under section 4980D of the Code is an excise tax of $100 per day with respect to each individual to whom the failure relates.  This could lead to enormous penalties quickly.

Take the hypothetical discussed above.  Suppose Employer A had all of the HCIs for the Employer A-Employer B controlled group.  Further suppose the Employer A-Employer B controlled group failed the nondiscrimination test as set forth by the future nondiscrimination regulations.  Employer B could be subject to a $10,000 penalty ($100 x 100) for just one day of noncompliance with the nondiscrimination rules assuming all 100 of Employer B’s employees are non-HCIs.  This would make any plan that violates the nondiscrimination plan unsustainable and restrict action plans utilizing different members of the controlled group.

Employers need to keep the nondiscrimination rules in the back of their mind when they are planning for the ACA.  Until the IRS and Treasury release regulations on the subject, employers will be left to guess what “similar to” the 105(h) nondiscrimination rules means.  Given the random nature of some of the regulations already released under the ACA, it would be wise for employers to have a contingency plan in case the nondiscrimination rules do not apply on a member by member basis of the controlled group like the section 4980H tax.