At Last, "Full-time Employee" Guidance... And the News is Good

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1 September 10, 2012 At Last, "Full-time Employee" Guidance... And the News is Good The Internal Revenue Service has issued long-awaited guidance on how employers are to determine which of their employees after 2013 are considered "full-time" (i.e., average at least 30 hours per week) for purposes of the federal health reform law. The guidance, issued in the form of a Notice rather than a regulation, closely tracks earlier statements from the IRS about how it proposed to require employers to determine "fulltime" status. Generally, employers subject to reform's "play or pay" rules receive a free pass with respect to new regular, full-time employees for the first three months of their employment, and for a full 12 months with respect to new seasonal and variable hour employees. The IRS says employers may rely on the guidance at least through While the news is mostly good, the guidance leaves several important questions unresolved, such as issues related to temporary staffing agencies, laid-off and re-hired employees (and other employees who experience changes in employment status), the definition of "seasonal employee," mergers and acquisitions, and other matters. The IRS will deal with these issues in future regulations. Additionally, the IRS issued a sister Notice addressing the requirement that health plans, beginning with the 2014 plan year, not impose a waiting period longer than 90 days on eligible employees. Quick Background An employee's status as "full-time" is important for federal health reform purposes. The Patient Protection and Affordable Care Act does not literally require an employer to offer health insurance. But beginning in 2014, larger employers have only the choice between offering coverage to "full-time employees" and risking penalties (we refer to this as the "play or pay" obligation). These larger employers are, generally, those who employed in their controlled group an average of at least 50 full-time equivalent employees during the preceding calendar year. They're required to offer full-time employees and their dependents at least some health insurance coverage, or risk one set of penalties. If the employer offers at least some coverage, but the coverage is not both adequately robust and affordable to the full-time employee, the employer risks a different set of penalties. The health reform law defines a full-time employee for this purpose as one who averages at least 30 hours per week. Coverage is considered adequately robust if, generally, it is designed to reimburse 60 percent of the enrollees anticipated medical expenses. Coverage

2 is considered "affordable" if the employee-only tier does not cost the employee more than 9.5 percent of his or her W-2 pay. Employers who hire full-time employees (or even part-time employees working substantial hours) and do not offer adequately robust and affordable health coverage have been concerned about how the "full-time employee" determination will be made. Guidance Overview Consistent with the Service's earlier thinking on the matter, the recent guidance: Confirms that employers may ignore - for "play or pay" purposes - regular, full-time employees for the first three months of their employment, Confirms employers may determine full-time employee status for a new seasonal and variable hour employee by averaging the employee's hours over a specific lookback measurement period of between three and 12 months, as the employer may choose, beginning on or near the employee's start date, Permits full-time status for ongoing employees to be determined over fixed measurement periods (e.g., the calendar year, plan year, etc.) of between three and 12 months, Requires employers to treat as "full-time" an employee who averages 30 or more hours a week over the employee's look-back measurement period; the employee is treated as full-time through a prospective "stability period" that follows the measurement period, regardless of the hours actually worked by the employee during that stability period, Permits employers to use different measurement and stability periods for specific, discrete groups of employees, such as salaried versus hourly, collectively bargained versus non-collectively bargained, etc., Authorizes brief "administrative periods" that follow - and even bracket - look-back measurement periods, to facilitate the tracking of hours and to give employers an opportunity to digest and act upon the "hours worked" data from a measurement period, Confirms that an employer's offer of health coverage to an employee will be considered "affordable" for purposes of the play-or-pay obligation if coverage does not cost the employee more than 9.5 percent of his or her W-2 pay; and Explains the IRS's interpretation of the obligation on the part of health plans (grandfathered or otherwise) to limit waiting periods to no longer than 90 days, beginning with the plan year that commences in Here's a closer look at the details. Employers Employing Regular, Full-Time Employees - The 3-Month Free Pass The look-back/stability period concept has little relevance for the employer who hires only regular, full-time employees. The guidance confirms that all employers subject to "play or pay" receive a free pass under those rules for a regular, full-time employee's first three months of employment. Lockton Comment: The guidance describes this free pass as applying for "three months" and, alternatively, for "three calendar months" (emphasis supplied). The distinction might be inadvertent - it might be a drafting error by the IRS - but it's important, because the guidance takes pains to define a "month" differently than it

3 defines a "calendar month." We suspect the IRS will iron this out over the next several weeks. After that initial three months the new regular, full-time employee is considered "full time" for health reform purposes, and the employer must offer health insurance to the employee and his or her dependents, or risk penalties. There seems little need for an employer to track the employee's hours going forward, as long as the employer concedes the employee is full-time. Of course, it's possible that an employee who was hired as regular, full-time might at some point begin to work substantially fewer hours and lose eligibility for health benefits. The employer might need to begin to track the employee's hours to determine if the employee must be treated as full-time for health reform purposes, so the employer will know whether it must offer coverage to the employee or risk penalties. Employers Hiring Seasonal and Variable Hour Employees - A Free Pass for Up to 12 Months Friday's guidance is most relevant for the employer of seasonal or variable hour employees. The "full-time" status of these employees is a critical issue for many such employers. Lockton Comment: An employee is considered a variable hour employee if, as of his or her start date, either (1) the employer can't reasonably conclude that the employee is expected to work an average of at least 30 hours per week, or (2) the employer expects the employee to work 30 or more hours per week - at least initially - but the employer expects that full-time employment will be of limited duration, and the employer can't conclude that the employee is expected to average at least 30 hours per week over the entire initial measurement period. A seasonal employee is one whom the employer reasonably and in good faith believes is a seasonal employee (the IRS will likely tighten this standard later). Measurement Periods and Stability Periods The IRS guidance uses the look-back measurement period, and prospective stability period, concepts as the basic building blocks of "full-time employee" determinations. Whereas an employer enjoys a free pass - for health reform's "play or pay" purposes - for the first three months of a new regular, full-time employee's employment, the employer enjoys a free pass for up to the first 12 months of a new seasonal or variable hour employee's employment. With respect to such an employee, the employer averages his or her weekly hours over a three- to 12-month initial measurement period (the employer selects the duration) that begins on or near the employee's start date, to see if the employee averaged at least 30 hours per week. If the employee did so, he or she is then treated as full-time (for health reform purposes) for an ensuing initial stability period, regardless of the hours actually worked by the employee in that stability period. Importantly, there's no requirement to continue to treat the employee as full-time if he or she terminates employment during a stability period. If the employee failed to average 30 hours per week, the employer may treat him or her as part-time for the ensuing initial stability period.

4 Lockton Comment: In this Alert, we describe as "part-time" any employee who is not considered "full-time" for health reform purposes. Going forward, the hours worked by the seasonal or variable hour employee are again tallied and averaged over a fixed, standard measurement period that will almost always begin within the employee's initial measurement period. That standard measurement period is followed in turn by a standard stability period, during which the employee is treated as full-time or part-time based on his or her average hours per week during that preceding standard measurement period. This cycle of standard measurement and stability periods continues for as long as the employee remains employed. Generally speaking, that cycle looks like this, although there are several important wrinkles we'll explore below: Initial Measurement, Administrative and Stability Periods The Initial Measurement Period As noted earlier, a new seasonal or variable hour employee's initial measurement period will normally begin on the employee's start date or close to it, such as the first day of the following month, or perhaps the first day of the payroll period that begins after the start date. In any event, the initial measurement period will almost always differ from one new seasonal or variable hour employee to another. Regardless of when it begins, the initial measurement period for seasonal and variable hour employees may be between three and 12 consecutive months, as the employer may choose. A "month" means the period from a specific day in one month to the prior day of the following month (i.e., June 10 - July 9). Lockton Comment: The employer may designate different measurement (and stability) periods for different, discrete groups of employees. Different periods are permitted for collectively bargained versus non-collectively bargained employees, salaried versus hourly employees, employees of different divisions or subsidiaries, and employees in different states. The employer averages the newly hired seasonal or variable hour employee's work hours over this initial measurement period to see if the employee averaged at least 30 hours per

5 week and thus must be considered a full-time employee for health reform purposes, at least for a while. Initial Administrative Periods If the employer delays the start of a new seasonal or variable hour employee's initial measurement period (that is, delays it beyond the employee's start date), that delay is treated as part of an "initial administrative period." In addition, any delay between the end of the initial measurement period and the beginning of the associated "initial stability period" is also treated as part of that initial administrative period. Lockton Comment: These administrative periods are handy, and may become rather prevalent. Employers may want a bit of time - particularly after the close of a measurement period - to tally the hours worked over that period, offer the employee health coverage (if applicable) and process the employee's application. Employers that intend to offer coverage to full-time employees, to avoid the risk of penalties under health reform, need to make the offer early enough that the employee can elect the coverage, and coverage can become effective, by the first day of the stability period that follows the relevant measurement period. But an administrative period can't be too long. These brief periods of time - prior to the start of the initial measurement period, and between the end of that measurement period and the beginning of the initial stability period - can never, in the aggregate, exceed 90 days. And there's a second limit that applies only to administrative periods for new seasonal and variable hour employees: The length of the initial measurement period, combined with any administrative periods, cannot extend beyond the last day of the first month that begins on or after the first anniversary of the employee's start date. Here's an example to illustrate the point: Example: ABC Company uses a 12-month initial measurement period for newly hired seasonal and variable hour employees, beginning on the first of the month following the employee's start date. The gap between the start date and the beginning of the initial measurement period is considered part of the initial administrative period. The Company also uses a one-month administrative period that follows that initial measurement period, and immediately precedes the beginning of the employee's initial stability period. ABC Company hires John, a new variable hour employee, on June 10, John's initial measurement period will run from July 1, 2014, to June 30, Thus, there is a short administrative period that runs from John's start date (June 10, 2014) to the first of the next month (July 1, 2014), when his initial measurement period begins, and a one-month administrative period (the month of July, 2015) that follows the close of John's initial measurement period. His initial stability period - the period for which the employer will treat him as full- or part-time, depending on his hours during the initial measurement period - begins August 1, ABC Company's approach complies with the IRS guidance. The initial measurement period does not exceed 12 months. The combined administrative periods don't exceed 90 days (here, they're about 51 days total). And the initial measurement period and

6 the combined administrative periods don't extend beyond July 31, 2015, which is the last day of the first month that begins after the first anniversary of John's start date. What if ABC Company believed it needed a two-month administrative period, after the close of John's initial measurement period? It would have to shorten the initial measurement period to 11 months, but that's the only change it would need to make. The Initial Stability Period A new seasonal or variable hour employee's initial stability period follows the initial measurement period (and any administrative period tagging along with that measurement period). If the new seasonal or variable hour employee averages at least 30 hours per week during the initial measurement period, he or she must be considered full-time for his or her initial stability period. That period must be at least six calendar months long, but no shorter than the initial measurement period (it may be longer, if the employer so desires). A "calendar month" means one of the full months named in the calendar (e.g., June). Lockton Comment: Note that the initial stability period should begin on the first day of a calendar month. If the initial measurement period ends during a month (say, the initial measurement period begins on an employee's start date of June 10, 2014, and ends on June 9, 2015), it appears the initial stability period could commence on June 9, 2015, but apparently would have to run through the six calendar months beginning with July, We suspect most or all employers will simply commence the stability period on the first day of a month. When would an employer want an initial stability period to run longer than the initial measurement period? Perhaps the employer wants the initial stability period to run 12 months, but also believes it needs a two-month initial administrative period following the close of the initial measurement period. We've already seen that an employer, with respect to new seasonal or variable hour employees, can't have a 12-month measurement period plus a two-month administrative period (for a total of 14 months). But the employer may use an 11-month initial measurement period, followed by a two-month initial administrative period, followed in turn by a 12-month initial stability period. Lockton Comment: If the employer must treat the employee as full-time during the initial stability period, and the employer intends to offer health coverage to the employee to avoid the risk of penalties, it must make the coverage available by the first day of the stability period; that is, coverage must be offered sufficiently in advance of the stability period that the employee has time to elect it, and coverage can become effective, by the first day of the stability period. This is where a short administrative period, following the close of a measurement period, comes in handy...it gives the employer time to accomplish all this. Lockton Comment: Remember that the employer may designate different measurement and stability periods for different, discrete groups of employees. Different standard measurement periods are permitted for collectively bargained

7 versus non-collectively bargained employees, salaried versus hourly employees, employees of different divisions or subsidiaries, and employees in different states. Special Stability Period Rule Where a New Seasonal or Variable Hour Employee is Not Full- Time. What if the variable hour or seasonal employee does not qualify as a full-time employee at the end of his or her initial measurement period? The employer may treat the employee as part-time, for health reform purposes, for the employee's initial stability period that follows that initial measurement period. But the length of the stability period can't exceed the initial measurement period by more than a month, and must close not later than the end of the fixed standard measurement period (and any associated administrative period) in which the initial measurement period ends. Lockton Comment: We'll deal with standard measurement periods in a moment, but suffice it to say that standard measurement periods are the measurement periods over which the seasonal or variable hour employee's hours are averaged after his or her initial measurement period. Unlike the initial measurement periods, these standard measurement periods are not unique to the employee, based on the employee's start date. Rather, they begin on a fixed date, such as the first day of the year, the first day of a plan year, etc. Here's an example: Example: ABC Company uses a 12-month initial measurement period for newly hired seasonal and variable hour employees, beginning on the first of the month following the employee's start date, and a one-month administrative period that follows that initial measurement period. The initial stability period is also 12 months. The Company uses a 12-month standard measurement period, beginning each January 1, without an associated administrative period. ABC Company hires Jane, a new variable hour employee, on June 10, Jane's initial measurement period will run from July 1, 2014, to June 30, 2015, and the administrative periods include the window from June 10 to July 1, 2014, and the month of July, Let's say Jane averages 28 hours per week over the initial measurement period. Her initial stability period begins August 1, The employer treats Jane as part-time, for health reform purposes, for the period August 1, 2015, through...not July 31, 2016, but December 31, Why is the stability period shorter than 12 months in this case? It's because Jane is treated as part-time, based on her hours during her initial measurement period. Because she's treated as part-time, her initial stability period can't extend beyond the end of the standard measurement period (plus any associated administrative period; in this example there is no administrative period attached to the standard measurement period) in which the initial measurement period ends. Jane's initial measurement period ends on June 30, The standard measurement period within which that initial measurement period ends is the January 1 - December 31, 2015, standard measurement period. So ABC Company can only treat Jane as part -time through December 31, 2015.

8 That makes the head hurt, but it makes sense. Because at the same time ABC Company is tracking Jane's hours during her initial measurement period, it also begins tracking her hours for the standard measurement period that begins after her start date (to wit, the January 1 - December 31, 2015, standard measurement period). So, by the time her initial stability period expires on December 31, 2015, ABC Company will be able to determine - based on her hours during the January 1 - December 31, 2015, standard measurement period - whether Jane remains a part-time employee or must be considered full-time for the ensuing stability period. Standard Measurement, Administrative and Stability Periods If they remain employed long enough (many will not, of course), new seasonal and variable hour employees segue from new employee status to "ongoing" employee status. Their status as full- or part-time is based on average hours per week over the employer's standard measurement period. These standard measurement periods may also be accompanied by administrative periods, under more liberal rules. And as you might suspect, these standard measurement and administrative periods are followed by "standard stability periods" during which the employer treats the employee as full- or part-time, depending on average weekly hours worked during the related standard measurement periods. When does this segue occur? By the date the employee has been employed for one full standard measurement period. When that happens, his or her hours are averaged over that standard measurement period, that is, the one he or she just completed. The Standard Measurement Period The standard measurement period for ongoing employees begins on a fixed date, such as the first day of the calendar or plan year. Standard measurement periods are expressed in calendar months, and must be between three and 12 calendar months, as the employer may choose. For example, an employer may decide to use six-month standard measurement periods, beginning each January 1 and July 1. Or it may decide to use a 12-month standard measurement period beginning January 1, or perhaps some other date (such as the first day of a non-calendar year plan year). Lockton Comment: Employers should not have to worry about tracking hours for employees the employers concede are "full-time." Remember, too, that the employer may designate different measurement and stability periods for different, discrete groups of employees (with some limitations discussed earlier). Often, a new seasonal or variable hour employee's first standard measurement period will begin during, and run simultaneously with - and beyond - the remainder of his or her initial measurement period. Example: Assume that an employer begins a new variable hour employee's initial measurement period on the start date, and the period runs for 12 months. Assume also that the employer uses the calendar year as the standard measurement period for all ongoing employees.

9 If the employer hires a new variable hour employee on June 10, 2014, the employee's initial measurement period will run from that date to June 9, 2015, and his or her first standard measurement period will run from January 1, 2015 to December 31, 2015, encompassing (and running simultaneously with) part of the initial measurement period. Standard Administrative Periods Employers may apply standard administrative periods of up to 90 days following the end of a standard measurement period. They overlap a simultaneously running stability period. Example: Assume the employer uses 12-month standard measurement periods that run from November 15 to the ensuing November 14. These are followed by 45-day administrative periods, followed in turn by 12-month stability periods beginning each January 1. Let's say an ongoing employee averages at least 30 hours per week for the standard measurement period from November 15, 2013 to November 14, The employer must treat the employee as "full-time" for the ensuing standard stability period from January 1, 2015 to December 31, What if the employee averages only 28 hours per week for the standard measurement period from November 15, 2014 to November 14, 2015? He's still treated as full-time for the duration of the January 1 - December 31, 2015 stability period. Standard Stability Periods With respect to employees who average at least 30 hours per week during a standard measurement period, the ensuing standard stability period must be at least six consecutive calendar months, and no shorter than the standard measurement period. So, if the standard measurement period is 12 months, the standard stability period must be at least 12 consecutive calendar months. If the employer uses a three-month, fourmonth or five-month standard measurement period, the standard stability period that follows it would have to be at least six consecutive calendar months (because the stability period must always be at least six months long). With respect to employees who average fewer than 30 hours during the standard measurement period, the length of the ensuing stability period - during which the employee is treated as part-time - cannot exceed the length of the standard measurement period. We assume most employers will designate a standard stability period that is the same, whether the employee is treated as full-time or part-time. Administrative Issues When should an employer begin tracking hours for its employees? The play or pay rules take effect on January 1, 2014 (unless they are delayed), so employers will need to look

10 back into establish measurement periods in so they'll know by January 1, 2014, which of their employees are "full-time" for health reform purposes. Which employees should an employer track? It seems to us the employer will need to track hours for any employee the employer is not conceding is full-time for health reform purposes. Who is going to do all these calculations? The employer and its wage/hour/payroll vendor will be the primary parties pulling the oar on this. Hours Worked Much here depends on an employee's average "hours" per week. What are these hours? Interestingly, the recent guidance is silent on this point, but a prior Notice from the IRS (Notice ) made clear that the Service is considering applying a definition substantially similar to how the Labor Department defines the term for purposes of crediting hours of service in other contexts, such as for counting service under a retirement plan. The IRS wrote: "[I]t is contemplated that...an employee's hours of service would include...each hour for which an employee is paid, or entitled to payment, for the performance of duties for the employer; and...on account of a period of time during which no duties are performed due to vacation, holiday, illness, incapacity (including disability), layoff, jury duty, military duty or leave of absence..." For employees not paid on an hourly basis (non-hourly employees), the employer would be permitted to calculate the number of hours of service by counting actual hours, using a "days worked" equivalency method (whereby the employee is credited with eight hours of service for each day for which the employee would be required to be credited with at least one hour of service), or using a "weeks worked" equivalency of 40 hours of service per week for each week for which the employee would be required to be credited with at least one hour of service. The employer would not be required to use the same method for all non-hourly employees, but may apply different methods for different classifications of non-hourly employees, if the classifications are reasonable and consistently applied. We're sure the IRS will clarify this before long, likely in regulations. W-2 Safe Harbor for "Affordability" Calculations The IRS has confirmed that, when making a determination of a health coverage offering's "affordability" to an employee, the employer's offer will be deemed "affordable" - for play or pay purposes - if the employee is not asked to spend more than 9.5 percent of his or her W-2 wages to purchase coverage. Based on earlier guidance, we presume this safe harbor applies with respect to "employee-only" coverage. 90-Day Waiting Periods The IRS has also confirmed several details relating to the health reform law's prohibition on health plan waiting periods that exceed 90 days. A waiting period is the length of time

11 an individual must wait, after becoming eligible for coverage, before coverage becomes effective (assuming he or she timely applied for the coverage). The guidance confirms that nothing about the waiting period rule requires an employer to offer coverage; the waiting period rule applies only to those individuals who qualify for coverage under the eligibility criteria set forth in the employer's health plan. But eligibility conditions that are conditioned solely on the passage of time may not exceed 90 days. So as a general rule, an employer can't say, "After you've served in an eligible classification for 60 days, you become eligible for coverage...and then your coverage becomes effective 90 days later." There is no accommodation under the guidance for current waiting periods that provide for coverage to begin on the first day of the month following 90 days of eligibility. Plans may continue to condition eligibility on an employee having worked for a given number of hours over a "reasonable" period of time. An employer may use the same sort of "measurement period" concept that larger employers use for determining "full-time" status. Where an employer conditions eligibility on an employee working full-time (as defined under the plan) or certain number of hours over a measurement period, the employer is generally permitted to impose up to a 90-day waiting period after the employee demonstrates his or her eligibility (based on hours worked during the measurement period). But in any event coverage should begin not more than 13 months after the employee's start date (plus the time remaining until the first day of the next month, if the start date is not the first of a month). If an employee could gain coverage within a 90-day waiting period if he or she were to submit an application, the fact that the employee's coverage is delayed beyond a 90-day waiting period because the employee failed to submit the application does not mean the employer violates the waiting period rule. The IRS guidance relating to waiting periods may be relied upon by employers at least through Ed Fensholt, J.D. Health Reform Advisory Practice Not Legal Advice: Nothing in this Alert should be construed as legal advice. Lockton may not be considered your legal counsel and communications with Lockton's Compliance Services group are not privileged under the attorney-client privilege. Circular 230 Disclosure: To comply with regulations issued by the IRS concerning the provision of written advice regarding issues that concern or relate to federal tax liability, we are required to provide to you the following disclosure: Unless otherwise expressly reflected herein, any advice contained in this document (or any attachment to this document) that concerns federal tax issues is not written, offered or intended to be used, and cannot be used, by anyone for the purpose of avoiding federal tax penalties that may be imposed by the IRS. Forward This was sent to shopfinger@lockton.com by complianceservices@locktoncompanies.com Instant removal with SafeUnsubscribe Privacy Policy. Lockton Benefit Group 444 West 47th Street Suite 900 Kansas City MO 64112