By Jamie L. Leary

To avoid triggering excise taxes under the play-or-pay mandate of the Affordable Care Act (ACA), an applicable large employer (ALE) must offer minimum-value health insurance to its full-time employees at affordable premiums, as defined by the ACA.

An ALE is defined very generally in the law as an employer with 50 or more full-time employees, including full-time equivalent employees. Under the ACA, a full-time employee averages at least 30 hours of work per week or 130 hours per month. And health insurance premiums are considered "affordable" if they are no more than 9.5 percent (indexed) of the employee's household income.

Because an employee's household income is typically unknown to an employer, the ACA's play-or-pay regulations provide three affordability safe harbors based on information accessible to an employer: federal poverty level guideline, the employee's rate of pay, or the employee's W-2 income. If you are an ALE, you should be familiar with these concepts, particularly as you put them into practice in complying with the ACA's new reporting requirements.

What may come as a surprise for ALEs is the IRS's recent announcement that paying additional cash compensation to employees who don't enroll in your health insurance plan effectively raises your health insurance premiums—perhaps resulting in premiums that no longer qualify as "affordable" for ACA purposes.

Before the ACA

Before the ACA, it wasn't uncommon for an employer that offered group health insurance coverage to its employees to provide an additional cash payment to employees who didn't enroll in the coverage. Sometimes, the employer would make a conditional offer to employees who were enrolled under spousal healthcare coverage; other times, the offer was unconditional.

The reasoning goes something like this: If you would have paid X dollars in group health insurance premiums for an employee, you are willing to compensate him an additional Y dollars if he doesn't enroll in your healthcare plan. Employees often viewed such arrangements as equitable because they received some small cash benefit in place of the waived healthcare benefits and the employer saved money that would otherwise have been spent on premiums.

When Congress passed the ACA in 2010, it was uncertain whether the law would prohibit opt-out arrangements. The play-or-pay regulations didn't address the issue, and it seemed such arrangements would continue to be permissible.

After the ACA

In informal guidance issued since the passage of the ACA, the IRS has promulgated certain rules to address what it apparently perceives as potential end runs around the play-or-pay rules. Q&A 9 in IRS Notice 2015-87 may be viewed as the latest installment of this type of guidance.

In that Q&A, the IRS applies an economics-based analysis to conclude that opt-out arrangements increase the true "cost" of health insurance coverage to employees. Putting some numbers to our X and Y scenario above helps illustrate the IRS's reasoning.

Suppose that you offer ACA-compliant health insurance to your employees, and the total monthly premium for self-only coverage is $700 for 2016. The monthly premium paid by an employee who enrolls in self-only coverage is $75. That premium would satisfy the federal poverty level safe harbor set forth in the play-or-pay regulations and is therefore presumptively affordable for ACA purposes. Your company pays the remainder of the monthly premium cost of healthcare coverage ($625) for an employee who enrolls.

Suppose, using the rationale discussed above, you offer to pay $100 per month to an employee who doesn't enroll in your health insurance plan. In the IRS's view, in order to enroll in your healthcare coverage, the employee must choose not only to pay $75 in premiums per month but also to give up an additional $100 in compensation per month—resulting in an effective premium of $175 per month.

A monthly premium of $175 wouldn't satisfy the play-or-pay's federal poverty level affordability safe harbor. In fact, not only would it fail to satisfy either of the other affordability safe harbors for some employees, but it would actually be unaffordable based on employee household income as well. As a result, a premium that was previously considered affordable can become unaffordable if the opt-out payment is considered part of the premium.

The IRS intends to propose regulations for opt-out arrangements that are expected to address variations on this theme, including the extent to which conditional opt-out arrangements are subject to the rules set forth in Q&A 9 of Notice 2015-87. The IRS anticipates that the rules announced in its regulations will not apply until the regulations' effective dates.

In the meantime

Until the IRS issues additional guidance, if you already had an opt-out arrangement in place on December 16, 2015, you are not required to report the opt-out payment as part of the employee premium on Form 1095-C, and the opt-out payment will not be treated as part of the employee premium for purposes of liability under the play-or-pay mandate.

However, your employees are permitted to include the opt-out payment as part of the premium charged to them—for instance, when they seek subsidized health insurance coverage on an ACA insurance exchange.

If you adopt an opt-out arrangement after December 16, 2015, any opt-out payment will be included in the employee premium for group health insurance coverage. Note that the IRS will presume that an opt-out arrangement was adopted after December 16, 2015, unless you can present proof that:

• You offered the arrangement for the plan year that included December 16, 2015;
• An authorized body or officer within your organization (e.g., a board of directors) specifically adopted the opt-out arrangement on or before December 16, 2015; or
• Your employees received written materials specifically communicating the opt-out arrangement on or before December 16, 2015.

If you are in this situation, not only will it affect how you complete Forms 1094-C and 1095-C, but it also has the potential to result in exposure to excise taxes under the play-or-pay mandate. For instance, an employee could decline to enroll in your healthcare plan, take the opt-out payment you offer, and seek subsidized coverage on an ACA insurance exchange because the premium isn't affordable under the ACA once the opt-out payment is included.

Each full-time employee who does that in 2016 would expose you to excise taxes under the ACA's play-or-pay penalty at a rate of $270 per month under Section 4980H(b) of the Internal Revenue Code.

Unfortunately, because of the IRS's interpretation, offering an opt-out arrangement may have become another case of "no good deed goes unpunished." If you offer an opt-out arrangement or are considering adopting one in the future, consult with benefits counsel to minimize the chances of a "gotcha" moment.

Jamie L. Leary, a contributor to West Virginia Employment Law Letter, can be reached at jamie.leary@steptoe-johnson.com.