By: HUB’s EB Compliance Team

The Affordable Care Act’s (ACA) employer health coverage mandate is a tax penalty that applies if certain larger employers do not offer compliant health coverage to applicable individuals. Employers can avoid the penalty by offering health coverage to full-time employees. If an employer fails to comply, then their full-time employees can receive federal tax credits towards buying individual coverage through an exchange marketplace. Employers generally pay a penalty if a full-time employee receives such a tax credit. Depending on the specific plan design, employers can offer compliant health coverage that avoids all ACA penalties or adopt a strategy that at least mitigates the most severe penalties.

Significantly though, an employer’s ACA penalty exposure hinges entirely on whether the organization satisfies the statutory definition of an “applicable large employer” (ALE). This article centers on an organization’s considerations as it grows into ALE status or shrinks out of ALE status.

Growing Into ALE Status

The IRS defines ALE status at Q5 of its ACA FAQ page. (https://www.irs.gov/affordable-care-act/employers/questions-and-answers-on-employer-shared-responsibility-provisions-under-the-affordable-care-act)

“Whether an employer is an ALE in a particular calendar year generally depends on the size of the employer’s workforce in the preceding calendar year. For example, an employer will use information about the size of its workforce during 2016 to determine if it is an ALE for 2017.

To be an ALE for a calendar year, an employer must have employed an average of at least 50 full-time employees (including full-time equivalent employees) during the preceding calendar year.”

Except for employers not in existence in the previous calendar year but who reasonably expect to employ 50 or more FTEs in their first year, ALE status is always based on the prior calendar year headcount and irrespective of the employer’s particular plan year.

For ALE status to attach, ACA’s workforce headcount rules require a combined count of the following:

  • Full-time employees, which are employees who average at least 30 hours per week or 130 hours per month, PLUS
  • Full-time equivalent (FTE) employees, which are calculated by taking the total work hours generated by all part-time employees and dividing those hours by 120

Note: Important common ownership/control group headcount aggregation rules apply, as well as a narrow seasonal workers exception applies if an employer only exceeds the 50-employee threshold for 120 days or fewer during the year. Both issues exceed the scope of this article, but useful details about these rules can be found at the links shared at the bottom of this article.

Also note that, as the health coverage mandate applies based on ALE status during the prior calendar year, some employers could be uncertain of a final headcount number until late December and then immediately face mandate obligations starting January 1 of the “following” year (e.g. the next day). The IRS addressed this problem by creating a “non-assessment” period in which the newly minted ALE is not required to begin offering coverage to full time employees until April of the next year. This “buffer period” enables the employer to explore and establish the most suitable program to achieve ACA compliance. In other words, the newly established ALE would not owe any penalty for January through March of the first year that the employer is an ALE.

Although this is an invaluably helpful plan sponsor rule, it’s important for employers to understand that this is a one-time use option. So, an entity that becomes an ALE is not allowed to “re-use” the three-month non-assessment period rule again in the future, even if that entity sinks below the ALE threshold and then later grows back into it during a subsequent calendar year.

Shrinking Out Of ALE Status

Unfortunately, to this date, there is comparatively little direct federal guidance addressing how an ALE is relieved of the mandate burden by reducing in size. However, applying the rules described above inversely, we can draw important logical inferences.

An employer loses ALE status for the current year if it averaged fewer than 50 full-time and full-time equivalent (FTE) employees during the preceding calendar year.

As described above, this count includes:

  • Full-time employees, which are employees who average at least 30 hours per week or 130 hours per month, PLUS
  • Full-time equivalent (FTE) employees, which are calculated by taking the work hours generated by all part-time employees and dividing them by 120

Since ALE status applies on a year-long average work size during the prior calendar year, any existing ALE employer that drops below 50 employees during a calendar year must continue offering health coverage until the next calendar year to avoid penalties. In other words, an employer is not instantly relieved of mandate responsibilities. The organization’s ALE status remains locked in place until the year following the year it averages less than 50 employees.

For example, an employer averaging 70 employees in 2024 but that averaged only 40 employees in 2025 would still be obliged to satisfy the mandate for all of 2025 (based on the preceding year’s headcount). In 2026, the employer loses ALE status (based on the preceding year headcount), but it must again measure its average headcount during 2026 to determine ALE status for 2027.

Further considerations

The ACA includes special rules for employees that work irregular hours that make the employer, as of the date of hire, uncertain as to whether the individual could be considered full-time or not. To address this, the IRS developed a “variable hour” employee category in which the employer uses a look-back average work hours measurement. Based on average hours earned during a look back period, the employer can definitively pronounce full-time (or not assert full-time status) during what the IRS defines as a “stability” period.

The ACA’s stability period rules require that the employee continue receiving an uninterrupted offer of health coverage even if his or her hours drop below full time inside the stability period. This is because the stability period rules are designed to give the employee some expectation of consistency in their health coverage.

What happens when an employer is no longer considered an ALE but still employs variable-hour employees who measured out as full-time during a look-back measurement period and are receiving coverage inside the protective zone of a stability period? This scenario creates a somewhat complex situation with respect to ACA health coverage requirements because once an employer finally loses ALE status, they are no longer subject to the ACA’s health coverage mandate (e.g., the employer is not required to offer health insurance to full-time employees to avoid penalties).

However, this does not immediately affect the health coverage obligations for employees who previously earned full-time status during the employer’s look-back measurement period (earned while that employer was an ALE). IRS rules governing stability period coverage requirements do not include any exception for an employer that loses ALE status. Employers should therefore still offer coverage for these employees during the stability period that was established under the measurement period rules. In other words, the employer must continue to offer coverage for the entire duration of the stability period, even if the employer is no longer an ALE during that time.

Conclusion

The road to understanding the full scope of the ACA may be intricate and complex for all, but employers who are just becoming ALEs need to particularly consider the compliance implications they face given the potential penalties involved.

Additional ACA HUB resources can be found online at:

Plus, the IRS has posted detailed ACA information at www.irs.gov, with key resources found here:

If you have any questions, please contact your HUB Advisor. View more compliance articles in our Compliance Directory.

NOTICE OF DISCLAIMER

Neither HUB International Limited nor any of its affiliated companies is a law or accounting firm, and therefore, they cannot provide legal or tax advice. The information herein is provided for general information only and is not intended to constitute legal or tax advice as to an organization’s or individual's specific circumstances. It is based on HUB International's understanding of the law as it exists on the date of this publication. Subsequent developments may result in this information becoming outdated or incorrect and HUB International does not have an obligation to update this information. You should consult an attorney, accountant or other legal or tax professional regarding the application of the general information provided here to your organization’s specific situation in light of your or your organization’s particular needs.