Compliance Corner: Determining Full-Time Employees for the ACA’s Employer Mandate

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The Affordable Care Act’s (“ACA”) Employer Mandate aims to increase health coverage among employees by presenting applicable large employers (“ALEs”) (i.e., those with 50 or more full-time or full-time equivalent employees on average during the prior year) with the choice to either “pay or play” under its rules—either provide health care coverage (that meets certain standards) to their full-time employees or risk being assessed monetary penalties by the Internal Revenue Service (“IRS”). Notably, counting full-time employees for purposes of providing offers of coverage and avoiding penalties is distinct from counting full-time employees for purposes of determining ALE status; however, both determinations are extremely important for an employer’s compliance with the ACA. This month’s Compliance Corner assumes that an employer has already determined it is an ALE and explains how employers can determine who is a full-time employee for purposes of complying with the Employer Mandate and avoiding related penalties. 

Background: There are two different types of Employer Mandate penalties, each of which the IRS assesses on a monthly basis. The first type of penalty is referred to the Section 4980H(a) penalty, which is assessed under Internal Revenue Code (“IRC”) Section 4980H(a). The IRS assesses this penalty when (i) an ALE does not offer minimum essential coverage (i.e., generally, coverage under any major medical plan) to at least 95% of its full-time employees and their dependents for a month; and (ii) at least one full-time employee receives a premium tax credit (“PTC”) to purchase coverage on an ACA health insurance exchange (referred to herein as “the exchange”). The Section 4980H(a) penalty, which is based on the ALE’s total full-time employee count, for any month is 1/12 of the “applicable payment amount” (currently, $2,970 annualized for 2024) multiplied by the ALE’s number of full-time employees, reduced by: (i) 30; and (ii) the number of employee’s in a limited non-assessment period. An ALE will be considered to have “offered” coverage to all full-time employees and their dependents for a month if the ALE offers the coverage to all but 5% (or, if greater, five) of its full-time employees and their dependents. An ALE will be deemed to have “offered” coverage for a plan year only if employees have an effective opportunity to elect or decline to enroll in the coverage at least once during the plan year.

The second type of penalty is assessed under IRC Section 4980H(b) (the “Section 4980H(b) penalty”), and the IRS assesses it when (i) an ALE offers full-time employees and their dependents minimum essential coverage; and (ii) one or more full-time employees receives a PTC to purchase coverage on the exchange because the employer’s coverage was unaffordable based on their household income or does not provide minimum value. The Section 4980H(b) penalty, which is assessed on an individual-employee basis, for any month is 1/12 of the “applicable payment amount” (currently, $4,460 annualized for 2024), but it is  only applied for each full-time employee who enrolled in coverage on the exchange and received a PTC for the month. To be affordable, an employee’s required premium contribution to the employer’s group health plan for self-only coverage must not be more than a certain percentage (i.e., indexed to 8.39% for 2024), of the employee’s household income (“HHI”) for the year. The IRS allows employers to use certain “safe harbors” (i.e., rate of pay, Form W-2 Box 1 wages, and the annual federal poverty line) to satisfy this standard as employers cannot reasonably be expected to know an employee’s HHI.

Counting Full-Time Employees: As you can see, an employer’s number of “full-time employees” is crucial to the determination of whether penalties should apply and the calculation of any such penalties. As such, the IRS has approved the use of two different determination methods: the Monthly Measurement Method (“MMM”) and the Look-Back Measurement Method (“LBMM”). Each method considers an employee’s “hours of service” for any given month. For this purpose, “hours of service” includes any hour for which an employee is either paid or eligible to be paid for performing duties for the employer, or when no duties are performed because of vacation, holiday, illness, disability, or other similarly leave of absence (however, this does not include periods of leave where the employee receives compensation under a workers' compensation or state wage replacement program or from an arrangement in which the employer did not contribute).

As detailed below, these measurement methods are very different with distinct rules and outcomes. While employers can use either measurement method (but most use one of these methods), it is very possible that one method will be more appropriate based on the employer’s workforce and administrative capabilities. Employers must use the same measurement method for all employees other than for the following employee classifications: (i) hourly v. salaried; (ii) employees in different states; (iii) union v. non-union; and (iv) employees in different union groups.

Monthly Measurement Method: Similar to how employers can count employees when determining the employer’s ALE status, the MMM looks at the number of hours an employee completes during a given month. Under the MMM, an employee is considered “full-time” for any given month if he or she works an average of 30 hours of service per week for the month, or a total of 130 hours of service for the month, which the IRS considers to be equivalent standards. This approach considers an employee’s hours of service worked during and/or after a month; however, in some cases, an employer will be unable to accurately predict an employee’s hours and eligibility at the beginning of the month when coverage needs to be offered. If an employer miscalculates and fails to offer coverage to someone who was full-time for a particular month because the employer did not know if the employee was full-time until the end of the month, the employer could be assessed a Section 4980H(a) penalty for the month. As such, the MMM is generally better suited for those employee populations with consistent schedules without much fluctuation.  

For example, under this approach, if an employee does not work at least 130 hours of service a month, the employer can consider the employee “part-time” and ineligible for coverage during that month. If the employer drops the employee from coverage for that month, the employee will be entitled to receive an offer of continuation coverage under COBRA (by virtue of a having a loss of coverage due to a reduction in hours). Moreover, if the same employee worked 130 hours of service during the next month, the employee would again be full-time and eligible for health coverage, and the employer would need to make an offer of coverage (again, at the beginning of the month) in order to avoid a Section 4980H(a) penalty. As you can see, the MMM, while straightforward, can create administrative hurdles if employee hours fluctuate significantly month-to-month. The MMM is primarily used by employers that have workforce working predictable and steady full-time schedules.

There is one significant advantage to using the MMM and that is the ability to use a “limited non-assessment period” (“LNAP”). A LNAP is a short period where an employer will not be penalized for failing to offer coverage to a full-time employee who is newly eligible for coverage but is subject to a waiting period requirement. Under this rule, an employer will not be subject to Section 4980H(a) penalties if it fails to offer coverage to an otherwise eligible employee, for up to a period of three (3) months, as long as it offers the employee coverage by the first day of the fourth full calendar month of eligibility (which will generally be the first day of the fourth full calendar month of employment for new hires). Employers may not use a LNAP more than once per an employee’s period of employment unless an employee experiences a “break in service” and is considered a “new employee” following the break in service (i.e., he or she has had a period of 13 consecutive weeks with no credited hours of service). If there is a true break in service, the employer can (but does not have to) treat the employee as a “new employee” and subject the employee to a LNAP. 

MMM Example: Tom is hired by Company (an ALE using the MMM).  Tom works 100 hours of service in January – March; 140 hours of service in April – November; and 120 hours of service in December. Since Tom worked 130 hours of service beginning in April, he was full-time and first eligible at that time. Company’s health plan has a 3-month waiting period. As such, Tom is subject to a LNAP beginning in April and lasting through June. Company must offer coverage to Tom no later than July 1 to avoid potential Section 4980H(a) penalties for  months April through June (the LNAP). Beginning in December, Company can drop Tom from active coverage as he did not complete 130 hours of service for the month and is no longer “full-time” for ACA purposes. Because Tom experienced a COBRA qualifying event in December (the loss of coverage caused by reduction of hours), Company must offer COBRA coverage to Tom.

Look-Book Measurement Method: In light of the difficulties posed by the MMM for some employers, the IRS established an alternative measurement method, the LBMM.  The LBMM is a good alternative to the MMM when employees’ hours of service regularly fluctuate above and below 130 hours in a calendar month, and predicting whether employees will satisfy the 130-hour requirement at the beginning of the month is difficult, if not impossible. This approach is more complicated than the MMM; however, it does come with certain advantages for both the employer and employees. Most notably, the LBMM provides employers with predictability regarding offers of coverage and gives employers flexibility regarding certain new hires by allowing employers to subject such employees to what is essentially a yearlong tracking period prior to offering coverage. Generally, under the LBMM, if employees satisfy a measurement period (i.e., they work an average of 30 hours of service a week or 130 hours or more for the month), they are “locked in” as coverage-eligible during a subsequent stability period (regardless of fluctuations in their hours of service during that subsequent period). In contrast to the MMM, this approach is applied a bit differently for new employees and ongoing employees, which is one of the reasons the LBMM can be more complicated to administer than the MMM.

Ongoing Employees: Current full-time status for ongoing employees is dependent on their hours of service during a “standard measurement period” (“SMP”), which is a prior period, set by the employer, of at least three (3) but not more than 12 months (e.g., the calendar year). Most employers have a 12-month SMP (and thus, employees must work 1,560 hours of service during the SMP to be considered full-time). The SMP must be applied consistently for all employees within the same category (e.g., salaried or hourly). If, during the SMP, an employee works an average of 30 hours of service a week (or worked 130 hours or more for the month),  then the employer is required to treat the employee as “full-time” during a corresponding “stability period”. The stability period immediately follows the SMP and includes any administrative period associated with the SMP (which can be up to 90 days). The stability period must be at least six (6) months long and cannot be shorter than the corresponding SMP that it follows.

Throughout the stability period, the employee is eligible for coverage, regardless of how his or her hours of service fluctuate (up or down) during the stability period; the employee is “locked in” to coverage due to his or her hours of service during the SMP. As such, if an employee begins working part-time hours during the stability period, it will have no effect on the employee’s “full-time” status during the stability period (since eligibility is based on the hours worked in the prior SMP). The employer cannot drop the employee from coverage upon the change in employment status without exposing itself to potential penalties. In contrast, if the employee does not work an average of 30 hours of service per week (or 130 hours of service a month for each month during the SMP), the employee can be treated as a “non-full-time” employee who is not eligible for coverage during the corresponding stability period (again, regardless of how such employee’s hours may fluctuate up or down during the stability period).

Notably, the stability period generally is, or at least overlaps with, a new standard measurement period for ongoing employees. Thus, while a non-full-time employee may not be eligible for coverage during a certain stability period, his or her hours during that time will be tracked as part of a new SMP and will affect whether the employee is considered full-time for the subsequent stability period that corresponds with that new SMP. At the end of each SMP, the employer must review all ongoing employees’ hours of service to determine whether they will be eligible for coverage during the corresponding stability period.  Employees who are eligible for coverage during a stability period but then fail to satisfy the hours requirements during the subsequent SMP can be removed from coverage as of the start of the new stability period (generally, the start of the new plan year). This will be a COBRA qualifying event for the employee.

New Employees: When considering whether a new employee is “full-time” under the LBMM, an employer must first consider whether the employee is reasonably expected to work full-time hours (i.e., an average of 30 hours of service per week during the month or 130 hours of service a month) upon hire and if the employee is a seasonal employee. If the employee is expected to work full-time hours and is not seasonal, the employee will be consider full-time at the time of hire, and thereafter, his or her status must be determined on a month-to-month basis, as if the MMM applied. If the employee works 30 hours of service per week, on average, the employee will be considered a full-time employee for that month and entitled to an offer of coverage.

If a new employee is classified as a variable-hour (i.e., the employer cannot determine whether he or she will work full-time hours), seasonal (i.e., a position in which the customary employment is less than six (6) months and runs during the same part of the year), and part-time employee (i.e., expected to work less than full-time hours), the employer may determine full-time status through a measurement process similar to that for ongoing employees. These employees can be placed into an initial measurement period (“IMP”), of between three (3) and 12 months that begins on the employee’s hire date or the start of the month following the employee’s hire date. This is essentially a LNAP, which can be long as 13 months (including an option administrative period), wherein the employer can avoid penalties for not offering such employees coverage. If, during the IMP, the employee satisfies full-time hours, then the employee will be considered “full-time” and eligible for coverage during the corresponding initial stability period. The initial stability period must be at least six (6) months long and cannot be shorter than the corresponding IMP that it follows. In contrast, if the new variable hour, seasonal, or part-time employee does not work full-time hours during the IMP, the employer can treat the employee as a “non-full-time” employee who is not eligible for coverage during the corresponding, initial stability period.

After a new variable-hour, seasonal, or part-time employee has been employed for a complete SMP, the employee should be treated as an ongoing employee. Accordingly, the employer must determine full-time status in the same manner as it does for ongoing employees, at the beginning of that SMP. For example: The employer uses a 12-month IMP beginning on date of hire for new variable, seasonal, and part-time employees and a calendar-year SMP for ongoing employees. If an employee was hired on February 1, 2024, the employee would be tracked in an IMP (from February 1 through January 31) and in the calendar year SMP beginning on January 1 of the year after the employee’s start date (e.g., January 1, 2025).

Conclusion: While this Compliance Corner has provided a bird’s eye view regarding how to count full-time employees for ACA employer mandate purposes, there are additional details not addressed herein that employer should be aware of before implementing either the MMM and LBMM, including rules related to a change in employment status and breaks in service, changing between measurement methods, and ACA reporting. Employers should work with their benefits consultants, third-party administrators, and ACA vendors to consider all aspects of this determination and evaluate which measurement method may be most applicable and helpful in their particular situation. Part of this process will be to consider the employer’s ability to administer the measurement method correctly as well as to satisfy its related reporting requirements.