Compliance with the Affordable Care Act (ACA) hinges on the concept of “applicable large employer” or "ALE" status.
ALE Status Uses a Prior-Year Methodology
If an employer has fewer than 50 full-time equivalents in one year, then the employer mandate and reporting requirements will not apply the following year; if it does have 50 or more in that first year, then those requirements will apply the year following the year in which the ALE threshold is met.
For example, if in 2020 an employer has 50 or more full-time equivalents, then that employer will be considered a large employer for ACA purposes in 2021, meaning that the employer will be subject to employer mandate and 1095 reporting requirements, including employer shared responsibility excise taxes (pay-or-play penalties) if the related affordability and minimum value standards are not met. Continuing with our example, if the employer has fewer than 50 full-time equivalents in 2020, then that employer will not be considered a large employer for ACA purposes in 2021 and will not be subject to those rules in 2021.
Counting Full-Time Equivalents
Large employer status is measured by a monthly count of full-time equivalents, not full-time employees. There’s a big difference. The ACA defines “full-time employee” as a person working 30 hours a week or more, on average. (The IRS then took 280 pages to explain what it means by "on average," by the way.) “Full-time equivalent” takes into account part-time employees as well.
Step 1: Remove Certain People
These people should be removed from the large employer calculation:
- US expats working overseas,
- 414(n)(2) leased employees (a specific kind of leased employee),
- the sole proprietor (if the employer is not incorporated),
- partners of the employer partnership (if the employer is a partnership), and
- owners of 2% of more of the shares of the employer corporation (if the employer is a sub-S corporation).
Step 2: Put the Full-Time Employees in One Bucket
Next, for each month, add up the number of people who worked 130 hours or more that month (and for salaried folks, those who were credited with 130 hours or more). That's the number of full-time employees. Put that number aside.
Step 3: Total Up Part-Time Employees' Hours and Divide by 120
Then separately add up all the hours worked that month by the rest of the employees, whether the positions are part-time or are full-time but the employee didn't reach 130 hours, and divide the total number of hours by 120. (No typo there. IRS regulations really do use a different threshold for converting part-time hours to full-time equivalents.) Round the result to two decimal places.
Add Them Together
Add to that figure the number of full-time employees in the other bucket. That’s your number of full-time equivalents for a given month.
Here’s a crude formula: full-time equivalents = # of FT employees + (all other employee hours / 120)
But wait. How do you determine the number of employees for a given the month if your employee count fluctuates throughout the month? In writing the pay-or-play regulations, the IRS didn't answer that question, but in discussing the issue with the American Bar Association's Joint Committee on Employee Benefits, it did shed some light. It appears that a full-time employee who worked a partial month (and thus who was not credited with 130 hours of service that month) will simply be considered a part-time employee whose hours count toward the pool of hours divided by 120—in other words, part of a full-time equivalent.
That means employees who have full-time schedules but who were hired mid-month or who terminated employment mid-month will generally not be in the full-time employee bucket for the month of hire or termination, as the case may be. They'll be in the part-time employee.
Basic Methodology of Applicable Large Employer Status
ALE status is determined on a calendar year basis using headcounts from the prior calendar year. The plan year is irrelevant for large employer status; it’s a calendar year determination regardless of whether the employer uses a fiscal plan year. There’s a little variation in determining large employer status for 2015, but for the most part large employer status for a particular year is determined by averaging the monthly headcount of full-time equivalents over the course of the prior calendar year. So you add up all 12 monthly full-time equivalent head counts (which should have two decimal places) and divide by 12. Drop any decimal places from the result, so 49.99 average full-time equivalents becomes 49, for example.
If, for example, the 2020 average monthly full-time equivalent headcount is 50 or greater, then the employer is an ALE in 2021. If the 2020 average monthly full-time equivalent headcount is between 0 and 49, the employer is not.
The same rules apply to any subsequent year. If the 2021 average monthly full-time equivalent headcount is 50 or greater, then the employer is an applicable large employer in 2022. If the 2021 average monthly full-time equivalent headcount is between 0 and 49, the employer is not.
Affiliated Employers Are Aggregated
Large employer status is determined on an aggregated basis for controlled groups (companies affiliated by ownership) and affiliated service groups (companies affiliated by services provided to each other). If in 2020, for example, two companies in a controlled group each have 30 full-time employees and enough part-time employee hours to equal 5 full-time equivalents (and no employee works for both companies), then they will both be considered large employers in 2021 because together they will have 50 or more average monthly full-time equivalents (70, to be exact).
Note that the aggregation does not take place after each company has determined its average monthly full-time equivalents. While it would be nice to just add up the full-time equivalents for each employer in the controlled group, it doesn't work that way. The hours and employees for every controlled group company are pooled together before you perform any calculations.
This means that if an employee worked for two controlled group companies, 25 hours for one company and 5 for another, that employee is a full-time employee and goes in the full-time employee bucket. If another employee worked 10 hours for one company and 10 hours for another, then 20 hours are put in the part-time employee bucket. (And then the entire bucket of hours is divided by 120, and that result is added to the full-time employee count to get full-time equivalents for the controlled group.)
Also, while there are no controlled group rules for nonprofits, churches or governmental units, they too can be aggregated with other employers for ACA purposes if, applying and interpreting the controlled group rules in good faith, there is a close enough analogy.
Finally, QSLOB rules are not applicable under the ACA, so related employers that don’t have to aggregate for discrimination testing purposes will have to aggregate for the ACA.
Grace Period for Employers New to the 50+ Club
In order to have time to calculate average monthly full-time equivalents and get health insurance, if necessary, an employer that becomes a large employer for the first time has until April 1 of the year it earned that badge to get affordable, minimum-value health coverage in place before penalties kick in.
What about Recently Established Companies?
If a company didn’t have employees in certain months because it wasn't in existence then, it might be nice to use zeros for those months and divide by 12, but that’s not how the rules work. Instead, the first two years of ALE status are determined using a different methodology than has been described thus far.
For the first calendar year or partial calendar year the employer is in existence, ALE status is a function of the employer’s “reasonable expectations” at the time the business comes into existence. If subsequent events (such as a spike or dip in sales) cause the actual number of full-time equivalents to differ from the employer’s reasonable expectation, those won’t cause the employer’s status to change. Basically, if the business plan or business model canvas suggests that there will be a workforce of 50 or more full-time equivalents, then that’s what the company’s status will be based on. If the company is a from-scratch, husband-and-wife startup using the couple’s savings, then that’s what the company’s status will be based on.
For the second calendar year of the company’s existence, large employer status is determined by averaging the prior calendar year’s actual monthly full-time equivalent headcount over the number of months the company was in existence that year.
So if a company was started in June of 2020, its 2020 large employer status is based on the expectations of the company (probably measured by the expectations of the company’s owners and executives) at the time the company was started. Its 2021 large employer status is based on the actual average monthly full-time equivalents in 2020, averaged over 7 months (June through December).
Note that there are predecessor and successor employer concepts in the rules as well, so if the company is recently established in the M&A context, things get a little more complicated. (Hint: Err on the side of caution and assume that if any party was subject to the employer mandate and reporting obligations prior to the deal, then the post-closing entity will be subject to them as well.)