The Patient Protection and Affordable Care Act and its Effect on Franchising

One of the goals of the ACA was to enable and encourage small business owners to provide better access to health insurance coverage for their employees. To facilitate this, the ACA offers small business tax credits to qualifying entities. At the same time, the law establishes a new “employer mandate” that requires applicable employers to offer qualifying coverage or potentially be subject to a penalty ' often referred to as “pay or play.” Small businesses that are aware of the requirements may stand to benefit from the tax credit, while those that fully understand the employer mandate requirements can make informed decisions about whether to “pay or play.”

Small business owners who offer coverage and employ fewer than 25 full-time equivalent (FTE) employees (defined below) have been able to take advantage of a Federal Small Business Health Care Tax Credit since 2010. (In addition to the Federal Tax Credit, some states also have additional tax credits for qualified small businesses.) To qualify for the tax credit, a small employer must pay average annual wages of $50,000 or less and must pay at least 50% of employees' premiums through a “qualifying arrangement.” The employer must pay a uniform percentage of the premium cost for each enrolled employee's health insurance coverage. The credit varies on a sliding scale by employer size, type and average wages.

Starting in January 2014, the maximum tax credit increased to 50%, but will only be available to small businesses that purchase coverage through a Small Business Health Insurance Marketplace (SHOP). In 2014, the federal SHOP Marketplaces will be open to small businesses with up to 50 FTEs; in 2016, SHOP Marketplaces will be open to employers with up to 100 FTEs. The SHOP Marketplaces were designed to function as a streamlined way for small employers to purchase more affordable coverage, given the larger risk pool. However, the Federal SHOP Marketplaces have experienced technical glitches and online enrollment has been delayed until November 2014. Until then, small businesses may purchase coverage from an agent or broker, using a paper application. The impact of this delay on the SHOP Marketplaces remains unclear.

The Employer Mandate

The ACA establishes an employer mandate to further incentivize employers to offer coverage. While the employer mandate provisions are statutorily required to take effect in 2014, the Administration has provided transitional relief under which penalties for noncompliance will not be enforced until 2015. The ACA requires certain employers to offer qualifying coverage to their full-time employees (and their dependents) or potentially be subject to one of two penalties. Breaking down which employers are subject to the mandate, which coverage qualifies, which employees must be offered coverage, and which penalties might apply has become an extremely complicated task. For these reasons, employers ' large and small ' should use the transition period to study the law's requirements and applicability to their businesses.

The ACA applies the employer mandate to “applicable large employers.” The term is somewhat deceptive because it includes those that employed, on average, at least 50 FTEs in the prior year (measured as the sum total of full-time employees and FTEs for each calendar month and dividing by 12). Full-time employees are defined as employees who are employed for an average of at least 30 hours of service per week over a calendar month (or 130 hours of service per month). (Hours of service means “each hour for which an employee is paid, or entitled to payment, for the performance of duties for the employer; and each hour for which an employee is paid, or entitled to payment by the employer for 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.” 29 CFR 2530.200b'2(a).) The number of FTEs is calculated by adding together all of the hours of service for all non-full-time employees in a given month (up to 120 hours for each non-full-time employee) and dividing by 120.

What's more, an employer's size is determined by looking at a “controlled group of entities” ' known as aggregation. Employers will be considered among the “controlled group” if the business entities share common owners or are otherwise related. Many franchisees own several units, often across various brands, and may therefore be subject to the employer mandate. Multi-unit franchisees also tend to form different entities to operate their individual businesses within the same brand, but should be aware that these arrangements could still fall under the mandate through aggregation.

Once a small business has determined whether it is subject to the employer mandate, the employer must decide whether it will “pay or play.” Applicable large employers must either offer affordable coverage that provides minimum value to at least 95% of all full-time employees (and their dependents), or the employer may be subject to one of two penalties. An employer may be subject to one penalty if it fails to offer any coverage to at least 95% of its full-time employees and at least one employee qualifies for a tax credit to purchase Marketplace coverage. This penalty is $2,000 per full-time employee (minus 30) if any full-time employee qualifies for a tax credit. An employer may be subject to an alternate penalty if it offers coverage that is either unaffordable or does not provide minimum value. To be affordable, the employee's share of self-only coverage must be less than 9.5% of his or her annual income. (There are three safe harbors that employers can use to ensure that coverage is affordable: based on an employee's W2 wages, rate of pay, or the Federal Poverty Level.) To meet the minimum value requirement, a plan must pay out at least 60% of the costs of the benefits covered. (There are four safe harbors that employers can use to ensure compliance: using an eyeball test, an Agency-administered minimum value calculator, actuarial certification, or purchasing a plan with an assigned metal tier ' Bronze, Silver or Gold ' through the SHOP Marketplace.) A non-compliant employer will be subject to the lesser of a $3,000 penalty for each employee who qualifies for a tax credit or the amount of the first penalty.

These requirements only scratch the surface of new definitions, calculations, transitional periods, exemptions and requirements that must be understood and considered. And these provisions have only been implemented through proposed rules and guidances, so there is opportunity for additions or changes that businesses will have to grapple with.

Will the ACA Hinder Franchise Growth?

Critics of the ACA claim the law will have an especially detrimental effect on franchising due to the nature of franchise ownership and operation. Some have suggested that “[f]ranchisors and franchisees, who often own groups of small businesses, will be at a comparative disadvantage relative to other businesses with fewer locations and fewer employees.” The Effects of the Patient Protection and Affordable Care Act on the Franchise Industry, Diana Furchtgott-Roth and Amlan Banerjee, Hudson Institute, September 2011 (available from the International Franchise Association (IFA) at http://bit.ly/1j7AeoK). There have been reports in the media of franchise systems considering increasing prices, reducing workforce or lowering wages in response to the ACA. Other reports suggest that franchisees may consider “sharing” workers; for example, scheduling an employee for 20 hours a week at one franchisee's location, while another (unrelated) franchisee schedules the same employee for 15 hours. Because the employer requirements are not yet finalized, the potential costs of the ACA to franchised businesses remain fluid, and many decisions have yet to be made. Therefore, the media reports around reactions contemplated by franchisees and franchisors may be premature and members of the franchising industry should continue reviewing all strategies and options going forward without assuming that others have made such sweeping changes.

In fact, in the midst of the media attention to more negative franchise reactions, there were signs of positive growth in franchising in 2013. The New York Times profiled a Pennsylvania-based entrepreneur who expanded his small tree-trimming and removal business through franchising rather than by opening more company-owned locations. See, “Why the Owner of Monster Tree Decided to Sell Franchises,” John Grossmann, The New York Times, Sept. 18, 2013. The owner estimates he can expand to between 75 and 100 units in five to 10 years through franchising, compared to just six to eight company-owned locations. Thus, some small business owners who have not considered franchising before may now consider it as a growth model, which could help strengthen the franchise sector overall. In fact, ADP announced in a press release that U.S. private-sector franchise jobs increased by 25,060 in October 2013, suggesting that franchising continues to grow. The release stated: “October's gains were well above recent months and the 12-month average monthly growth rate'. The franchise industry's job creation this month represents 20[%] of the total employment growth, as reported in the October ADP National Employment Report.” Press Release, ADP Research Institute (R), “U.S. Added 25,060 Franchise Jobs in October, According to ADP National Franchise Report (SM)” (Nov. 13, 2013) (on file with author; quoting Ahu Yildirmaz, senior director of the ADP Research Institute).

What Can Franchisors Do?

Franchisors across the board rely on multi-unit growth by franchisees that enter into various types of development agreements for particular regions, from large, established franchisors to smaller start-up businesses. Although it is too soon to speculate whether franchisees will refrain from entering into multi-unit development agreements to avoid falling within the parameters of the employer provisions, there are ways in which franchisors can incentivize multi-unit development.

Some franchisors already offer reduced initial franchise fees for multi-unit franchisees, whereby the franchisee pays less up-front costs to develop a designated number of stores. Another option more franchisors may consider is a reduced, or phased-in, royalty structure; this means that the franchisee pays a reduced royalty for the first few years of operations and then pays the standard royalty for the remainder of the term. This allows the franchisee flexibility to use the extra funds for other purposes, while the franchisor gets the benefit of growing the brand further across multiple units. If a franchisee is wary of the potential burden ACA compliance would have on their multi-unit business, a reduced initial franchise fee or reduced royalty structure might ease some of their financial fears, at least in the short term.

Conclusion

There are still many unknowns surrounding the ACA as 2014 begins, and there may continue to be more questions than answers for several months to come. To navigate the ACA to fully realize any potential benefits and protect against potential liabilities, both franchisors and franchisees should stay informed by conducting independent research and consulting with legal counsel and other advisors.

David Oppenheim is a Shareholder with Greenberg Traurig, LLP, who specializes in franchising law and operates out of the New York and New Jersey offices. Danielle White is an Associate with Greenberg Traurig, LLP, who focuses on health care law and operates out of the Washington, DC office.

The dominant issue in the U.S. political and media landscape heading into 2014 continues to be the implementation of the Patient Protection and Affordable Care Act (ACA) and its potential impact on the U.S. economy. Many consider the ACA to be a milestone in moving the American health care system toward greater efficiency, increased coverage and improved quality of care. Many others, however, remain concerned that the law will have detrimental consequences for individuals, employers and the health care industry. The ACA's reforms were designed to improve individuals' access to health insurance coverage and bolster the quality of products available ' particularly because, beginning in 2014, most individuals will be required to either purchase health insurance or pay a tax penalty. However, critics continue to voice concerns that individuals will not be able to keep their current health plans if they like them and argue that some provisions will have a detrimental impact on hiring practices, the prevalence of full-time employment and administrative costs, particularly among small businesses.

As the ACA continues to be implemented, franchisors and franchisees must be vigilant in understanding whether they are subject to the ACA's mandates, penalties and tax credits. The franchising industry must be sufficiently informed and prepared to manage the uncertainty surrounding both compliance requirements and costs. Navigating the ACA amidst myriad news reports, political talking points, commercials and editorials can be challenging at best. However, there are some clear knowns ' and unknowns ' that franchisors and franchisees must be aware of today in order to be prepared for tomorrow.

Tax Credits and SHOP Marketplaces

One of the goals of the ACA was to enable and encourage small business owners to provide better access to health insurance coverage for their employees. To facilitate this, the ACA offers small business tax credits to qualifying entities. At the same time, the law establishes a new “employer mandate” that requires applicable employers to offer qualifying coverage or potentially be subject to a penalty ' often referred to as “pay or play.” Small businesses that are aware of the requirements may stand to benefit from the tax credit, while those that fully understand the employer mandate requirements can make informed decisions about whether to “pay or play.”

Small business owners who offer coverage and employ fewer than 25 full-time equivalent (FTE) employees (defined below) have been able to take advantage of a Federal Small Business Health Care Tax Credit since 2010. (In addition to the Federal Tax Credit, some states also have additional tax credits for qualified small businesses.) To qualify for the tax credit, a small employer must pay average annual wages of $50,000 or less and must pay at least 50% of employees' premiums through a “qualifying arrangement.” The employer must pay a uniform percentage of the premium cost for each enrolled employee's health insurance coverage. The credit varies on a sliding scale by employer size, type and average wages.

Starting in January 2014, the maximum tax credit increased to 50%, but will only be available to small businesses that purchase coverage through a Small Business Health Insurance Marketplace (SHOP). In 2014, the federal SHOP Marketplaces will be open to small businesses with up to 50 FTEs; in 2016, SHOP Marketplaces will be open to employers with up to 100 FTEs. The SHOP Marketplaces were designed to function as a streamlined way for small employers to purchase more affordable coverage, given the larger risk pool. However, the Federal SHOP Marketplaces have experienced technical glitches and online enrollment has been delayed until November 2014. Until then, small businesses may purchase coverage from an agent or broker, using a paper application. The impact of this delay on the SHOP Marketplaces remains unclear.

The Employer Mandate

The ACA establishes an employer mandate to further incentivize employers to offer coverage. While the employer mandate provisions are statutorily required to take effect in 2014, the Administration has provided transitional relief under which penalties for noncompliance will not be enforced until 2015. The ACA requires certain employers to offer qualifying coverage to their full-time employees (and their dependents) or potentially be subject to one of two penalties. Breaking down which employers are subject to the mandate, which coverage qualifies, which employees must be offered coverage, and which penalties might apply has become an extremely complicated task. For these reasons, employers ' large and small ' should use the transition period to study the law's requirements and applicability to their businesses.

The ACA applies the employer mandate to “applicable large employers.” The term is somewhat deceptive because it includes those that employed, on average, at least 50 FTEs in the prior year (measured as the sum total of full-time employees and FTEs for each calendar month and dividing by 12). Full-time employees are defined as employees who are employed for an average of at least 30 hours of service per week over a calendar month (or 130 hours of service per month). (Hours of service means “each hour for which an employee is paid, or entitled to payment, for the performance of duties for the employer; and each hour for which an employee is paid, or entitled to payment by the employer for 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.” 29 CFR 2530.200b'2(a).) The number of FTEs is calculated by adding together all of the hours of service for all non-full-time employees in a given month (up to 120 hours for each non-full-time employee) and dividing by 120.

What's more, an employer's size is determined by looking at a “controlled group of entities” ' known as aggregation. Employers will be considered among the “controlled group” if the business entities share common owners or are otherwise related. Many franchisees own several units, often across various brands, and may therefore be subject to the employer mandate. Multi-unit franchisees also tend to form different entities to operate their individual businesses within the same brand, but should be aware that these arrangements could still fall under the mandate through aggregation.

Once a small business has determined whether it is subject to the employer mandate, the employer must decide whether it will “pay or play.” Applicable large employers must either offer affordable coverage that provides minimum value to at least 95% of all full-time employees (and their dependents), or the employer may be subject to one of two penalties. An employer may be subject to one penalty if it fails to offer any coverage to at least 95% of its full-time employees and at least one employee qualifies for a tax credit to purchase Marketplace coverage. This penalty is $2,000 per full-time employee (minus 30) if any full-time employee qualifies for a tax credit. An employer may be subject to an alternate penalty if it offers coverage that is either unaffordable or does not provide minimum value. To be affordable, the employee's share of self-only coverage must be less than 9.5% of his or her annual income. (There are three safe harbors that employers can use to ensure that coverage is affordable: based on an employee's W2 wages, rate of pay, or the Federal Poverty Level.) To meet the minimum value requirement, a plan must pay out at least 60% of the costs of the benefits covered. (There are four safe harbors that employers can use to ensure compliance: using an eyeball test, an Agency-administered minimum value calculator, actuarial certification, or purchasing a plan with an assigned metal tier ' Bronze, Silver or Gold ' through the SHOP Marketplace.) A non-compliant employer will be subject to the lesser of a $3,000 penalty for each employee who qualifies for a tax credit or the amount of the first penalty.

These requirements only scratch the surface of new definitions, calculations, transitional periods, exemptions and requirements that must be understood and considered. And these provisions have only been implemented through proposed rules and guidances, so there is opportunity for additions or changes that businesses will have to grapple with.

Will the ACA Hinder Franchise Growth?

Critics of the ACA claim the law will have an especially detrimental effect on franchising due to the nature of franchise ownership and operation. Some have suggested that “[f]ranchisors and franchisees, who often own groups of small businesses, will be at a comparative disadvantage relative to other businesses with fewer locations and fewer employees.” The Effects of the Patient Protection and Affordable Care Act on the Franchise Industry, Diana Furchtgott-Roth and Amlan Banerjee, Hudson Institute, September 2011 (available from the International Franchise Association (IFA) at http://bit.ly/1j7AeoK). There have been reports in the media of franchise systems considering increasing prices, reducing workforce or lowering wages in response to the ACA. Other reports suggest that franchisees may consider “sharing” workers; for example, scheduling an employee for 20 hours a week at one franchisee's location, while another (unrelated) franchisee schedules the same employee for 15 hours. Because the employer requirements are not yet finalized, the potential costs of the ACA to franchised businesses remain fluid, and many decisions have yet to be made. Therefore, the media reports around reactions contemplated by franchisees and franchisors may be premature and members of the franchising industry should continue reviewing all strategies and options going forward without assuming that others have made such sweeping changes.

In fact, in the midst of the media attention to more negative franchise reactions, there were signs of positive growth in franchising in 2013. The New York Times profiled a Pennsylvania-based entrepreneur who expanded his small tree-trimming and removal business through franchising rather than by opening more company-owned locations. See, “Why the Owner of Monster Tree Decided to Sell Franchises,” John Grossmann, The New York Times, Sept. 18, 2013. The owner estimates he can expand to between 75 and 100 units in five to 10 years through franchising, compared to just six to eight company-owned locations. Thus, some small business owners who have not considered franchising before may now consider it as a growth model, which could help strengthen the franchise sector overall. In fact, ADP announced in a press release that U.S. private-sector franchise jobs increased by 25,060 in October 2013, suggesting that franchising continues to grow. The release stated: “October's gains were well above recent months and the 12-month average monthly growth rate'. The franchise industry's job creation this month represents 20[%] of the total employment growth, as reported in the October ADP National Employment Report.” Press Release, ADP Research Institute (R), “U.S. Added 25,060 Franchise Jobs in October, According to ADP National Franchise Report (SM)” (Nov. 13, 2013) (on file with author; quoting Ahu Yildirmaz, senior director of the ADP Research Institute).

What Can Franchisors Do?

Franchisors across the board rely on multi-unit growth by franchisees that enter into various types of development agreements for particular regions, from large, established franchisors to smaller start-up businesses. Although it is too soon to speculate whether franchisees will refrain from entering into multi-unit development agreements to avoid falling within the parameters of the employer provisions, there are ways in which franchisors can incentivize multi-unit development.

Some franchisors already offer reduced initial franchise fees for multi-unit franchisees, whereby the franchisee pays less up-front costs to develop a designated number of stores. Another option more franchisors may consider is a reduced, or phased-in, royalty structure; this means that the franchisee pays a reduced royalty for the first few years of operations and then pays the standard royalty for the remainder of the term. This allows the franchisee flexibility to use the extra funds for other purposes, while the franchisor gets the benefit of growing the brand further across multiple units. If a franchisee is wary of the potential burden ACA compliance would have on their multi-unit business, a reduced initial franchise fee or reduced royalty structure might ease some of their financial fears, at least in the short term.

Conclusion

There are still many unknowns surrounding the ACA as 2014 begins, and there may continue to be more questions than answers for several months to come. To navigate the ACA to fully realize any potential benefits and protect against potential liabilities, both franchisors and franchisees should stay informed by conducting independent research and consulting with legal counsel and other advisors.

David Oppenheim is a Shareholder with Greenberg Traurig, LLP, who specializes in franchising law and operates out of the New York and New Jersey offices. Danielle White is an Associate with Greenberg Traurig, LLP, who focuses on health care law and operates out of the Washington, DC office.