ACA - Owners being excluded in ALE Calculation

I haven't had reason to come across this before but it's an interesting question. I also don't see an immediate answer unless I'm missing something obvious. 

I think the issue is whether a family member of a 2% S corp shareholder is simply an "employee" under 54.4980H-1(a)(15) or whether stock attribution makes the family member a 2% shareholder as well. I don't see anything in the ACA statute or regulations referring to an attribution system to use for this purpose. 

The regular 2% S corp shareholder fringe benefit rule is in Section 1372 and says that, for purposes of applying the fringe benefit rules under Subtitle A (Income Taxes), a 2% S corp shareholder is deemed to be a partner and that Section 318 attribution applies. But the ACA excise taxes are found in Subtitle D (Miscellaneous Excise Taxes). 

Would be interested to hear if others are aware of something on point.

This is a great question.  @EBECatty I agree with your analysis here.  

Normally we're looking at this issue from the Section 125 cafeteria plan perspective as to whether the individual can make pre-tax contributions.  In that case, the cafeteria plan rules are clear that the the attribution rules do apply to also block eligibility for the spouse/children of the more-than-2% shareholder of an S Corp. This is done by specifically pointing to §1372(b), which in turn points to §318.

In other words, even though the spouse and children may be employees of the S Corp, they are treated as self-insured for cafeteria plan eligibility rule purposes via attribution.  They even have an example on the regs directly on point.

In this case, the §4980H regs do nothing of the sort.  Neither does the preamble or any other guidance I can find.  It simply refers to a "2-percent S Corporation shareholder" with no section reference to §1372(b), §318, or anywhere else.  Given that it's all we have to work with, I would read it to not include attribution--consistent with your original approach @Morgan.  If the IRS wanted attribution to apply, they could have explicitly done so as they did with the cafeteria plan regs.

If this vendor is firmly stating that they believe the spouse and children can be excluded from the ALE calculation based on attribution, I'd ask them for what guidance they are relying on.  My guess is it's just the standard attribution rules that aren't incorporated by reference in the §4980H regs.  I'd consider that an aggressive interpretation that could expose them to quite large §4980H and §6056 liability if the IRS disagreed.

Prop. Treas. Reg. §1.125-1:

(g) Employee for purposes of section 125.

...

(2) Self-employed individual not an employee.

(i) In general. The term employee does not include a self-employed individual or a 2-percent shareholder of an S corporation, as defined in paragraph (g)(2)(ii) of this subsection. For example, a sole proprietor, a partner in a partnership, or a director solely serving on a corporation's board of directors (and not otherwise providing services to the corporation as an employee) is not an employee for purposes of section 125, and thus is not permitted to participate in a cafeteria plan. However, a sole proprietor may sponsor a cafeteria plan covering the sole proprietor's employees (but not the sole proprietor). Similarly, a partnership or S corporation may sponsor a cafeteria plan covering employees (but not a partner or 2-percent shareholder of an S corporation).

(ii) Two percent shareholder of an S corporation. A 2-percent shareholder of an S corporation has the meaning set forth in section 1372(b).

...

(iv) Examples. The following examples illustrate the rules in paragraphs (g)(2)(ii) and (g)(2)(iii) of this section:

Example (1). Two-percent shareholders of an S corporation.

(i) Employer K, an S corporation, maintains a cafeteria plan for its employees (other than 2-percent shareholders of an S corporation). Employer K's taxable year and the plan year are the calendar year. On January 1, 2009, individual Z owns 5 percent of the outstanding stock in Employer K. Y, who owns no stock in Employer K, is married to Z. Y and Z are employees of Employer K. Z is a 2-percent shareholder in Employer K (as defined in section 1372(b)). Y is also a 2-percent shareholder in Employer K by operation of the attribution rules in section 318(a)(1)(A)(i).

Treas. Reg. §54.4980H-1(a):

(15) Employee. The term employee means an individual who is an employee under the common-law standard. See § 31.3401(c)-1(b). For purposes of this paragraph (a)(15), a leased employee (as defined in section 414(n)(2)), a sole proprietor, a partner in a partnership, a 2-percent S corporation shareholder, or a worker described in section 3508 is not an employee.

Thank you @Brian Gilmore and @EBECatty for your input. I searched for hours to find anything pointing to attribution in regards to an ALE calculation and couldn't find it. I will proceed in taking a conservative approach and just exclude the greater than 2% shareholders for this client. I have asked for their guidance and will share it if they have anything of substance.