Pay or Play Penalty - Affordability Safe Harbors

The Affordable Care Act (ACA) requires applicable large employers (ALEs) to offer affordable, minimum value health coverage to their full-time employees or pay a penalty. This employer mandate provision is also known as the “employer shared responsibility” or “pay or play” rules. An ALE is only liable for a pay or play penalty if one or more of its full-time employees receive a subsidy for coverage under an Exchange.

The pay or play final regulations provide guidance on determining affordability of an employer-sponsored plan, including three optional safe harbors that employers may use. This ACA Overview describes the ACA’s affordability determination and safe harbors for purposes of these rules.

Applicable Large Employer (ALE)

Only ALEs are subject to the employer shared responsibility rules.

• ALEs are employers that employ, on average, at least 50 full-time employees, including full-time equivalents (FTEs), during the preceding calendar year.
• All ALEs are subject to these rules, including for-profit, nonprofit and government employers.

Affordability Safe Harbors

The IRS has provided three optional safe harbors that ALEs may use to determine their plan’s affordability:

• Form W-2 safe harbor;
• Rate of pay safe harbor; and
• Federal poverty level safe harbor.

Affordability Determination

Under the employer shared responsibility rules, an ALE that offers health coverage to substantially all of its full-time employees (and dependents) may be subject to a penalty if the health coverage does not provide minimum value or is unaffordable. For this purpose, an ALE’s health coverage is considered affordable if the employee’s required contribution to the plan does not exceed 9.5% (as adjusted) of the employee’s household income for the taxable year. “Household income” is the modified adjusted gross income of the employee and any family members (including a spouse and dependents).

The affordability test applies only to the portion of the annual premiums for self-only coverage, and does not include any additional cost for family coverage. Also, if an employer offers multiple health coverage options, the affordability test applies to the lowest-cost option that provides minimum value.

Changes to the Affordability Percentage

The affordability contribution percentage is adjusted annually for inflation. IRS Notice 2015-87 clarified that ALEs using an affordability safe harbor may use the adjusted affordability contribution percentages. Employer-sponsored coverage will generally be considered affordable under the employer shared responsibility rules if the employee’s required contribution for self-only coverage does not exceed:

Overview of the Affordability Safe Harbors

Because an employer generally will not know an employee’s household income, the IRS has provided three optional affordability safe harbors that ALEs may use to determine affordability based on information that is available to them—the Form W-2 safe harbor, the rate of pay safe harbor and the federal poverty level safe harbor.

An employer may use one or more of the affordability safe harbors if it offers its full-time employees (and dependents) the opportunity to enroll in minimum essential coverage under a health plan that provides minimum value with respect to the self-only coverage offered to the employees.

Safe Harbor Application

The three affordability safe harbors are all optional. An employer may choose to use one or more of the affordability safe harbors for all its employees or for any reasonable category of employees, provided it does so on a uniform and consistent basis for all employees in a category.

Reasonable categories of employees generally include:

• Specified job categories;
• Nature of compensation (for example, salaried or hourly);
• Geographic location; and
• Similar bona fide business criteria.

A listing of employees by name (or other specific criteria having substantially the same effect) is not considered a reasonable category.

The affordability safe harbors are only used to determine whether an ALE’s coverage satisfies the affordability test under the employer shared responsibility penalty. These safe harbors do not affect an employee’s eligibility for an Exchange subsidy, which is based on the affordability of employer-sponsored coverage relative to an employee’s household income. This means that, in some instances, an ALE’s offer of coverage to an employee could be considered:

• Affordable (for example, based on W-2 wages) for purposes of determining whether the employer is subject to a penalty; and, at the same time,
• Unaffordable (based on household income) for purposes of determining whether the employee is eligible for an Exchange subsidy.

Form W-2 Safe Harbor

Under the Form W-2 safe harbor, an ALE may determine the affordability of its health coverage by reference only to an employee’s wages from that ALE, instead of by reference to the employee’s household income. For this purpose, “wages” is the amount that is required to be reported in Box 1 of the employee’s Form W-2.

An ALE satisfies the Form W-2 safe harbor for an employee if the employee’s required contribution for the calendar year for the ALE’s lowest cost self-only coverage that provides minimum value during the entire calendar year (excluding COBRA or other continuation coverage except with respect to an active employee eligible for continuation coverage) does not exceed 9.5% (as adjusted) of that employee’s Form W–2 wages from the employer for the calendar year.

Eligibility for the Form W-2 Safe Harbor

To be eligible for the Form W-2 safe harbor, the employee’s required contribution must remain a consistent amount or percentage of all Form W–2 wages during the calendar year (or during the plan year for plans with non-calendar year plan years). Thus, an ALE may not make discretionary adjustments to the required employee contribution for a pay period. A periodic contribution that is based on a consistent percentage of all Form W–2 wages may be subject to a dollar limit specified by the employer.

Timing of the Form W-2 Safe Harbor

ALEs determine whether the Form W-2 safe harbor applies after the end of the calendar year and on an employee-by-employee basis, taking into account W-2 wages and employee contributions.

Partial-Year Offers of Coverage

For an employee who was not offered coverage for an entire calendar year, the Form W-2 safe harbor is applied by:

• Adjusting the employee’s Form W-2 wages to reflect the period when the employee was offered coverage; an
• Comparing the adjusted wage amount to the employee’s share of the premium for the employer’s lowest cost self-only coverage that provides minimum value for the periods when coverage was offered.

Specifically, the amount of the employee’s compensation for purposes of the Form W-2 safe harbor is determined by multiplying the wages for the calendar year by a fraction equal to the number of calendar months for which coverage was offered over the number of calendar months in the employee’s period of employment with the ALE during the calendar year. For this purpose, if coverage is offered during at least one day during the calendar month, or the employee is employed for at least one day during the calendar month, the entire calendar month is counted in determining the applicable fraction.

Download the full Compliance Advisor to learn more about:

• Rate of Pay Safe Harbor;
• Federal Poverty Line Safe Harbor;
• Cafeteria Plan Contributions, HRA Contributions & Wellness Program Incentives;
• HRA Contributions;
• Wellness Program Incentives;
• Unconditional Opt-Out Arrangements;
• Conditional Opt-Out Arrangements; and,
• Fringe Benefit Payments for Federal Contract Workers.