IRS Affordability Safe Harbors Help Avoid ACA Penalties
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How exactly do employers prove to the IRS that the healthcare plans they are offering to their workforce are affordable under the Affordable Care Act?
It’s an important question for employers with 50 or more full-time and full-time equivalent employees that are considered by the IRS to be Applicable Large Employers or ALEs and that are required to comply with the ACA’s Employer Mandate. On an annual basis, ALEs are required to offer certain health coverage under Section 4980H of the Internal Revenue Code and file information returns to the IRS regarding such health coverage under Section 6056 of the Code.
Employers must offer affordable healthcare coverage to their full-time employees to satisfy Section 4980H(b) of the ACA’s Employer Mandate. Fortunately, the IRS has made available three affordability safe harbors that employers can use to help prove ACA affordability when submitting annual ACA returns to the IRS.
The three safe harbors employers can use when proving ACA affordability to the IRS are the Rate of Pay, W-2, and Federal Poverty Line (FPL). Below we have outlined the three safe harbors and provided general formulas to use to help you calculate ACA affordability correctly.
Rate of Pay Safe Harbor
The Rate of Pay Safe Harbor is a method for proving ACA affordability that is based on an employee’s hourly rate or monthly salaried rate. Best practices suggest performing this safe harbor test for each full-time employee, every month.
To calculate if coverage is affordable for the 2021 tax year under the Rate of Pay Safe Harbor and using hourly workers earnings, take the employee’s lowest hourly rate as of the first day of the coverage period and multiply that rate by 130 (130 is the minimum total of hours on a monthly basis required for an employee to be treated as full-time under the ACA). Take that product and multiply it by the 2021 affordability threshold, 9.83%. This will identify the maximum monthly premium that the employee may be required to pay to satisfy 2021 ACA affordability. Take, for example, $20/hr x 130 hours x 9.83% = maximum monthly premium of $255.58. For this particular situation, to claim the Rate of Pay Safe Harbor using hourly wages, the monthly contribution cannot exceed $255.58.
For a salaried employee, take the monthly salary as of the first date of the coverage period and multiply it by the appropriate affordability percentage for the year. Again, for 2021 the ACA affordability threshold is 9.83%. Here’s an example: $2,000 monthly salary x 9.83% = maximum monthly premium of $196.60 to claim the Rate of Pay Safe Harbor.
W-2 Safe Harbor
The W-2 Safe Harbor is a method for proving ACA affordability that involves the use of an employee’s W-2 Box 1, gross income. To claim the W-2 Safe Harbor, the following formula is generally used: W-2 Box 1 Wages multiplied by 9.83% with an adjustment for partial year coverage. For a real-world example of the W-2 Safe Harbor in use for the 2021 tax year, download the Safe Harbor Playbook for Calculating ACA Affordability.
FPL Safe Harbor
The Federal Poverty Line (FPL) Safe Harbor is a method for proving ACA affordability that is based on an employee’s annual household income, which is a function of that employee’s household size and is adjusted on an annual basis. Each year, the Department of Health and Human Services (HHS) publishes the annual FPL. For the 2021 tax year, the mainland FPL for a household size of one is $12,880.
To calculate the FPL Safe Harbor, take the mainland FPL for a household size of one and multiply it by 9.83%. Next, divide the product by 12.
Here’s the 2021 FPL Safe Harbor formula: $12,880 x 9.83% / 12 = $105.51.
If the employee contribution for self-only coverage meets or is below $105.51, then the FPL Safe Harbor is met and the coverage offered is affordable for the 2021 tax year.
ALEs should note that the FPL Safe Harbor is arguably the simplest to administer because contribution rates can be standardized across entire employee groups. However, using the FPL Safe Harbor for providing ACA affordability may cost ALEs more due to the monthly premium contribution amount for employees being lower than calculating individual contributions on a per-employee basis.
Plan Nuances That May Affect Affordability
There are a number of considerations that can affect the affordability of a plan. Opt-out payments, wellness plans, flex credits, and Health Reimbursement Arrangements (HRAs) are some of the more common considerations that may either increase or decrease the affordability of an employer-sponsored health plan. If your organization has components like these, you may want to seek an outside expert to help you make sure that the contributions identified on Line 15 of Form 1095-C are accurate.
Implementing safe harbors when administering your health plan is one thing. Communicating this information to the IRS is another. In fact, if you successfully set up your affordability safe harbors for an applicable tax year but incorrectly code them on the 1095-Cs, you could be subject to IRS penalty assessments and the onus will fall on you for proving otherwise. If you have questions about entering ACA affordability codes on Form 1095-C, check out our post, The Codes on Form 1095-C Explained.
For the 2020 tax year, additional codes were added for use on Form 1095-C. These new codes specify HRAs integrated with individual health insurance coverage or Medicare, subject to certain conditions. Applying the correct code combinations is essential for preventing the issuance of Letter 226J to your organization, which the IRS is currently issuing for the 2018 tax year.
Choosing an IRS safe harbor for proving ACA affordability can be difficult, but employers should know that they do not need to apply one safe harbor across their entire workforce and should choose what makes the most sense for their organization. If you’re interested in learning more about ACA safe harbors, including real-world examples, and which safe harbor method may be best for your organization, download the Safe Harbor Playbook for Calculating ACA Affordability.
Implementing safe harbors when administering your health plan is one thing and communicating this information to the IRS is another. Minizmize risk, avoid penalties, and navigate the complexities of the ACA with full-service support from Trusaic.
