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 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.
Affordability of healthcare coverage offered by employers to its full-time employees is an important part of the formula to satisfy the ACA Employer Mandate that demonstrates ALEs have appropriately offered affordable health coverage. The IRS provides three affordability safe harbors that employers may claim when submitting their annual ACA information returns. 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).
Rate of Pay Safe Harbor
The Rate of Pay Safe Harbor is a method for proving ACA affordability based on an employee’s hourly rate or monthly salaried rate or wages. Best practices suggest performing this safe harbor test for each full-time employee, every month.
Hourly Workers: To determine the affordability threshold for an hourly worker, for example, take the employee’s lowest hourly rate for the month and multiply by 130 (the minimum total of hours on a monthly basis to be treated as a full-time employee under the ACA). Take that product, multiply by 9.78% for 2020. This will identify the maximum monthly premium that the employee may be required to pay to satisfy affordability per ACA regulations.
Here’s an example: Alex works 130 hours at a $15 hourly rate in March.
Multiply $15 by 130. Take the result of $1,950 and multiply by 9.78%. The $190.71 is the maximum amount for March that Alex’s employer can require Alex to pay to cover himself if the employer wants to satisfy affordability for that month with respect to that employee.
Salaried Worker: To determine the affordability threshold for a salaried employee, multiply the monthly salary by 9.78%.
Here’s an example: Angela is a full-time employee who receives a monthly salary of $10,000. Multiply $10,000 by 9.78%. The $978 is the maximum monthly amount that Angela’s employer can require Angela to pay to cover herself if the employer wants to satisfy affordability for that month with respect to that employee.
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. It can be the trickiest safe harbor to use because it cannot be determined until the end of the year. The reason for this is because you need the amount in the W-2 Box 1 for the affordability calculation. In order to claim the W-2 Safe Harbor, the following formula is generally used: W-2 Box 1 Wages multiplied by 9.78% with an adjustment for partial year coverage.
Here’s an example: John is paid an annual salary of $42,000 per year. He was employed for only 9 out of the 12 months of the year and was offered coverage throughout those 9 months. Take $42,000 and multiply it by 9.78%. Multiply that result by 9/12. The product, $3,080.70, corresponds to the maximum annual amount that John’s employer can require John to pay for self-only coverage in order to meet the W-2 safe harbor for the total of 9 months. In other words, for each of those 9 months, John’s employer may not require him to pay more than $345.10 per month for self-only coverage.
FPL Safe Harbor
The Federal Poverty Line (FPL) Safe Harbor is a method for proving ACA affordability that is based on employee’s annual household income, which is a function of that employee’s household size and is adjusted on an annual basis. For 2020, the mainland FPL is $12,760 for a household size of 1. In order to meet the FPL Safe Harbor, an employer must show that the full-time employees were offered self-only coverage that did not exceed the product of the FPL multiplied by 9.78% and then divided by 12 ($12,490 x 9.78% / 12 = $101.79). If the employee contribution for self-only coverage meets or is below this amount, then the FPL safe harbor is met.
Here’s an example: Sabrina is paid $2,000 a month, corresponding to $24,000 annually. Sabrina’s employer set up uniform contribution rates for self-only coverage at a required contribution rate at $60.00 a month. This monthly contribution is below the FPL ceiling of $101.79 per month and hence, the FPL Safe Harbor is met.
If an employer sponsored plan is offered to the full-time employee and his/her dependents and meets the FPL Safe Harbor (and Minimum Value) for self-only coverage, the offer would be a “Qualifying Offer,” which would then eliminate the need to code Line 15, which ordinarily requires a specific dollar amount of each monthly contribution.
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. Notably, starting in 2020, the Form 1095-C included new codes for HRAs integrated with individual health insurance coverage or Medicare, subject to certain conditions. Applying the correct code combinations is essential to preventing the issuance of Letter 226J to your organization, which the IRS is currently issuing for the 2018 tax year.
If your organization has received IRS Letter 226J, click here to learn best practices for responding to the penalty.
To learn more about ACA compliance in 2021, click here
To learn more about ACA compliance in 2020, click here.
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