Since employers don’t know their employees’ household incomes, how do they document what’s “affordable” on their 1095-C returns to the IRS?
Content updated on April 4, 2018
The 3 affordability safe harbors
If an employer is offering full-time employees and their dependents health insurance that meets the ACA standard of minimum essential coverage and offers minimum value (what’s needed for a taxpayer to comply with the ACA individual mandate), the IRS allows the employer to use one or all three of these tests for affordability:
- W-2 Wages safe harbor
- Rate-of-Pay safe harbor
- Federal Poverty Line (FPL) safe harbor
Just one safe harbor per plan. Employers with multiple plans can apply different safe harbors to different plans – they need not be identical.
Watch On-Demand: Concepts behind the Affordable Care Act’s mandate
Making sense of ‘affordable’
When applying ACA tax regulations to Tax Year 2021, “affordable” means that the employee’s share of self-only health coverage cannot exceed 9.83% of household income. (Though the affordability percentage is written in the Internal Revenue Code as 9.56%, subsequent IRS guidance hinted at adjustments for inflation.) Editor’s update: Adjustment of the affordability percentage to
- 9.56%* for Tax Year 2015 (IRS Rev. Proc. 2014-37)
- 9.66% for Tax Year 2016 (IRS Rev. Proc. 2014-62)
- 9.69% for Tax Year 2017 (IRS Rev. Proc. 2016-24)
- 9.56% for Tax Year 2018 (IRS Rev. Proc 2017-36)
- 9.86% for Tax Year 2019
- 9.78% for Tax Year 2020
- 9.83% for Tax Year 2021
- 9.61% for Tax Year 2022
Since employers typically don’t have all the information needed to identify total household income, the IRS advises employers to base the affordability percentage on an employee’s gross wages.
Without tracking the affordability requirements, an employer risks the penalty for non-compliant coverage that kicks in when one full-time employee seeks coverage on an exchange and gets a subsidy for it. For Tax Year 2022, this penalty (aka the ACA tack hammer penalty) would be – before taxes – $343.33 a month per employee times the number of employees who got subsidized coverage on an exchange. This amount is adjusted annually for inflation:
- $270.00 / month for Tax Year 2016
- $282.50 / month for Tax Year 2017
- $290.00 / month for Tax Year 2018
- $378.00 / month for Tax Year 2019
- $338.33 / month for Tax Year 2021
- $343.33 / month for Tax Year 2022
By using a safe harbor calculation and documenting it on Line 16 of an employee’s Form 1095-C, an employer will not be liable for a penalty if that employee got subsidized coverage on an exchange and the subsequent return from the exchange shows that the subsidy was based on the employee’s household income.
Affordability test: W-2 Wages safe harbor
The W-2 Wages safe harbor bases affordability on whether the worker’s premium contribution to the lowest-cost, minimum value, self-only coverage does not exceed 9.61%* of wages reported on Form W-2 Box 1 for the calendar year 2022. (In the final regulations, the IRS rejected adding back in wages due to salary reduction elections under a Section 401(k) plan or a cafeteria plan under Section 125.)
Without referencing total household income, the W-2 safe harbor sets the employee’s contribution amount based on their wages. The employee contribution to the actual employer expense for providing the coverage is not capped.
However, this safe harbor isn’t tied to a minimum number of hours worked. If an employee works fewer hours, the organization will have to pay more of the plan’s cost.
To make this a bit easier, the employer using the W-2 safe harbor may set each employee’s cost for self-only 2022 coverage at 9.61%* of W-2 Box 1 wages for the month and then set a monthly maximum. Doing so will ensure the employee’s contribution stays affordable for lower-paid workers, while higher-paid workers are not charged excessively. However, setting a monthly maximum is not mandatory as there is no relationship between the maximum an employee can be expected to contribution to their self only coverage and the actual cost the employer has in providing that coverage. The company’s dollar amount or percentage must be consistent throughout the calendar or plan year.
If an employer elects to set a maximum deduction per month, there may be a downside: When employees’ wages fluctuate, they could reach the maximum in one pay period but not earn enough in another pay period to cover their share of the plan cost. Thus, setting up this deduction as a percentage of wages may be the safest tack, allowing you to pick which pay codes to use; it will also not be affected by TSA deductions.
Affordability test: Rate-of-Pay safe harbor
Employers can avoid ACA penalties by using the Rate-of-Pay safe harbor even if an hourly employee’s hourly rate of pay is reduced during the year.
Under the Rate-of-Pay safe harbor, coverage for an hourly employee is considered affordable if the employee’s required contribution for the calendar month of 2022 for the lowest-cost, self-only coverage does not exceed 9.61%* of an amount equal to 130 hours multiplied by the lower of the employee’s hourly rate of pay on the first day of the coverage period (generally the first day of the plan year) or the employee’s lowest hourly rate of pay during the calendar month.
If an hourly employee treated as a full-time employee earns $10 per hour in a calendar month (and earned at least $10 per hour as of the first day of the coverage period) but has one or more calendar months with a significant amount of unpaid leave or otherwise reduced hours, the employer may still require an employee contribution of up to 9.61% (adjusted for inflation in 2022) of $10 x 130 hours, or $124.93.
For this test, salaried employees’ pay can be considered at the hourly rate equivalent.
The Rate-of-Pay safe harbor doesn’t work for employees who make tips or work commission-only. The other two safe harbors can be used in these situations.
Rate-of-Pay may be the best for employees whose work hours fluctuate. By multiplying the hourly rate by a constant 130 hours, it avoids the threat posed by the W-2 safe harbor that an employee’s hours could be reduced so much that the coverage costs fall mostly on the company.
The gap between the federal minimum wage and what is paid to the employee may make this a better option, especially as local legislation on living wages may expose employers to higher cost.
Affordability test: Federal Poverty Line (FPL) safe harbor
The third safe harbor for employers who want to avoid ACA penalties is the FPL test. For coverage to be affordable, the employee’s required contribution for the lowest-cost, self-only coverage that provides minimum value cannot exceed 9.61%* of the Federal Poverty Line (FPL) for calendar year 2022 divided by 12.
This method is the simplest safe harbor to use because it establishes one universal cost for all employees within that plan’s category.
The Federal Poverty Line for 2022 for an individual is $12,880. The employer sets the annual employee contribution for employee-only coverage for each month as an amount equal to 9.61%* multiplied by $12,880, which is $1,237.77, and then divided by 12 for a monthly premium of $103.14.
- $11,880 * 9.66% / 12 = $95.63 for Tax Year 2016
- $12,060 * 9.69% / 12 = $97.38 for Tax Year 2017
- $12,140 * 9.56% / 12 = $96.72 for Tax Year 2018
- $12,140 * 9.86% / 12 = $99.78 for Tax Year 2019
- $12,140 * 9.78% / 12 = $98.94 for Tax Year 2020
- $12,140 * 9.83% / 12 = $99.45 for Tax Year 2021
- $12,880 * 9.61% / 12 = $103.14 for Tax Year 2022
The downside to using the FPL safe harbor is that the poverty line is based on the federally mandated minimum wage, $7.25 an hour. Some states and municipalities are raising their minimum wages.
Which ACA safe harbor is optimal?
Of the three safe harbors, the Rate-of-Pay option offers companies the best protection and provides the safest way to have employees contribute their share of coverage under ACA rules.
This choice assumes that workers offered company-provided health insurance coverage are expected to work at least 30 hours, just as they did during the measurement period that gave them ACA eligibility for coverage.
The Rate-of-Pay option also protects employers faced with changes to local minimum wage laws. If an employer satisfies the criteria of a safe harbor and the employee is incapable of meeting the deduction, the employer can remove that employee from the plan.
You don’t have to figure out ACA affordability by yourself
Integrity Data can guide you in understanding the employer reporting requirements of the Affordable Care Act, including how to test for affordability and avoid costly penalties. Here’s how:
- Join the ACA reporting webinar for employers that we host every week.
- Or contact our ACA compliance team.
Related post: Manage ACA compliance for Tax Year 2016: Know the IRS penalty risks
*Adjusted annually for inflation
Integrity Data’s publications and presentations are intended to provide current and accurate information about the subject matter covered. They are designed to introduce employers to the IRS reporting requirements of the Affordable Care Act.
These publications and presentations are provided with the understanding that neither Integrity Data, nor the authors and presenters, are rendering legal or accounting advice. With respect to how the Affordable Care Act affects your business, verify the information that is presented with legal counsel.
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Last Review: 12/12/2022 – Revision: 1.4
Applies To: Microsoft Dynamics GP; ACA Compliance Solution
Categories: ACA Plan Setup, Year End – 1095-C and Filing
Keywords: Safe Harbor
KB Number: KB14-072