Content updated on February 11, 2020

affordability safe harbor guidance for Line 16 of 1095-C form_Integrity Data

To sharpen the rendering of this image, please click to enlarge – particularly to see the footnote of the change in IRS guidance for Code 1A, which was announced January 25, 2016.

Since employers don’t know their employees’ household incomes, how do they document what’s “affordable” on their 1095-C returns to the IRS?

The IRS gives employers three ways to declare on their Affordable Care Act returns – specifically, Line 16 of Form 1095-C – just how affordable their employees’ contributions to coverage were.

If you employ lower-wage workers, you especially have to pay attention to the affordability safe harbors. Fines for offering non-compliant coverage – aka the ACA tack hammer penalty, covered in this article – will be assessed monthly. Calculations for these three tests are called the affordability safe harbors. You may also hear them mentioned in reference to Section 4980H, which is the ACA section of the Internal Revenue Code with the Employer Shared Responsibility Provisions.

  • The penalty-assessment period began January 1, 2015 for employers with 100 or more full-time employees, including full-time equivalents.
  • If you have 50 of more full-time employees, including full-time equivalents, your penalty-assessment period under Section 4980H began January 1, 2016.

Here we explain the safe harbor rules, so you can decide how these options can best serve your company.

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 do not need to be identical.

Making sense of “affordable”

When applying ACA tax regulations to Tax Year 2020, “affordable” means that the employee’s share of self-only health coverage cannot exceed 9.78% 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:

For details on this change in IRS guidance for ACA reporting, please see the SHRM (Society of Human Resources Management) article IRS Pinpoints ACA Affordability Percentage for Safe Harbors.

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 2020, this penalty (aka the ACA tack hammer penalty) would be – before taxes – $321.67 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
  • $312.50 / month for Tax Year 2019
  • $321.67 / month for Tax Year 2020

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

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 9.78% (for 2020) of wages reported on Form W-2 Box 1 for the calendar year. (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 would 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 coverage at 9.78% (for 2020) 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 contribute 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