1095-C reporting: How to use affordability safe harbors

Content updated on 10/24/2023

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 2023, “affordable” means that the employee’s share of self-only health coverage cannot exceed 9.12% 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:

• 9.78% for Tax Year 2020
• 9.83% for Tax Year 2021
• 9.61% for Tax Year 2022
• 9.12% for Tax Year 2023

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 2023, this penalty (aka the ACA tack hammer penalty) would be – before taxes – $360 a month per employee, times the number of employees who got subsidized coverage on an exchange. This amount is adjusted annually for inflation:

• $321.67 / month for Tax Year 2020
• $338.33 / month for Tax Year 2021
• $343.33 / month for Tax Year 2022
• $360.00 / month for Tax Year 2023

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 9.12% (for 2023) 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 9.12% (for 2023) 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

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 for the lowest-cost, self-only coverage does not exceed 9.12% (for 2023) 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 9.12%* (adjusted for inflation in 2023) of $10 x 130 hours.

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 9.12% (for 2023) of the Mainline Federal Poverty Line (FPL) Safe Harbor for calendar year 2023 ($14,580 for 2023) 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.

Poverty level guidelines are typically not available until the end of January or later. Therefore, the IRS allows employers to use the poverty guidelines that were in effect within six months prior to the start of the employer’s plan year.

For example, an employer with a January 1, 2023 plan year start date, would use the 2023 guideline amount to determine the 2023 FPL monthly threshold amount. So for this example, the employer would multiply $14,580 by 9.12% then divide by 12, which is $110.81. This means that the employee’s monthly contribution for self-only coverage cannot exceed $110.81 in order to meet affordability under the FPL safe harbor.

• $14,580 * 9.12% / 12 = $110.81 for Tax Year 2023

The downside to using the FPL safe harbor is that the poverty line is based on the federally mandated minimum wage. Some states and municipalities are raising their minimum wages.

Note: Alaska and Hawaii are unique states with higher income guidelines – those can be found here.