The ACA offer of coverage part 2: Affordability

Question: What makes an employer’s offer of coverage affordable for purposes of avoiding potential Affordable Care Act (ACA) employer mandate penalties?

Short answer: The ACA affordability standard generally requires offering coverage that meets the applicable required contribution percentage for the plan year, as determined under one of three available safe harbor approaches. Applicable large employers must offer full-time employees coverage that is affordable to avoid the ACA employer mandate Section 4980H(b) B Penalty.

Starting point: The ACA employer mandate

The ACA employer mandate (also referred to as employer shared responsibility or pay or play) rules apply to employers that are applicable large employers, or ALEs. In general, an employer is an ALE if it (along with any members in its controlled group) employed an average of at least 50 full-time employees, including full-time equivalent employees, on business days during the preceding calendar year.

The ACA employer mandate offer of coverage requirements

An offer of coverage made by an ALE to a full-time employee must meet four requirements to avoid potential ACA employer mandate penalty liability:

• The offer must be for minimum essential coverage (part 1)
• The offer must be affordable (part 2)
• The plan must provide minimum value (part 3)
• The full-time employee must have an effective opportunity to enroll (part 4)

Why it matters: Potential ACA employer mandate B Penalty liability

ALEs offering minimum essential coverage (MEC, generally including any major medical plan) to at least 95% of full-time employees and their children to age 26 avoid potential Internal Revenue Code (IRC) Section 4980H(a) A Penalty liability. To avoid IRC Section 4980H(b) B Penalty liability, the offer must also provide minimum value and meet the ACA affordability standards.

The B Penalty may apply for each full-time employee who is:

• Not offered MEC;
• Offered coverage that does not provide minimum value; or
• Offered unaffordable coverage

The 2027 B Penalty is $472.50/month ($5,670 annualized) for each such full-time employee receiving subsidized coverage on the exchange.

Key point: An ALE’s failure to offer coverage that meets the ACA affordability standard for any given full-time employee creates potential B Penalty liability.

The annual required contribution percentage threshold

The ACA affordability test is based on the monthly employee-share of the premium for employee-only coverage under the ALE’s lowest-cost plan option that provides minimum value in which the full-time employee is eligible to enroll. In other words, the test looks to the lowest possible amount a full-time employee could pay each month to enroll in the employer’s major medical plan, regardless of what plan option (if any) the employee elects.

In applying this test, the standard applies an annual required percentage threshold to determine whether that lowest possible employee contribution is affordable. This percentage threshold changes each year. For plan years beginning in 2027, the annual required percentage is 10.22%.

The IRS affordability safe harbors for employers

The ACA affordability test looks to whether the employee contribution amount is within the applicable required contribution percentage of the full-time employee’s household income. However, given that employers generally are not aware of employees’ household income, the IRS makes available three safe harbors for ALEs to determine whether an offer of coverage is affordable for purposes of avoiding B Penalty liability:

• Federal poverty line affordability safe harbor
• Rate of pay affordability safe harbor
• Form W-2 affordability safe harbor

ALEs may choose different safe harbors for any reasonable category of employees as long as they apply each safe harbor on a uniform and consistent basis for all employees in each category. The IRS states that reasonable categories include specified job categories, nature of compensation (such as salaried or hourly), geographic location and similar bona fide business criteria. Listing employees specifically by name (or other categories having the same effect) is not considered a reasonable category.

Option 1: Federal poverty line affordability safe harbor

The most straightforward path for ALEs to avoid affordability liability is to satisfy the federal poverty line affordability safe harbor. To qualify, the monthly employee-share of the premium for the ALE’s lowest-cost plan option (which provides minimum value) at the employee-only coverage tier cannot exceed the applicable annual required contribution percentage (10.22% in 2027) of the federal poverty line for a single individual, divided by 12. Employers are permitted to use the federal poverty line threshold that is in effect within six months before the first day of the plan year.

For a 2027 calendar plan year, this requires offering at least one medical plan option providing minimum value with an employee-only contribution that does not exceed $135.93 per month. The monthly limit is based on 10.22% of the 2026 federal poverty line for a single individual in the contiguous 48 states and D.C., divided by 12. Different thresholds apply for Alaska and Hawaii, and special timing rules may apply for non-calendar-year plans.

This federal poverty line safe harbor is particularly attractive because it is simple, predictable and administratively efficient—no analysis of employee compensation levels is required. The safe harbor also may permit the employer to use the streamlined Qualifying Offer Method for ACA reporting by including Code 1A on Form 1095-C Line 14, eliminating the need to include the employee required contribution on Line 15.

Key point: ALEs should consider offering a plan option that costs full-time employees no more than the federal poverty line affordability safe harbor threshold ($135.93/month in 2027) to simplify affordability compliance (and ACA reporting).

Option 2: Rate of pay affordability safe harbor

The rate of pay affordability safe harbor applies the applicable annual required contribution percentage to each full-time employee’s rate of pay. The safe harbor calculation differs based on whether the full-time employee is paid on an hourly or salaried basis.

• Hourly full-time employees: Hourly rate of pay × 130 hours × applicable annual required contribution percentage (10.22% in 2027)
• Salaried full-time employees: Monthly salary × applicable annual required contribution percentage (10.22% in 2027)

For example, if the ALE’s lowest-paid hourly full-time employees earn $20 per hour, the monthly affordability limit in 2027 is $265.72. If the lowest-paid salaried full-time employees earn $36,000 annually, the monthly affordability limit in 2027 is $306.60. An ALE in this situation with a single uniform contribution structure meets the rate of pay safe harbor for all full-time employees in both categories if the lowest-cost medical plan option providing minimum value does not exceed the lower of the two ($265.72 per month in 2027).

Key point: ALEs not meeting the federal poverty line affordability safe harbor should consider the rate of pay affordability safe harbor as the alternative. While it requires additional calculations based on employee compensation levels, this safe harbor retains the key ability to determine affordability prospectively prior to the start of the plan year.

Option 3: Form W-2 affordability safe harbor

The Form W-2 affordability safe harbor provides that coverage is affordable if the employee required contribution for the lowest-cost plan option does not exceed the applicable annual required contribution percentage (10.22% in 2027) of the employee’s Form W-2 Box 1 wages.

This safe harbor presents a few challenges that often make the other safe harbor approaches more administratively attractive. For one, the Form W-2 safe harbor is less predictable because final Box 1 wages are not fully known until after year-end. The safe harbor may also be more difficult to satisfy because Box 1 excludes common compensation amounts such as 401(k) plan deferrals and Section 125 cafeteria plan salary reduction contributions. Furthermore, the Form W-2 safe harbor generally does not permit mid-year adjustments to the employee required contribution. ALEs should weigh these administrative challenges if considering this safe harbor approach.

On the other hand, the Form W-2 approach may present advantages for ALEs with employees for whom tips represent a significant portion of their compensation, or for employees compensated solely on the basis of commissions. As the IRS recognizes, it is generally impractical to apply a rate of pay affordability safe harbor approach for these types of full-time employees.

Key point: ALEs not meeting the federal poverty line affordability safe harbor will in many cases find the rate of pay safe harbor to be the more desirable alternative. Nevertheless, the Form W-2 affordability safe harbor may still merit consideration for certain workforces.

Other important ACA affordability considerations: Opt-out credits

ALEs offering an opt-out credit for employees to waive the medical plan generally must follow the eligible opt-out arrangement conditions to avoid adversely affecting the affordability determination.

An eligible opt-out arrangement meets the following two conditions:

• The opt-out credit is conditioned on the employee declining to enroll in the major medical plan; and
• The opt-out credit is conditioned on the employee providing reasonable evidence (including an employee attestation) annually that the employee and all members of the employee’s expected tax family have or will have minimum essential coverage that is not individual market coverage during the plan year

Opt-out credits not meeting these conditions generally must be added to the employee-share of the lowest-cost plan option providing minimum value that is used to determine affordability. For example, an ALE offering an opt-out credit of $50 per month in combination with a lowest-cost plan option providing minimum value at $100 per month would in most cases have to base the affordability analysis on an employee required contribution of $150 for ACA purposes.

Key point: ALEs offering an opt-out credit should have a process to ensure only employees attesting to other non-individual market coverage receive the credit. This eligible opt-out arrangement approach avoids jeopardizing the ability to meet an affordability safe harbor.

Other important ACA affordability considerations: Flex credits

ALEs offering flex credits for employees to allocate among different Section 125 cafeteria plan qualified benefits generally must follow the health flex contribution conditions to avoid adversely affecting the affordability determination.

Health flex contributions meet the following three conditions:

• The employee may not opt to receive the amount as a taxable benefit (i.e., it is not a cashable flex credit);
• The employee may use the amount to pay for minimum essential coverage (i.e., the employer’s major medical plan); and
• The employee may use the amount exclusively for health coverage costs (e.g., medical, dental, vision, health FSA)

Flex credits not meeting these conditions generally do not qualify as reducing the employee-share of the lowest-cost plan option providing minimum value that is used to determine affordability. For example, an ALE offering $500 per month in cashable flex credits that can be allocated to the medical plan (and offering no other employer contribution for the medical plan) would have to base the affordability analysis on the entire premium amount for the lowest-cost plan option.

Key point: ALEs offering a defined contribution-style flex credit approach should meet the health flex contribution conditions to ensure the amounts made available qualify as an employer contribution for purposes of meeting an ACA affordability safe harbor.

Key takeaways

Meeting the ACA affordability standard is one component of ensuring ALEs are not subject to potential employer mandate penalty liability. ALEs avoid B Penalty exposure by offering an affordable plan (that provides minimum value) to all full-time employees. Employers should assess the appropriate safe harbor approach annually when designing the upcoming plan year employee contribution levels.

While some aspects of the affordability rules are complex, it is clear in most cases that ALEs should utilize the federal poverty line safe harbor where available. This standard, based on a fixed dollar amount that adjusts annually, ensures the offer of coverage is deemed affordable for all full-time employees regardless of compensation levels, with additional streamlined ACA reporting advantages. For plan years beginning in 2027, the federal poverty line affordability safe harbor is available where the monthly employee-share of the premium for the lowest-cost major medical plan option (that provides minimum value) at the employee-only tier does not exceed $135.93.

ALEs not able to meet the federal poverty line safe harbor should consider the rate of pay and Form W-2 safe harbors. The advantages offered by the rate of pay safe harbor often make it the preferred alternative.

Summary of ACA affordability safe harbor approaches