The Bar is Changing Again for Defining Affordability Under the ACA
Is your health plan affordable for employees as defined by the Affordable Care Act (ACA)? Being affordable is a basic goal of the law — after all, it’s the first word of the name! But defining ACA affordability is a moving target. The IRS tweaks the formula used to define it every year to keep up with various factors.
Applicable large employers (ALEs), basically those with at least 50 employees or 50 full-time equivalents, need to know the current definition because it’s one of the triggers for penalties under the ACA’s employer mandate. Let’s look at how the bar for affordability is changing yet again and what you can do to be prepared.
Calculating the percentage
The IRS calculates ACA affordability using the “applicable contribution percentage.” This term refers to a maximum percentage of an employee’s household income that the employee can be charged as a “required contribution” for health benefits for the least expensive plan option, based on the single coverage rate. (The test is the same whether an employee is buying single coverage or a family plan.)
Because employers can’t be held accountable for knowing employees’ household income, the applicable contribution percentage is pegged to an employee’s earnings. This figure was 9.5 percent when the ACA’s employer shared responsibility provisions took effect in 2015. The number has generally inched up ever since. For 2020, however, it drops slightly from 9.86 percent in 2019 to 9.78 percent.
ALEs with many relatively low-wage employees will need to pay close attention to that new affordability threshold and possibly recalibrate cost-sharing amounts for next year. That’s because the lowest-paid employees are the ones most likely to flunk the affordability test.
Putting the numbers to work
For example, the approximate maximum amount you could charge an employee who earns a $12 hourly wage next year for the least expensive employee-only plan would be around $1,831. (This figure is based on hourly employees averaging 130 hours per month, the minimum number considered full-time and eligible for health benefits under the ACA.) That’s about 1 percent lower than the maximum you could charge a $12 per hour employee this year.
Although a 1 percent drop wouldn’t be much if your plan costs were staying level, chances are that’s not the situation. If your costs are rising by at least 1 percent, and employees’ costs were close to those numbers this year, you might need to lower employees’ costs for 2020, or increase their wages, to make the numbers work.
Keep in mind that the employee “required contribution” that can’t exceed the applicable contribution percentage figure doesn’t include deductibles and co-pays. Another ACA measure, the “minimum value” test, takes care of that. As explained by the IRS, a health plan provides minimum value “if it covers at least 60 percent of the total allowed cost of benefits that are expected to be incurred under the plan and provides substantial coverage of inpatient hospitalization services and physician services.”
Three safe harbor tests
From the start, the IRS recognized that employers don’t have access to data about employees’ household incomes for affordability determination purposes. So, it came up with three safe harbor methods you can use instead, applying the annually adjusted applicable contribution percentage calculation:
- The rate-of-pay test. To use it, take the lower of the hourly employee’s wage at the beginning of the plan year (typically January 1) and the lowest wage rate during the month being measured. (Odds are the lower number will be the beginning of the plan year pay rate.) Multiply that wage rate by 130, as in the example above. Assuming a $12 hourly rate on January 1, here’s the math: $12 ×130 = $1,560 × 9.78% = $152.57 ($1,831 annualized). That’s the maximum the $12 per hour employee could be charged monthly for single coverage under your least expensive plan, without failing the affordability test. You’re still covered under this safe harbor if employees take a lot of unpaid leave or have reduced hours during a given month, so long as the wage rate itself doesn’t drop. For salaried employees, just use each month’s salary in lieu of an assumed hourly-based monthly pay amount.
- The W-2 wages method. Here you multiply the applicable contribution percentage by an amount equal to the prior year’s W-2 Box 1 gross income number. You might have to do a little guesswork, because you won’t have that W-2 number yet when you set employee contribution rates for the next plan year. Also, this method is safest when employees’ wages are likely to remain fairly level. That’s because, if an employee’s wages drop enough in any month to make the employee’s coverage unaffordable based on the formula, this safe harbor doesn’t let you off the hook. Another consideration is that W-2 Box 1 wages don’t include employee pay that employees decide to move to a 401(k) plan or Section 125 plan. Those amounts cannot be added back to employee pay when you do the maximum employee health plan cost-share calculation.
- The Federal Poverty Line (FPL) for single individual approach. The FPL for a one-person household in 2019 is $12,490. Using this safe harbor and the 2019 applicable contribution percentage of 9.86%, the maximum monthly affordable employee contribution would be $102.63. Note: Each year’s adjusted FPL is announced early in the year, but the IRS will let you use the FPL number issued within the past six months. This basically means you can rely on the previous year’s FPL for your calculations.
Choosing a safe harbor
One safe harbor might make more sense for one category of employees than another. For example, for simplicity’s sake, salaried employees whose pay will remain steady for the entire year might be well suited to the W-2 safe harbor. On the other hand, a different group of employees, paid by the hour with pay rates that fluctuate, might be better candidates for one of the other two safe harbors.
Using different safe harbor methods for different groups of employees is fine, according to the IRS, “provided that the categories used are reasonable and [used] on a uniform and consistent basis for all employees in a particular category.”
Assessing your risk
No one said being an ALE is easy. If your organization is subject to the employer mandate, and therefore its penalties, assess whether changes to the definition of “affordability” could put you at financial risk. Ask your CPA for help crunching the numbers.