Under the Affordable Care Act, a company with fifty or more employees must provide them with affordable health insurance, meaning the employee’s share of the premium cannot exceed 9.5% of the employee’s household income. Although that may seem relatively cut-and-dry, putting it into action will be challenging to say the least. One of the biggest challenges will be determining household income. In response to this, the IRS has proposed three safe harbors as alternatives to determining the household income, which would also allow employers to comply with the mandate and avoid a penalty.
Household income is used as the target because the Affordable Care Act ties affordability to the tax credits and subsidies that are available to help people purchase insurance within the new marketplace created by the law. However, employers are typically in no position to find out how much their employees’ household income is. This would involve discovering the income of their employee’s spouse and income from second jobs, hobbies, and other sources.
The first option would be for the company to use the wages it reports to the IRS on Form W-2 as a substitute for household income. As long as the employee’s share of the insurance premium is less than 9.5% of the wages in Box 1 of the form, the coverage would be considered affordable.
The second option would be for the company to determine a baseline monthly wage based on the first months hourly rate or salary. However, unlike the first option, the wage calculated here would not exclude deferrals (such as 401k contributions), so it would be higher. In addition, if a company reduced the employee’s rate or salary over the year, it would not be able to use this option. This eliminates the option for many companies simply because they cannot plan for wage cuts.
The last option for the company would be to substitute the federal poverty level guidelines for an individual employee’s household income. The idea being that if the company has coverage that is affordable at that income level, it will be considered affordable by the IRS as well.
With each of these safe harbors, employers are trading convenience or certainty for a potentially lower threshold for affordability. In addition, the rule could also create confusion for employees who try to buy insurance on an exchange. This is because none of these safe harbors will be used by the exchanges to determine if the company insurance plan offered is actually affordable for the family when they go to buy.
In response to that, as the IRS acknowledged in its proposed rule, there could be situations where an employer’s offer of coverage would be considered affordable for the purposes of the employer mandate but unaffordable when the worker seeks coverage on the exchange. In that situation, the employer would get a pass. Even though the employee would get the tax credits to buy personal insurance, the company would not be penalized.
In addition, these safe harbors are voluntary. If a company would like, they could always attempt to calculate each employee’s household income. This could be far more beneficial for the company, especially if the employee’s spouse has a significant salary. For example, if you have an employee who makes $75,000, his insurance costs would have to be below $7,125 per year in order to avoid penalties. However, if his wife happens to be a doctor who makes $400,000 a year, the threshold for their portion of the insurance costs would be over $45,000.
As the IRS continues to hammer out these rules, the employer mandate is one of the aspects of the Affordable Care Act that has been postponed to 2015. Two other provisions, out-of-pocket caps and verification of income for personal tax subsidies, have been postponed from their legal 2014 implementation date to 2015. This delay is designed to allow the IRS and insurance companies more time to prepare for the changes.