The “Affordability” Penalty for Large Employers Under the Federal Patient Protection and Affordable Care Act

The “Affordability” Penalty for Large Employers Under the Federal Patient Protection and Affordable Care Act

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The federal Patient Protection and Affordable Care Act (ACA) requires all employers with more than 50 full-time equivalent employees to either provide health care coverage or pay an IRS penalty.  The law further stipulates what services must be included in the health coverage employers provide for their employees, plus requires that the cost of the coverage must be affordable for the employee.  To be deemed affordable, employers must ensure that employees are not contributing more than 9.5% of their annual salary to premium payments.

Employers will be subject to the penalty if any of their full-time employees earning between 100-400% of the Federal Poverty Level seek a federal subsidy to purchase coverage in the state-based health exchange and a subsidy is awarded based on a determination that employer provided coverage does not meet the affordability standard.  The affordability penalty is $3,000 per each employee for which premium contributions are determined to not meet the affordability requirement.

The following are frequently asked questions covering this issue:

I am providing health care coverage to my employees.  Doesn’t that mean I am not subject to any of the IRS penalties?

Currently there are two different penalties a large employer, those with more than 50 full-time equivalent employees, could receive.  The first penalty is for not providing coverage to full-time employees (employers are not required to provide coverage to part-time employees).   A second penalty will apply if an employer provides coverage but the amount the employer asks the full-time employee to contribute to the coverage premiums exceeds 9.5% of that employee’s income.

What if my employee chooses employee plus dependent coverage,  are employee premium contributions for this higher cost coverage still limited to 9.5% of the employees income?

No.  If an employee chooses employee plus dependent coverage the affordability requirement will not apply.

How can I tell if I have low-income employees who are eligible for federal subsidies?

Subsidies are available to all individuals with incomes between 100-400% of the Federal Poverty Level.  The subsidies are variable with the highest subsidies going to those with the lowest incomes.  In 2014, those with annual incomes roughly between $11,170 and $44,680 will be eligible for the federal subsidies.  The Federal Poverty Level adjusts annually with inflation so each year employers must reevaluate premium contributions to ensure they will not violate the affordability standard.

Employers should look to Box 1 on an employee’s W-2 form and use those wages to get an idea of the employee’s annual income.   A safe harbor is granted for employers who use those wages and develop employee premium contributions for low income full-time employees that do not exceed 9.5% of the employee’s income.

What strategies can I use to set employee premium contributions so I do not run afoul of the affordability requirement?

Recent rules by the federal departments of Labor and Health and Human Services, recommend three strategies an employer could use to establish employee premium contributions that will garner safe harbor status from the affordability penalty in 2014:

  • Option 1: Take the wages of the lowest paid full-time employee and determine at what level the monthly premium contribution would exceed 9.5% of that employee’s income.  To do this they suggest using wages included in Box 1 of the employee’s W-2.
    • EX:  An employer’s lowest paid employee earned $15,000 last year.  9.5% of this employee’s annual salary ($15,000 x.095), yields an annual contribution of $1,425, or a monthly contribution ($1,425/12) of $118 per month.
    • Utilizing this option, an employer could either set a standard premium contribution for all employees that does not exceed the amount derived above (ex. In the example above $118 is the maximum amount allowed so the employer could choose a set amount well below that, such as $110 per month for each employee selecting employee only coverage); or follow the same process for employees in different wage bands, setting the premium rate for each wage band that does not exceed 9.5% of the wages covered by the band (ex.  Wage Band 1, $15,000-$25,000 = $110 per month; Wage Band 2, $26,000-$35,000 = $197 per month; and Wage 3, $36,000-$45,000 = $285 per month); or utilize any other method of deriving the maximum allowed premium contribution using W-2 wage information.
  • Option 2:  Use the predetermined annual earning calculation for individuals at 100% of the Federal Poverty Level to derive the maximum amount a low income employee would be required to contribute to the cost of their coverage.
    • EX:  The annual earnings of an individual at 100% of the Federal Poverty Level is $11,170 per year in 2013.  Calculate 9.5% of those earnings ($11,170 x .095) to  yield a maximum annual contribution $1,061 per year or dividing by 12 for a monthly contribution of ($1,061/12), $89 per month.
    • Utilizing this method, employers could either set all employee contribution rates at this level, or vary employee premium contributions by wage using one of the other approaches to determine amounts for all other employees.
  • Option 3:  Use the hourly rate paid to the lowest paid employee, find 9.5% of the rate, and multiply that amount by 130 hours as allowed by the federal rule.
    • EX:  The lowest paid employee earns $9.75 per hour.  9.5% of that hourly rate (9.75x.095) yields $.93 per hour.  This rate multiplied by 130 ($.93 x 130) yields a maximum monthly contribution of $120.
    • Utilizing this method, employers could either establish that all employees will pay the amount derived by the lowest hourly rate, or establish varying premium contributions by following the same process for each hourly rate paid to their employees.

What happens if my employee is eligible for Medicaid and decides to apply for that program, am I still subject to the affordability penalty?

No, employers will not be subject to a penalty for any full-time employees that are either receiving or who are eligible for and not yet enrolled in the state Medicaid program.  The same is true for those enrolled in the federal Medicare program.

How will the state know whether the premium contribution violates the affordability requirement?  Will they just take my employee’s word?

No.  The employee will be asked to submit documentation regarding their wages and the premium contribution you have set.  The state will then ask you to verify this information as well as identify the method you used to determine whether the contribution rate would meet the affordability standard.  They will compare the documentation provided and determine whether you utilized one of the safe harbor methods detailed above and make a decision.   No employer will be at fault if they followed any of the processes identified above.

How much is the penalty?

The affordability penalty is $3,000 for each full-time employee that goes to the exchange and is awarded a federal subsidy based on the affordability requirement.

Am I allowed to have different employee premium contributions based on income?

Yes, an employer may develop variable employee premium contributions that require individuals with higher incomes to contribute more to the cost of coverage.  As you develop the variable premium contributions, keep in mind that subsidies are available to all individuals with incomes up to 400% of the Federal Poverty Level.  Always check the amount of the premium you set to make sure you are not charging any one subsidy eligible employee more than 9.5% of their annual income.  Individuals with incomes that exceed 400% of the Federal Poverty Level can be required to pay up to 50% of the employee only premium.

Establishing varying premium contributions based on higher earnings will also reduce employer contribution levels.  Employers who set one premium contribution rate for all full-time employees will contribute considerably more to coverage than those employers who require higher contributions from higher wage employees.  Keep in mind that that although varying premiums are allowed, discrimination rules prohibit an employer from establishing a lower premium contribution for a higher paid employee than that of a lower wage employee.

Can I remove an employee from my plan if they move to part-time status?

Employers must establish a stability period during which employees are guaranteed access to health care coverage.  This stability period can be 6, 9 or 12 months in duration.  An employer is not allowed to remove an employee from their plan within that stability period unless the employee affirmatively states they are unable to pay the monthly employee premium contribution.

Currently a safe harbor exists for employers that if the employee drops coverage due to a reduction in hours that leads to an inability to pay the monthly employee premium contribution, and that employee accesses a federal subsidy through the state exchange for coverage, the employer will not be subject to the affordability penalty.

What if I have one truly low-income full-time employee and I do not want to set a separate premium contribution for this employee.  Can I just encourage them to go to the exchange where I know they can access subsidized coverage?

Yes, you may refer an employee to the exchange knowing that you will be assessed the $3,000 penalty for that one employee and not experience any additional penalties.  The same would be true for any number of employees for which you just want to send to the exchange.  As long as you are fully aware you will be expected to pay the penalty, you may send as many of your full-time employees to the exchange as you like.

Is it possible the affordability penalty could cost me more than if I were to just refuse to provide coverage?

No.  The affordability penalty has somewhat of a cap – the law stipulates the affordability penalty may not exceed the penalty that would be charged an employer that decides not to provide coverage.

  • EX:  An employer has 72 full-time equivalent employees, but only 37 full-time employees for which they must provide coverage.  If the employer decided to not provide coverage, the penalty for not providing coverage is $2,000 times each employee after the first 30 (remember this penalty for not providing coverage allows for a set-aside or disallowance of the first 30 full-time employees).  In this situation, the employer would pay an IRS penalty of $14,000 ($2,000 x 7) for not providing coverage.

If this employer provided coverage and wanted to charge all employees $250 per month for health care coverage but found that this amount exceeds 9.5% of the annual wages for two of their employees, the employer could make a choice.  They could offer the coverage to all employees and if all accept at $250, they have no issues.  However, if the two low-income individuals say the coverage is too expensive, the employer can either lower the premium contributions for these two employees, or encourage them to go to the exchange, knowing the employee will be eligible for the subsidy and the employer subject to the penalty.  The penalty once these employees are accepted for subsidies would be $3,000 x 2 or $6,000.   If the premium contribution was set too high for each of the 7 employees instead of just 2 and they all went to the exchange and were granted subsidies, the penalty would be calculated as $3,000 x 7 or $21,000 but because this exceeds the penalty for not providing coverage identified above as $14,000, the affordability penalty would be revised to $14,000 for this employer under this specific example.

Donna Steward, President, Kiawe Public Affairs

This publication is intended to inform employers about  provisions of the Patient Protection and Affordable Care Act and how those provisions may affect them.  This information should not be construed as legal  or tax advice, and readers should not act upon the information contained therein without professional counsel.

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