An “applicable large employer” is subject to a penalty if either (1) the employer fails to offer to its full-time employees (and their dependents) the opportunity to enroll in minimum essential coverage (MEC) under an eligible employer-sponsored plan and any full-time employee obtains a subsidy for health coverage on a government exchange (Section 4980H(a) liability) or (2) the employer offers its full-time employees (and their dependents) the opportunity to enroll in MEC under an eligible employer-sponsored plan, but one or more full-time employees obtains a subsidy on an exchange because the employer’s coverage was not affordable or does not provide minimum value (Section 4980H(b) liability).

What does “affordable” mean for this purpose? Affordable means that an employee’s required contribution for individual coverage under his employer’ plan may not exceed 9.5 percent (indexed) of the employee’s household income. As employers do not generally have the household income information of their employees, the regulations under Internal Revenue Code Section 4980H provide three separate safe harbors under which an employer may determine affordability based on information that is readily available to the employer – (1) the Form W-2 wages safe harbor, (2) the rate of pay safe harbor, and (3) the federal poverty line safe harbor.

  • For example, if an employer uses the Form W-2 safe harbor, health coverage will be deemed to be affordable for Section 4980H(b) liability purposes if an employee’s required contribution is no more than $190 per month and his Form W-2 compensation is $2,000 per month ($190 is 9.5% of $2,000).

However, if the employer also offers employees an “opt-out” payment for those who decline coverage, then this opt-out amount must be counted as part of the employee contribution, according to informal discussions with Internal Revenue Service representatives (speaking in their individual rather than official capacities).

  • Therefore, using the previous example, if the employer offers employees a $100 per month opt-out payment, the employee contribution amount would be deemed to be $290 per month, rendering the insurance unaffordable under the Form W-2 safe harbor ($290 is 15.5% of $2,000).

While this impact of cash opt-out payments on affordability is not clearly articulated in the Section 4980H regulations, the Internal Revenue Service’s informal position described above is consistent with the final regulations relating to the requirement to maintain minimum essential coverage and makes sense from an economic standpoint. We note that the Internal Revenue Service also stated informally that it may treat similar cash payments to Service Contract Act and Davis-Bacon Act employees differently.

Employer takeaway: If you have analyzed affordability without taking into account any opt-out payments you offer, you should take another look at whether your plan is affordable.