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Pay or Play Penalty – Affordability Safe Harbors

Filed under: Health Care Reform

The Affordable Care Act (ACA) requires large employers to offer affordable, minimum value health coverage to their full-time employees or pay a penalty. These employer mandate penalties are also known as "shared responsibility" or "pay or play" penalties.

The employer mandate provisions were set to take effect on Jan. 1, 2014. However, on July 2, 2013, the Treasury announced that the employer mandate penalties and related reporting requirements will be delayed for one year, until 2015. Therefore, these payments will not apply for 2014. On July 9, 2013, the Internal Revenue Service (IRS) issued Notice 2013-45 to provide more formal guidance on the delay. Proposed rules were released on the reporting requirements on Sept. 5, 2013. Future guidance may also impact the rules described in this document. No other provisions of the ACA are affected by the delay.

On Jan. 2, 2013, the Internal Revenue Service (IRS) published proposed regulations that provide further guidance on whether coverage will be considered affordable. The IRS previously announced the Form W-2 safe harbor, which allows employers to assess affordability for each employee according to the employee's Form W-2 wages only (rather than household income). The proposed regulations:

  • Incorporate the Form W-2 safe harbor; and
  • Establish two additional affordability safe harbors: the rate of pay safe harbor and the federal poverty line safe harbor.

The regulations are not final. However, employers may rely on the proposed regulations until final regulations or other applicable guidance is issued.

Also, on May 3, 2013, the IRS released a proposed rule on ACA's minimum value and affordability requirements. This proposed rule includes guidance on how health reimbursement arrangements (HRAs) and wellness program incentives are counted in determining the affordability of employer-sponsored coverage.


The affordability of any health coverage offered by a large employer is a key point in determining whether the employer will be subject to a shared responsibility penalty. The coverage is considered affordable if the employee's required contribution to the plan does not exceed 9.5 percent of the employee's household income for the taxable year. "Household income" means the modified adjusted gross income of the employee and any members of the employee's family, including a spouse and dependents.

Because employers may be largely unaware of the income levels of their employees' family members, they could find it difficult to assess whether the coverage they offer would be considered affordable. To address this issue, the three affordability safe harbors provide alternate methods of determining the affordability of their health coverage.

These safe harbors are all optional. An employer may choose to use one or more of these safe harbors for all its employees or for any reasonable category of employees, provided it does so on a uniform and consistent basis for all employees in a category.

Safe Harbor Application

The proposed rules clarify that the affordability safe harbors apply only for purposes of determining whether an employer's coverage satisfies the 9.5 percent affordability test for purposes of the employer shared responsibility penalty under Code section 4980H(b). The safe harbors do not affect an employee's eligibility for a premium tax credit, which would continue to be based on the affordability of employer-sponsored coverage relative to an employee's household income.

This means that, in some instances, an employer's offer of coverage to an employee could be considered affordable (based on W-2 wages) for purposes of determining whether the employer is subject to a penalty, and the same offer of coverage could be treated as unaffordable (based on household income) for purposes of determining whether the employee is eligible for a premium tax credit.


Under the Form W-2 safe harbor, an employer may determine the affordability of its health coverage by reference only to an employee's wages from that employer, instead of by reference to the employee's household income. Wages for this purpose is the amount that is required to be reported in Box 1 of the employee's Form W-2. The proposed rules emphasize that wages for the purposes of the Form W-2 safe harbor does not take into account any elective deferrals to a 401(k), 403(b) or cafeteria plan.

Eligibility for the Form W-2 Safe Harbor

To be eligible for the Form W-2 safe harbor, an employer must:

  • Offer its full-time employees (and their dependents) the opportunity to enroll in minimum essential coverage under an employer-sponsored plan; and
  • Ensure that the employee portion of the self-only premium for the employer's lowest cost coverage that provides minimum value (employee contribution) does not exceed 9.5 percent of the employee's W-2 wages.

If the employer satisfies both of these requirements for a particular employee, along with any other conditions for the safe harbor, the employer will not be subject to a penalty for providing unaffordable coverage with respect to that employee. This is the case even if the employee receives a premium tax credit or cost sharing reduction to purchase coverage through a health insurance exchange.

Timing of the Form W-2 Safe Harbor

Whether the safe harbor applies will be determined after the end of the calendar year and on an employee-by-employee basis, taking into account W-2 wages and employee contributions. However, an employer could also use the Form W-2 safe harbor prospectively, at the beginning of the year, by structuring its plan and operations to set the contribution for each employee at a level that would not exceed 9.5 percent of that employee's W-2 wages for that year. Employers may also make adjustments for pay periods so that the employee contribution does not exceed 9.5 percent of the employee's W-2 wages.

Form W-2 Safe Harbor for New Employees

For an employee who was not a full-time employee for the entire calendar year, the Form W-2 safe harbor is applied by adjusting the employee's Form W-2 wages to reflect the period when the employee was offered coverage. The adjusted wages will then be compared to the employee share of the premium during that period.

Specifically, the amount of the employee's compensation for purposes of the Form W-2 safe harbor is determined by multiplying the wages for the calendar year by a fraction equal to the months the employee was employed. That adjusted wage amount is then compared to the employee share of the premium for the months that coverage was offered to determine whether the Form W-2 safe harbor was satisfied for that employee.


The rate of pay safe harbor was designed to be easy to apply and allow employers to prospectively satisfy affordability without the need to analyze every employee's wages and hours. For hourly employees, the rate of pay safe harbor allows an employer to:

  • Take the hourly rate of pay for each hourly employee who is eligible to participate in the health plan as of the beginning of the plan year;
  • Multiply that rate by 130 hours per month (the benchmark for full-time status for a month); and
  • Determine affordability based on the resulting monthly wage amount.

Specifically, the employee's monthly contribution amount (for the self-only premium of the employer's lowest cost coverage that provides minimum value) is affordable if it is equal to or lower than 9.5 percent of the computed monthly wages (that is, the employee's applicable hourly rate of pay multiplied by 130 hours). For salaried employees, monthly salary would be used instead of hourly salary multiplied by 130 hours.

An employer may use the rate of pay safe harbor only if, with respect to the employees for whom the employer applies the safe harbor, the employer did not reduce the hourly wages of hourly employees, or the monthly wages of salaried employees, during the year.


An employer may also rely on a design-based safe harbor using the federal poverty line (FPL) for a single individual. The FPL safe harbor allows employers to disregard certain employees in determining the affordability of health coverage (that is, employees who cannot receive a premium tax credit because of their income level or eligibility for Medicare, and therefore cannot trigger an employer's liability for a shared responsibility penalty).

Specifically, employer-provided coverage is considered affordable if the employee's cost for self-only coverage under the plan does not exceed 9.5 percent of the FPL for a single individual. For households with families, the amount that is considered to be below the poverty line is higher, so using the amount for a single individual ensures that the employee contribution for affordable coverage is minimized. Employers can use the most recently published poverty guidelines as of the first day of the plan year of the applicable large employer member's health plan.


The proposed rule from May 3, 2013 includes special rules for determining how HRAs and wellness program incentives are counted in determining the affordability of employer-sponsored coverage. (Employer contributions to health savings accounts (HSAs) do not affect the affordability of employer-sponsored coverage because HSA amounts may generally not be used to pay for health insurance premiums.)

HRA Contributions

Under the proposed rule, amounts made newly available under an HRA that is integrated with an employer-sponsored plan for the current plan year are taken into account only in determining affordability if the employee may either:

  • Use the amounts only for premiums; or
  • Choose to use the amounts for either premiums or cost-sharing.

Treating amounts that may be used either for premiums or cost-sharing only toward affordability prevents double counting the HRA amounts when assessing minimum value and affordability of employer-sponsored coverage.

Wellness Program Incentives

The proposed rule also contains clarification on affordability when premiums may be affected by wellness programs. Under the proposal, the affordability of an employer-sponsored plan is determined by assuming that each employee fails to satisfy the wellness program's requirements, unless the wellness program is related to tobacco use. This means the affordability of a plan that charges a higher initial premium for tobacco users will be determined based on the premium charged to non-tobacco users, or tobacco users who complete the related wellness program, such as attending smoking cessation classes.

Transition relief is provided in the proposed rule for plan years beginning before Jan. 1, 2015. Under this relief, if an employee receives a premium tax credit because an employer-sponsored health plan is unaffordable or does not provide minimum value, but the employer coverage would have been affordable or provided minimum value had the employee satisfied the requirements of a nondiscriminatory wellness program that was in effect on May 3, 2013, the employer will not be subject to the employer mandate penalty.

The transition relief applies for rewards expressed as either a dollar amount or a fraction of the total required employee premium contribution. Also, any required employee contribution to premium determined based upon assumed satisfaction of the requirements of a wellness program under this transition relief may be applied to the use of an affordability safe harbor.

It is unclear how the delay of the employer mandate penalties will impact this transition relief.

Source: Internal Revenue Service

This article is not intended to be exhaustive nor should any discussion or opinions be construed as legal advice. Readers should contact legal counsel for legal advice.

Design © 2013 Zywave, Inc. All rights reserved. 1/13; BK 10/13

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