January 5, 2024

Pay or Play Penalty—Affordability of Health Coverage

The Affordable Care Act (ACA) requires applicable large employers (ALEs) to offer affordable, minimum value health coverage to their full-time employees or pay a penalty. This employer mandate provision is also known as the “employer shared responsibility” or “pay or play” rules. An ALE is only liable for a pay or play penalty if one or more of its full-time employees receive a subsidy for coverage under an Exchange.

Under the pay or play rules, an ALE’s health coverage is considered affordable if the employee’s required contribution to the plan does not exceed 9.5% (as adjusted) of the employee’s household income for the taxable year. For plan years beginning in 2023, the affordability percentage is 9.12%. This percentage decreases to 8.39% for plan years beginning in 2024.

Because an employer generally will not know an employee’s household income, the IRS has provided three optional safe harbors that ALEs may use to determine affordability based on information that is available to them—the Form W-2 safe harbor, the rate of pay safe harbor and the federal poverty level safe harbor. This Compliance Overview describes the ACA’s affordability determination and safe harbors for purposes of the pay or play rules.

Applicable Large Employer

Only ALEs are subject to the employer shared responsibility rules.

  • ALEs are employers that employ, on average, at least 50 full-time employees, including full-time equivalents (FTEs), during the preceding calendar year.
  • All ALEs are subject to these rules, including for-profit, nonprofit and government employers.

Affordability Safe Harbors

The IRS has provided three optional safe harbors that ALEs may use to determine their plan’s affordability:

  • Form W-2 safe harbor;
  • Rate of pay safe harbor; and
  • Federal poverty level safe harbor.

Affordability Determination

Under the employer shared responsibility rules, an ALE that offers health coverage to substantially all of its full-time employees (and dependents) may be subject to a penalty if the health coverage does not provide minimum value or is unaffordable. For this purpose, an ALE’s health coverage is considered affordable if the employee’s required contribution to the plan does not exceed 9.5% (as adjusted) of the employee’s household income for the taxable year. “Household income” is the modified adjusted gross income of the employee and any family members (including a spouse and dependents).

The affordability test applies only to the portion of the annual premiums for self-only coverage and does not include any additional cost for family coverage. Also, if an employer offers multiple health coverage options, the affordability test applies to the lowest-cost option that provides minimum value.

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