ACA Affordability Threshold for 2021: What ALEs Need to Know

Are you required to follow the Affordable Care Act (ACA)? If so, you need to know the affordability threshold for 2021 when setting cost-sharing amounts for the 2021 plan year.

What is “affordability threshold?”

If you have at least 50 full-time employees, you are an Applicable Large Employer (ALE) under the Affordable Care Act. As an ALE, you must offer at least 95% of your full-time employees “affordable” health insurance that contains “minimum essential coverage,” as defined by the ACA regulation. ALEs who fail to meet these requirements are subject to penalties from the IRS.

In an effort to make health insurance affordable for employees, the ACA limits the amount an ALE can charge employees for the least-expensive self-only plan. This limit — which is a percentage of the employee’s household income — is known as the “affordability threshold.”

Each year, the IRS announces the ACA affordability threshold for the next year.

This limit — which is a percentage of the employee’s household income — is known as the “affordability threshold.”

Affordability threshold for 2021

As stated in IRS Revenue Procedure 2020-36, the affordability threshold for 2021 is 9.83%, increasing from 9.78% in 2020. This means that — for the least-expensive self-only plan — ALEs cannot charge employees more than 9.83% of their household income. Note that the affordability threshold does not extend to family coverage or higher-priced plans, only to the least-expensive self-only plan.

The affordability threshold for 2021 is 9.83%, increasing from 9.78% in 2020.

Recognizing that ALEs normally do not know their employees’ household incomes, the IRS developed 3 safe harbors for calculating “affordability.”

Safe harbor # 1: The employee’s Form W-2 wages

This safe harbor relies on the employee’s Form W-2 Box 1 wages to determine “affordability.” However, it poses some issues.

• First: You will not know the employee’s Form W-2 Box 1 wages for 2021 until you’ve processed the employee’s final paycheck for 2021. This is why the IRS allows ALEs to use employees’ current Form W-2 wages. In other words, for plan year 2021, you can refer to the employee’s 2020 Form W-2 wages. But, this approach is risky, especially when used for hourly employees who do not work stable hours.
• Second: Form W-2 Box 1 contains gross taxable wages. It does not include pretax deductions, such as for traditional 401(k) or Section 125 health plans, which lower Box 1 wages. If the employee has such pretax deductions, their cost-sharing amount will not be based on their total wages.
• Third: The employee’s premium must stay consistent throughout the plan year, either as a percentage or a dollar amount of their W-2 wages. So, if the employee earns less in 2021 (than their 2020 Form W-2 wages), you cannot reduce their pay to offset the cost-sharing differences.

You may set the employee’s cost-sharing amount as a fixed percentage, instead of as a dollar amount. This way, the computation will always equal 9.83% of the employee’s W-2 wages. However, you will need to ensure your payroll system can facilitate this percentage format.

Keep in mind, as well, that employees who work varying hours may become confused by the fluctuating percentage-driven amounts reflected on their pay stubs. Further, the percentage format does not eliminate the risk of the employee earning less (in 2021) than their 2020 Form W-2 wages.

Despite the drawbacks, the W-2 safe harbor method has a distinct advantage: It includes compensation for hours worked and hours not worked (such as paid leave and holidays). Since this method does not limit compensable hours, it may increase the employee’s “affordable” monthly premium, and potentially offset any losses incurred for that employee.

W-2 safe harbor calculation

In terms of calculation, the W-2 safe harbor is quite straightforward. Simply multiply the W-2 Box 1 wages by the affordability percentage. Then, divide the result by the number of months coverage is offered to the employee for the year.

In terms of calculation, the W-2 safe harbor is quite straightforward.

Example of W-2 Affordability for 2021 Plan Year

Box 1 wages of $40,000 x affordability percentage of 9.83% x 12 months of coverage

= monthly premium of $327.67

In this example, you can deem coverage affordable if the employee’s monthly premium is equal to or less than $327.67.

For employees hired mid-year 2020, the calculation (for 2021 plan year) is based on their 2020 Form W-2 wages and the number of months coverage is available to them during 2020.

Safe harbor #2: The employee’s rate of pay

This safe harbor lets you calculate “affordability” according to the employee’s hourly rate or monthly salary.

Hourly Affordability for 2021 Plan Year

Multiply the employee’s hourly rate (as of the start of the plan year) by 130 hours. Then, multiply the result by the affordability percentage.

For example, $16 per hour x 130 hours x 9.83% = monthly premium of $204.46.

If the employee’s hourly rate increases during the year, you can keep using the older, lower rate throughout that year.

Salary Affordability for 2021 Plan Year

Multiply the employee’s monthly salary (as of the first day of the plan year) by 9.83%.

For example, monthly salary of $3,000 x 9.83% = monthly premium of $294.90.

The rate of pay safe harbor is often preferred over the W-2 method, for these reasons:

• The “130-hours-per-month” applies to all hourly employees, no matter how many hours they work. This makes it easier to accurately predict employees’ cost-sharing amounts.
• If coverage is “affordable” for the lowest-paid hourly employee, then it is automatically “affordable” for other hourly employees — since all are restricted to the “130-hours-per-month” standard.
• Pretax deductions have no impact on the rate of pay calculation.

On the downside:

• You cannot use the rate of pay safe harbor on non-hourly employees whose salaries have been reduced in any month during the plan year.
• If an hourly employee works more than 130 hours for the month, you cannot increase their monthly premium, even though they earned more money.
• You cannot use the rate of pay safe harbor for tipped and commission-only employees.

Safe harbor #3: Federal Poverty Level (FPL)

This safe harbor establishes “affordability” based on the federal poverty level. To arrive at each employee’s monthly premium, simply multiply the FPL for a household of one by the affordability percentage and then divide the result by 12.

The Department of Health and Human Services (HHS) publishes the annual FPL each January. However, you don’t have to wait until January, as ALEs can use the FPL that’s in effect 6 months before the start of the new plan year.

FPL Affordability Calculation for 2021 Plan Year

$12,760 (2020 FPL) x 9.83% / 12 = monthly premium of $104.53.

The clear upside to the FPL safe harbor is that the monthly premium applies to all employees, and does not require any employee wage information. With this method, you will always meet the affordability threshold.

But while the FPL safe harbor is the simplest to administer, it may not be the most cost-effective option for ALEs. With the FPL rate being so low, it tends to deliver the smallest monthly premium for employees while increasing the ALE’s cost-sharing amount.

Overview of safe harbor calculations for 2021

Final tips

• You may use different safe harbors for different employees, so long as you stay within the IRS’ permitted categories — such as geographic location or salaried versus hourly.
• Analyze the strengths and weaknesses of each safe harbor calculation, then see which method is best for your business processes (including ACA reporting).
• Administering the Form W-2 and rate-of-pay safe harbors via separate HR and payroll systems causes duplicate work and increases the risk of errors. An integrated HR/payroll system helps you avoid these pitfalls.