In order to be deemed “affordable,” the employee cost for self-coverage cannot exceed a certain percentage of the employee’s household income or of one of the three affordability “safe-harbors.” (Photo: Shutterstock)

Under the Affordable Care Act’s (ACA) Employer Shared Responsibility provisions—also known as the “employer mandate” or “pay or play provisions”—applicable large employers (ALEs) with 50 or more full-time employees (working an average of 30 hours or more) risksignificant penalties if they don’t make affordable health coverage available to their employees. Under these provisions, employers must either offer minimum essential coverage that is “affordable” and provides “minimum value” to full-time employees, or potentially pays an employer shared responsibility payment to the IRS. These provisions penalize employers who either do not offer coverage or do not offer coverage which meets minimum value and affordability standards.

Some employers may choose to offer their employees “opt-out payments” or “cash in lieu of benefits,” which are essentially cash incentives to waive employer-provided medical coverage. These opt-out arrangements are generally permissible under ACA but come with limitations. A key under ACA is to offer employees health care that is affordable, but, when an employee declines the opt-out payment, how do you calculate “affordable?”


To avoid penalties under ACA, ALEs must offer affordable, minimum value health coverage to substantially all of their full-time employees. 

This percentage is set at 9.5 percent, but is adjusted annually for the per capita growth in insurance premiums in the individual market. For 2017, it was 9.69 percent, but will decline to 9.56 percent in 2018.

The three affordability “safe-harbors” are in place because employers are not likely to know the household income of their employees, and may be unable to accurately determine what is “affordable.” Under these safe harbors, employers are generally allowed to use an employee’s W-2 wages, rate of pay, or the federal poverty line, instead of household income in making the affordability determination. 

Regardless of the calculation method used, the problem many employers face is they forget they might have to include the value of the cash incentive offered to the employee when making an affordability calculation. Whether an opt-out payment will need to be included when calculating affordability depends on whether the payment is made under a conditional or an unconditional opt-out arrangement.

‘Conditional’ versus ‘unconditional’

In Notice 2015-87, 2015-52 I.R.B. 889, the IRS discussed the impact employer opt-out payments have on affordability calculations. The Notice discusses two distinct opt-out payments: conditional and unconditional. Conditional opt-out payments are those which require the employee to provide substantiation of other coverage, such as a spouse’s family coverage, in order to receive the payment. Unconditional opt-out payments have no such requirement.

According to the Notice, ALEs are not required to include in their affordability calculations the value of unconditional opt-out arrangements adopted on or before Dec. 16, 2015, or conditional opt-out arrangements, regardless of their date of adoption. IRS Notice 2015-87.The IRS has been pushing for a change in this regard, however.

On July 8, 2016, the IRS issued proposed regulations which would require employers to include nearly all opt-out arrangements in their affordability calculations. Under the proposed regulations, ALEs would have to include cash offered to the employee under all unconditional opt-out arrangements, regardless of when the arrangement was adopted, and under conditional opt-out arrangements which are not deemed “eligible” (see discussion below). That’s a 180-degree turn from where the IRS stood when it issued Notice 2015-87. For now, these changes are on hold. On Dec. 19, 2016, the IRS published its Final Rule, which finalized many provisions in the July 2016 proposed regulations, but not those revising the rule on opt-out arrangements.

The IRS has said it is still examining issues related to opt-out payments and their impact on affordability. It plans to finalize those proposed regulations in the future. No word yet on when the future will come.

‘Eligible’ opt-out arrangements

If the IRS proceeds with enforcing the proposed regulations concerning opt-out arrangements, all payments offered under opt-out arrangements will count as employee contributions when calculating affordability, unless the arrangement is a conditional opt-out arrangement that meets certain eligibility criteria. To be an “eligible” opt-out arrangement under the proposed regulations:

• The employee’s right to receive an opt-out payment must be conditioned on the employee providing reasonable evidence that the employee and the employee’s family have or will have minimum essential coverage (other than coverage in the individual market) during the period of coverage to which the opt-out arrangement applies.

• “Reasonable evidence” may include the employee’s attestation, and must be provided at least annually, but no earlier than a reasonable period of time before the commencement of the period of coverage to which the opt-out arrangement applies. The reasonable evidence may be obtained during the regular open enrollment period that occurs within a few months before the commencement of the period of coverage without being deemed too early.

• The arrangement must provide the employer will not make opt-out payments if the employer knows or has reason to know the employee or family member does not or will not have minimum essential coverage.

How to calculate affordability

ALEs should review their opt-out arrangements to confirm they meet the eligible exception from the ACA affordability calculation. At least for now, if an arrangement is conditional upon the employee providing some form of substantiation of other coverage, the value of that payment is not included as a contribution when calculating affordability. If the arrangement is unconditional, and was adopted after Dec. 16, 2015, then the value of that payment is included as a contribution by the employee.

For example, an ALE offers its employees coverage that requires employees to contribute $3,000 for self-only coverage, but offers the same employees a $1,000 incentive if they decline to enroll. An employee does not have to provide substantiation of other coverage. For purposes of calculating affordability, an employee’s contribution amount would be $4,000. Since this is an unconditional arrangement and an employee who elects coverage is giving up the additional cash compensation, the $1,000 opt-out payment increases the employee’s required contribution for affordability purposes regardless of whether the employee enrolls in the plan, or declines to enroll and is paid the opt-out payment. If the same arrangement was made conditional upon proof of other coverage, or if it predated Dec. 16, 2015, it would not be included.

The problem is many ALEs do not realize the importance of including their unconditional opt-out arrangements in their affordability calculations, resulting in miscalculations. For example, if an employee with a household income of $40,000 is offered the plan discussed above, this would not be affordable. To be affordable at the 2017 threshold of 9.69 percent, an employee with a household income of $40,000 would have to contribute less than $3,876. Without considering the opt-out payment of $1,000 the employer would be in compliance. However, the opt-out arrangement brings the employee past the 9.69 percent threshold.

This will become even more complicated for employers if the IRS proceeds with its plan to expand the rule in the future.

Repercussions for employers

Applicable large employers that offer an opt-out payment to their employees should make a careful determination into what type of arrangement is being offered. If the arrangement is unconditional and adopted after Dec. 16, 2015, the ALE must include the opt-out payment as an additional contribution when calculating affordability.  At least for now, if the arrangement is conditional, the opt-out arrangement will not increase the employee’s required contribution.

Improperly calculating affordability can subject employers to steep penalties. Employers who offer coverage that provides minimum essential coverage but is not affordable are subject to a monthly penalty which for 2017 was the lesser of $3,390 divided by 12 per full-time employee receiving a premium tax credit, or, $2,260 divided by 12 per every full-time employee minus the first 30 employees (which is the penalty if no coverage at all is provided). These amounts are adjusted annually for inflation. The numbers for 2018 are $3,480 and $2,320, respectively.

This is an often-overlooked area of the law and easily missed. Unfortunately for large employers, miscalculating affordability under the ACA could cost tens of thousands of dollars. Employers should be mindful that this rule exists, and should keep an eye out for any new rules promulgated by the IRS. The IRS is pushing for stricter rules on opt-out arrangements, as evidenced by the July 8, 2016 proposed regulations, and we might see the very limits they are pushing for come to fruition in the near future.  Of course, with a new Administration, the future may be even harder to predict.

Robert G. Brody is founder and managing partner of Brody and Associates. Lindsay M. Rinehart is an associate and John F. Woyke, is of counsel at the firm.