Can Employers Create a Goldilocks Zone?

Can Employers Create a Goldilocks Zone?
 
Ever since I read the Shared Responsibility proposed regulations I have been fascinated with an idea that could place employers and employees in the best possible position.  For an employer that means no penalty under §4980H and low health coverage expenses.  For an employee that means affordable, flexible health coverage.  Unfortunately, the ACA forces employers to compete against employees with only one party being able to achieve its wish.  Or does it? 
 
As was discussed in Affordability – How Employers and Employees Have Competing Interests, an employer doing the bare minimum to comply with the ACA will offer bronze coverage to its employees forcing them to pay 9.5 percent of their wages for health coverage.  This would seem to make the employer’s employees ineligible for premium tax credits.  Alternatively, an employer could choose to pay a penalty under the Play or Pay Mandate and allow its employees who meet the other requirements for premium tax credits to receive government subsidized health coverage.  As a result of health coverage expenses being deductible for employers and the structure of the Play or Pay Mandate penalty, an overwhelming majority of employers with 50 or more full-time equivalent employees will be in a better financial position offering bronze coverage to their workforce.
 
The Shared Responsibility proposed regulations make it clear that if a safe harbor affordability test is satisfied, the employer will not be liable under §4980H for not providing affordable coverage even if the coverage is not in fact affordable to the employee.  For this reason the opportunity to create a goldilocks zone exists.  A goldilocks zone would allow an employer to avoid a §4980H penalty while maintaining an employee’s eligibility for a premium tax credit.  If a goldilocks zone is to be created, the employer will have to offer affordable coverage under one of the affordability safe harbors while making the coverage unaffordable for the employee for purposes of receiving a premium tax credit.
 
The first key to creating a goldilocks zone is understanding how eligibility for a premium tax credit can be destroyed by an employer.  An individual is only eligible for a premium tax credit if the individual is, among other things, not eligible for minimum essential coverage under an eligible employer-sponsored plan that is affordable.  For premium tax credit purposes an employer’s coverage is considered affordable if the employee’s premium payments for self-only coverage does not exceed 9.5 of the employee’s household income.
 
Household income is defined as the modified adjusted gross income of a person plus any amount excluded from gross income under §911 plus any amount of interest received or accrued that is exempt from tax.  For a successful creation of a goldilocks zone, understanding how adjusted gross income is determined is the only relevant factor as any amount excluded from gross income under §911 and any amount of interest received or accrued that is exempt from tax is an unlikely type of income for the individuals who can utilize the strategy. 
 
To calculate an individual’s adjusted gross income the sum of the individual’s gross income is calculated following the rules of §61 then certain items listed in §62 are deducted.  Importantly for the creation of a goldilocks zone, elective deferrals, such as contributions to a 401(k) plan or a 403(b) plan, are not included in an individual’s adjusted gross income.
 
If an individual is married or has dependents that the individual is taking a deduction for under §151, the income of those individuals are aggregated together in determining the individual’s household income.  For example, if an employee has a spouse and two children and the employee is taking a §151 deduction for the spouse and the two children, the employee’s household income will include the modified adjusted gross income of all four individuals.
 
The second part of the equation for the creation of a goldilocks zone is satisfying one of the three affordability safe harbors to avoid a §4980H penalty.  The first affordability safe harbor to consider is the form W-2 safe harbor which allows an employer to satisfy the affordability test of §4980H so long as the employer’s lowest cost self-only coverage that provides minimum value does not exceed 9.5 percent of the employee’s W-2 wages.  The wages included in a W-2 are too similar to the definition of modified adjusted gross income to create any goldilocks zone on a large scale for employers.  Thus, if a goldilocks zone is to be created one of the other two safe harbors will need to be utilized.
 
The second affordability safe harbor to consider for a goldilocks zone is the federal poverty line safe harbor which allows an employer to satisfy the affordability test of §4980H so long as the employee’s monthly required contribution for the employer’s lowest cost self-only coverage that provides minimum value does not exceed 9.5 percent of the monthly federal poverty line for a single individual.  In 2013 the federal poverty line for an individual in the continental United States is $11,490, which makes the monthly Federal poverty line $957.50.  Therefore, if an employer charges its employees $90 or less (957.50 x 0.095 = ~$90) the employer will satisfy the federal poverty line safe harbor.  The problem for an employer with the federal poverty line safe harbor when trying to create a goldilocks zone is a large majority of its workforce will likely make significantly more than the federal poverty line amount ($11,490 in 2013).  Therefore, an employer will not be able to make the coverage unaffordable for purposes of calculating affordability for premium tax credit eligibility.
 
The final affordability safe harbor to consider for a goldilocks zone is the rate of pay safe harbor.  The rate of pay safe harbor can be broken into two tests, one test for hourly employees and another test for salaried employees.  For hourly employees, if the employee’s required contribution for the month for the employer’s lowest cost self-only coverage that provides minimum value does not exceed 9.5 percent of the product of the employee’s hourly rate of pay and 130 hours, the coverage will be deemed affordable for §4980H purposes.  For salaried employees, if the employee’s required contribution for the month for the employer’s lowest cost self-only coverage that provides minimum value does not exceed 9.5 percent of the employee’s monthly salary, the coverage will be deemed affordable for §4980H purposes.
 
Unlike the form W-2 safe harbor, the rate of pay safe harbor does not take into account an employee’s elective deferrals.  Thus, if an employee defers $1,000 into a 401(k) plan or a 403(b) plan, the employer does not have to factor that into the rate of pay safe harbor.  This is confirmed in the preamble to the Shared Responsibility proposed regulations which states: 

The determination of whether employer-sponsored coverage is affordable for an employee under section 36B(c)(2)(C)(i) (the tax code section that determines eligibility for premium tax credits) is based on modified adjusted income and does not take into account any elective deferrals to a section 401(k), section 403(b) or cafeteria plan.  Given that these amounts are not taken into account in determining the affordability of coverage for purposes of an employee’s eligibility for a section 36B credit, it would be inconsistent to allow employers to add back those amounts in determining their liability under section 4980H(b), which is linked to that employee’s section 36B credit.  However, see the rate of pay affordability safe harbor, which could be used regardless of the amount of an employee’s elective deferrals.

As a result of elective deferrals not being accounted for in the rate of pay safe harbor there is an opportunity for an employer to offer affordable coverage under the rate of pay safe harbor that is in fact not affordable to the employee when determining eligibility for a premium tax credit.  If the employer with the assistance of the employee can create this scenario, the employer will not be liable for the employee under §4980H and the employee could be eligible for a premium tax credit.  The goldilocks zone puts each party in a better position.
 
As discussed above, the rate of pay safe harbor limits the hours of service an employer can include for hourly employees to 130 hours.  The 130 hours represents the monthly hours of service an employee has to accumulate to be considered a full-time employee.  The fact an employer cannot take into account all of an employee’s hours of service for a month will make it unlikely an employer can create a goldilocks zone for a significant number of hourly employees.  The difference between the employee’s household income when determining eligibility for a premium tax credit will be significantly higher than the employee’s rate of pay safe harbor amount if the employee is working a standard 40 hour work week.
 
Unlike hourly employees, all of a salaried employee’s income associated with the employer is included in the rate of pay safe harbor.  Thus, an employer can create a goldilocks zone for a potentially large number of employees using this safe harbor.  The employer will need to setup or use an already existing elective deferral structure such as a 401(k) plan or a 403(b) plan to allow employees to create a goldilocks zone. 
 
Consider the following example that illustrates the goldilocks zone.  Holly is a salaried employee earning $2,000 per month.  Holly has no other sources of income and is not married.  Holly’s employer offers her a bronze plan that provides minimum value at a cost to Holly of $190 per month.  Holly’s employer also sponsors a 401(k) plan that Holly is eligible to participate.  Holly defers $50 per month into the 401(k) plan.  For this oversimplified example Holly’s employer would meet the affordability test using the rate of pay safe harbor as her monthly premium for self-only coverage does not exceed 9.5 percent of her monthly salary (190/2,000 = 0.095).  As a result of satisfying the rate of pay safe harbor, Holly’s employer will not be responsible for a §4980H penalty with regard to her.  However, for premium tax credit purposes Holly would not be receiving affordable coverage from her employer as her monthly cost of coverage, $190, exceeds 9.5 percent of her monthly household income (190/(2,000 – 50) = 0.097).  Thus, Holly would not be eligible for an employer sponsored plan that is affordable.  This would allow Holly to still be eligible for a premium tax credit so long as the other conditions are satisfied.  Holly would likely be able to receive a bronze plan similar to, or probably even better than, the one the employer is offering for free with the assistance of a premium tax credit.  She would also have the flexibility to purchase a silver, gold, or platinum plan that best fits her needs with the assistance of a premium tax credit.
 
One pitfall with the goldilocks zone strategy is it won’t work for two income households.  If Holly in the example above was married to Stanley who also earned $2,000 per month, Holly and Stanley would have to put away more than half their monthly salary in order to find the goldilocks zone.  This is not realistic and it defeats the purposes of the goldilocks zone. 
 
Using the rate of pay safe harbor to create a goldilocks zone will only be viable for single income salaried households.  In some situations it may be worth converting hourly employees to salaried employees.  A host of other tax issues would have to be explored before coming to a final conclusion.  The goldilocks zone may be more theoretical than reality to a large majority of employers.  However, it is something an employer should at least be aware of in case its workforce demographics are just right.
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