The Affordable Care Act requires an employee to have a minimum amount of health coverage starting in 2014, and requires an employer to offer affordable health coverage to its employees.  But how do these health mandates apply to the employee’s spouse and dependents?  Recent IRS regulations fill in several pieces of this puzzle.

Several provisions of the Affordable Care Act work together to expand health coverage.  An individual mandate requires most individuals to maintain minimum essential health coverage or pay a penalty.  In order to encourage employers to offer health coverage to their employees, an employer mandate imposes an excise tax on large employers that fail to offer affordable, minimum value coverage to their full-time employees.  If a lower-income individual is not eligible for affordable coverage from another source and purchases individual health insurance, the individual receives a refundable premium tax credit that helps make the coverage affordable.  Although these provisions are related, each provision applies in a different way to an employee’s family members.  The family coverage rules have important implications for the design and administration of employer group health plans.

Applying the Individual Mandate to Family Members

An individual may obtain minimum essential health coverage from a variety of sources: a government program like Medicare or Medicaid; an insured or self-insured employer group health plan (including a grandfathered plan); or individual coverage purchased through a regulated marketplace called an “Exchange.”  An individual must pay a penalty if he fails to maintain minimum essential coverage, unless an exemption applies.

The individual also must pay a penalty for any non-exempt person whom he could claim as a dependent on his federal income tax return (whether or not he actually claims the dependent) if the dependent does not have minimum essential coverage.  An individual’s dependents are not limited to his minor children: he can also claim a wide spectrum of relatives (brothers, sisters, parents, aunts, uncles, nieces, nephews, in-laws, etc.) as dependents, provided that they have little income and depend on him for support; and he can also claim unrelated individuals living in his household who meet the income and support tests.  When a husband and wife file a joint return, they are jointly liable for the penalty with respect to the dependents they could claim on their return.  If more than one person could claim a dependent, the person who actually claims the dependent (or who has priority to claim the dependent, if no one does) is responsible for the penalty.

The individual mandate includes a series of exemptions from the requirement to maintain minimum essential coverage.  The exemptions are based on religious beliefs, nonresident alien status, hardship, or other factors.  If an individual is exempt from the requirement to maintain minimum essential coverage for himself, he still must pay the penalty for his dependents who lack coverage, unless the dependents also qualify for an exemption.

The Treasury Department and IRS recently proposed a regulation interpreting the individual mandate and the exemptions.  The proposed regulation explains how the individual mandate and exemptions apply to an employee and his family members who are eligible for employer health coverage.  (HHS proposed a companion regulation that establishes the criteria for the hardship exemption and explains certain procedural requirements for claiming an exemption.)

The Affordability Exemption Under the Individual Mandate

One exemption provides that an individual is not subject to the individual mandate if the individual does not have access to affordable minimum essential coverage.  This exemption has an important relationship to employer group health plan coverage, since an employee’s or family member’s eligibility for coverage under an employer’s plan, and the cost of the coverage, often determine whether the exemption applies.

An employee’s own coverage under an employer group health plan is “affordable” if his required contribution for the lowest-cost self-only coverage (whether paid through salary reduction or otherwise) is not more than 8% of his household income.  (HHS will adjust the 8% threshold after 2014 to the extent that growth in health insurance premiums outpaces the rate of income growth.)  For the employee’s family members who are not otherwise exempt from the individual mandate, coverage under the employer’s plan is affordable if the employee’s required contribution for the lowest-cost option that would provide minimum essential coverage to his family members is not more than 8% of their household income.

If an employee is eligible for minimum essential coverage under his employer’s group health plan, the “affordability” of the employee’s coverage is tested solely by reference to his required contributions under the employer plan, even if the employee also has access to minimum essential coverage from another source.  For example, if an employee is eligible for minimum essential health coverage from his employer, but his required contribution for self-only coverage exceeds 8% of his household income, the affordability exemption applies and the employee is not subject to the individual mandate even if he could purchase affordable individual coverage through an Exchange.  In contrast, if a person is not eligible for minimum essential coverage under an employer health plan, “affordability” is tested by reference to the cost of the individual coverage the person could purchase through an Exchange.

The required contribution under the employer group health plan also determines the affordability of a family member’s coverage when three requirements are met: the family member is eligible for coverage under the employer plan by reason of a relationship to the employee; the family member is properly claimed as a personal exemption deduction on the employee’s tax return (even if the family member is the employee’s spouse rather than a dependent); and the family member is not eligible for coverage under a group health plan sponsored by the family member’s own employer.

For example, when a husband and wife file a joint return, each is claimed as a personal exemption deduction on the return, even though neither spouse is a dependent of the other.  Accordingly, if the husband is eligible for coverage under a group health plan of his wife’s employer (but does not have health coverage from his own employer), the affordability test for family members will apply to the husband, and his coverage will be affordable if his wife is not required to contribute more than 8% of household income to obtain coverage for her husband under her employer’s plan.  If the husband is the only family member included in the affordability test, the wife’s required contribution for employee-plus-one coverage (assuming the employer’s plan offers it) would determine affordability; if the couple also has dependent children who are included in the affordability test for family members, the lowest-cost option that would provide minimum essential coverage to her husband and her children would determine affordability.

As explained above, an employee is responsible for the penalty with respect to any person whom he could claim as a dependent; but the affordability test for family members does not apply unless the employee actually claims the dependent for purposes of the personal exemption deduction.  If a person is eligible for coverage under an employer group health plan by reason of a relationship to the employee, but the employee is not able to (or chooses not to) claim the person as a dependent on his tax return, the affordability test for family members will not apply to that person.

For example, an employee generally may not claim his child as a dependent on his tax return after the child reaches age 19 (or age 24, if the child is a student), although the Affordable Care Act might require the employer’s group health plan to cover the child until age 26.  In this case, the affordability of the adult child’s health coverage is determined (for purposes of the individual mandate) without reference to the coverage offered under the plan of the parent’s employer.  If the only other coverage available to the adult child is individual coverage purchased through an Exchange, the cost of that coverage in relation to the child’s household income (rather than the employee’s household income) will determine whether the child is eligible for affordable coverage.  If the child is not exempt from the individual mandate and fails to maintain minimum essential coverage, the child (rather than the employee) is liable for the penalty.

The affordability rules described above for employees and their family members also apply to former employees and their family members—for example, to retirees and their spouses who are eligible for retiree medical coverage from the retiree’s former employer.  Under a special rule, an individual who is eligible for health care continuation (“COBRA”) coverage from an employer group health plan is treated as being eligible for coverage under the plan for purposes of the affordability test only if the individual actually enrolls in COBRA coverage.  In all other cases, the individual is treated as being eligible for coverage under the employer group health plan if the individual could have enrolled during an open enrollment or special enrollment period, regardless of whether the individual actually enrolls.

To see how the affordability exemption works, consider an employee with a non-working spouse and two dependent children.  The employee’s 60-year-old mother also lives in his household, and he claims her as his dependent.  The household’s annual income is $40,000.  The employee, spouse, and children (but not the employee’s mother) are eligible for minimum essential coverage under a group health plan maintained by the employee’s employer.  The employee’s required contribution for self-only coverage is $200 per month, and his required contribution for family coverage is $300 per month.

In this example, the employer coverage is affordable for the employee, since the annual required contribution for self-only coverage ($2,400) is less than 8% of household income (8% x $40,000 = $3,200).  The employer coverage is not affordable for the employee’s spouse and dependents, however, since the employee’s required contribution for family coverage ($3,600) exceeds 8% of household income ($3,200).  Accordingly, the employee’s spouse and dependents are exempt from the penalty, even if they are able to purchase affordable individual coverage through an Exchange.  Because the employee’s mother is not eligible for minimum essential coverage under the employer’s group health plan, her eligibility for the exemption is based on her access to affordable coverage from another source.  The employee will be required to pay the penalty if his mother is able to purchase affordable coverage through an Exchange but does not do so.

If an individual is eligible for minimum essential coverage under a plan maintained by the individual’s own employer, affordability is tested solely by reference to the plan of the individual’s employer, even if the individual also is eligible for coverage under a different plan as an employee’s family member.  In our example, if one of the employee’s two dependent children gets a job in a restaurant after school and is eligible for self-only health coverage from the restaurant with a required contribution of $100 per month ($1,200 per year), the child will no longer be exempt from the penalty, because the child will be eligible for affordable coverage under a group health plan offered by the child’s employer.

Similarly, if both husband and wife work and are eligible for minimum essential coverage under group health plans maintained by their respective employers, the affordability test applies to each person solely by reference to the cost of self-only coverage under the plan of his or her own employer.  Because the husband and wife (assuming they file a joint tax return) are jointly liable for their dependents, they will owe a penalty for their dependent children if the children are eligible for affordable family coverage under the employer group health plan of either parent and the parent fails to maintain minimum essential coverage for the children.

In a case where more than one member of the family works, and the working members are eligible for minimum essential coverage under group health plans maintained by their employers, the required contribution for self-only coverage might be less than 8% of household income for each individual, but might exceed 8% of household income in the aggregate.  In our example of the child working after school in a restaurant, the parent and child have affordable self-only coverage from their respective employers, but the combined cost of their coverage ($3,600) exceeds 8% of household income.  Although the affordability exemption does not apply in this situation, the parent may apply to an Exchange for a hardship exemption from the individual mandate.

Applying the Employer Mandate to Family Members

A person whose household income is between 100% and 400% of the federal poverty line, and who purchases individual health coverage through an Exchange, is eligible for a refundable federal premium tax credit that helps pay the cost of the coverage.  A person who is eligible for the premium tax credit also receives cost-sharing reductions from insurers in some cases.

A lower-income person receives a premium tax credit for purchasing individual coverage only if the person is not eligible for affordable minimum-value health coverage from another source, such as an employer health plan.  The employer mandate is designed to encourage large employers (those with at least 50 full-time employees) to offer affordable health coverage to these employees.  The employer mandate imposes a substantial excise tax on an employer that fails to offer affordable coverage; but the employer becomes subject to the excise tax only if at least one full-time employee purchases health coverage through an Exchange and qualifies for a premium tax credit.

The employer mandate imposes two levels of tax:

  • “A” Tax:  If a covered employer fails to offer its full-time employees (and their dependents) the opportunity to enroll in minimum essential coverage, the employer must pay an excise tax equal to 1/12 of $2,000 per month times the number of its full-time employees in excess of 30.
  • “B” Tax:  If a covered employer offers minimum essential coverage to its full-time employees (and their dependents), but the coverage is not affordable or not sufficiently valuable, the employer must pay an excise tax equal to 1/12 of $3,000 per month times the number of its full-time employees who receive a premium tax credit or cost-sharing reduction.

Although the “B” tax is a higher amount per employee, it usually will apply to fewer employees (only those who receive premium tax credits rather than all full-time employees).

The Treasury Department and IRS recently issued a proposed regulation interpreting the employer mandate.  We have described the employer mandate in a previous post and in an advisory.

The Affordability Test Under the Employer Mandate

The affordability test used to determine whether the “B” tax applies is different from the affordability exemption under the individual mandate.  Employer group health coverage is affordable for purposes of the “B” tax if an employee’s required contribution is no more than 9.5% of the employee’s annual household income for the lowest-cost self-only coverage that provides minimum value.  The coverage provides “minimum value” if it covers at least 60% of the total allowed costs of benefits provided under a typical large employer plan.

Although the affordability test is based on the employee’s required contribution as a percentage of household income, the proposed regulation recognizes that an employer will seldom know the amount of an employee’s household income.  Accordingly, the proposed regulation allows employers to use one of three safe harbors to determine affordability, substituting the employee’s W-2 wages or rate of pay for household income, or assuming that the employee’s household income is equal to the federal poverty line for a single individual (in most states, $11,490 in 2013).

If employer coverage meets this test, it is considered affordable not only for the employee, but also for the employee’s dependents.  Accordingly, the affordability test under the employer mandate is different in at least four significant ways from the affordability exemption under the individual mandate:

  • Coverage is “affordable” for the employee if the required contribution for  self-only coverage does not exceed 9.5% of household income (as compared with 8% under the individual mandate exemption);
  • The affordability of coverage for the employee’s family members is based on the required contribution for self-only coverage (whereas the individual mandate uses the required contribution for family coverage);
  • The employer can use a safe harbor in which the affordability percentage is applied to W-2 wages, rate of pay, or the federal poverty line rather than the employee’s household income (whereas the individual mandate exemption uses actual household income);
  • The employer mandate tests the affordability of coverage that meets a 60% “minimum value” threshold (whereas the individual mandate exemption tests the affordability of “minimum essential coverage,” a much lower threshold).

Because of these differences, an employee or family member might be eligible for “affordable” coverage under an employer group health plan for purposes of the employer mandate even though the same employer coverage is deemed to be “unaffordable” for purposes of the exemption from the individual mandate.

Dependent Coverage Under the Employer Mandate

One of the most puzzling aspects of the employer mandate is the statute’s treatment of dependents.  Both the “A” tax and the “B” tax appear to require a large employer to offer health coverage to the dependents of its full-time employees.  The tax is triggered, however, only if a premium tax credit is paid with respect to an employee: the fact that a premium tax credit is paid with respect to an employee’s dependent does not trigger the tax.  The “B” tax, if it applies, is based solely on the number of full-time employees (not dependents) who qualify for a premium tax credit.  In addition, as explained above, the affordability of coverage is determined using the cost of an employee’s self-only coverage, without regard to the cost of coverage for the employee’s dependents.

The proposed regulation resolves this issue by requiring an applicable large employer to offer minimum essential coverage to employees’ children (up to age 26) in order to avoid the “A” tax.  If an employer offers coverage to its full-time employees but not to their children, the employer will be treated as if it does not offer minimum essential coverage.  In this case, the employer will be subject to the “A” tax applied to all full-time employees if any full-time employee receives the premium tax credit.

The proposed regulation defines a “child” as a full-time employee’s natural or adopted child, stepchild, or eligible foster child.  Even employers that generally cover their employees’ dependent children might not cover foster children.  An employer must offer minimum essential health coverage to the employee’s children younger than 26 even if the employee is not able to claim them (or chooses not to claim them) as dependents on the employee’s tax return.  For example, the employer mandate requires an employer to offer minimum essential coverage to a child younger than 26 who is married and lives in a different state from the employee, even though the adult child is not the employee’s dependent and the employee is not responsible for the penalty if the adult child fails to satisfy the individual mandate.  In contrast, however, the employer mandate does not require the employer to offer minimum essential coverage to other family members whom the employee can claim as dependents, even though the employee must pay a penalty if these dependents are subject to the individual mandate and fail to maintain minimum essential coverage.

An employee’s spouse is not treated as a dependent for purposes of the employer mandate, even if the employee files a joint return and claims a personal exemption deduction for the spouse.  As a result, an employer is not required to offer minimum essential coverage to spouses in order to avoid the “A” tax.

An employer incurs an excise tax under the employer mandate only if a full-time employee qualifies for a premium tax credit.  A lower-income employee is still eligible for the premium tax credit—even though his or her employer offers minimum essential coverage—if the employer’s coverage is not affordable or sufficiently valuable.  Accordingly, an employer cannot avoid the “A” tax by offering unaffordable minimum essential coverage to all full-time employees, but not to their dependents, since the offer of unaffordable minimum essential coverage would not prevent a lower-income employee from claiming the premium tax credit and triggering the “A” tax.

In contrast, however, if an employer offers affordable minimum-value coverage to all full-time employees who are between 100% and 400% of the federal poverty line, but offers their dependents only minimum essential coverage that does not meet the minimum-value test, the employer will avoid both the “A” tax (because dependents are offered minimum essential coverage) and the “B” tax (because no employee will qualify for a premium tax credit).

In theory, an employer could avoid both the “A” tax and the “B” tax by offering affordable minimum-value coverage to all full-time employees who are between 100% and 400% of the federal poverty line and offering no coverage to their dependents, since no employee will qualify for the premium tax credit as long as he or she has affordable minimum-value coverage.  The structure of the affordability safe harbors makes this strategy perilous, however.  In order to rely on any of the three affordability safe harbors, an employer must offer minimum essential coverage to dependents.  Because an employee qualifies for the premium tax credit based on household income rather than rate of pay or W-2 compensation, a lower-income employee who satisfies an affordability safe harbor under the employer mandate might still be eligible for the premium tax credit.  Accordingly, any employer that wishes to rely on an affordability safe harbor to avoid the “B” tax must at least offer minimum essential coverage to dependents in order to ensure that the safe harbor is truly safe.

Applying the Premium Tax Credit to Family Members

An individual whose household income is between 100% and 400% of the federal poverty line is potentially eligible for the premium tax credit if he or members of his family obtain coverage through an Exchange.  The premium tax credit helps a lower-income individual pay for the individual health coverage he purchases for himself or his family members.  A married couple must file a joint return in order to qualify for the premium tax credit.

An individual receives a premium tax credit for each eligible member of his family who receives coverage through an Exchange.  The individual’s “family” consists of the people claimed as a personal exemption deduction on his federal income tax return.  Accordingly, the definition of “family” for purposes of the premium tax credit is similar to the definition used in the individual mandate to determine whether the affordability test for family members applies: it includes an employee’s spouse and any person whom the employee actually claims as a dependent.  A spouse or dependent who meets this definition is included in the employee’s “family” for purposes of the premium tax credit even if the spouse or dependent is exempt from the individual mandate.

The federal poverty line is based on an individual’s family size: the poverty line is higher for larger families.  The same definition of “family” determines an individual’s family size for this purpose.   In 2013, 400% of the federal poverty line in the 48 contiguous states is $94,200 for a family of four; but this line is adjusted annually for inflation.  The poverty line is higher in Alaska and Hawaii.

An individual who meets the household income test may claim a premium tax credit for himself or a family member only if the person for whom he claims the credit is not eligible for minimum essential coverage from a governmental program (such as Medicare, Medicaid, CHIP, TRICARE, or a veterans’ health program).  An employee or family member also becomes ineligible for the premium tax credit if the person is eligible for affordable, minimum-value coverage under an employer group health plan, or if the person actually enrolls in minimum essential coverage (whether or not affordable or sufficiently valuable) under the employer’s group health plan.

The Affordability Test Under the Premium Tax Credit

The same affordability and minimum-value tests that apply under the employer mandate also apply for purposes of the premium tax credit.  Accordingly, coverage under an employer group health plan is “affordable” if the employee’s required contribution is no more than 9.5% of the employee’s annual household income for the lowest-cost self-only coverage that provides minimum value.  (HHS may adjust the 9.5% threshold after 2014 to the extent that growth in health insurance premiums outpaces the rate of income growth, and may adjust the threshold after 2018 to the extent that growth in health insurance premiums outpaces growth in the consumer price index.)   The employer coverage provides “minimum value” if it covers at least 60% of the total allowed costs of benefits provided under a typical large employer plan.

When the Treasury Department and IRS issued final regulations interpreting the premium tax credit in May of 2012, they reserved guidance on the question whether the affordability of a family member’s coverage would be determined using the required contribution for family coverage rather than the required contribution for self-only coverage.  Many commenters argued that the required contribution for family coverage was a more appropriate measure of an employee’s ability to afford a family member’s coverage.

The Treasury Department and IRS resolved this question in a recent regulation.  The regulation concludes that the affordability of a family member’s coverage for purposes of the premium tax credit must be based on the employee’s required contribution for self-only coverage (the same test that applies under the employer mandate), even if the required contribution for family coverage exceeds 9.5% of the employee’s household income.  As a result of this interpretation, a lower-income employee will not be eligible to claim the premium tax credit either for himself or for his family members if the employer sets the cost of self-only coverage at a level that satisfies the employer mandate, even though the employee might be unable to afford the cost of family coverage under the employer’s plan.  Because the affordability threshold is lower for purposes of the exemption from the individual mandate (and is based on the cost of family coverage for the employee’s family members), the employee and the family members will be exempt from the individual mandate if the cost of self-only coverage is 9.5% of household income, and the employee will not owe a penalty if they fail to maintain minimum essential coverage.

The test for affordability under the premium tax credit uses the employee’s actual household income: it does not include the safe harbors based on the employee’s W-2 pay, rate of pay, or federal poverty limit.  An employee’s household income might be either higher or lower than the safe harbor amount.  For example, sources of income in addition to compensation from the employer could make household income higher than safe harbor income, whereas personal exemptions and above-the-line deductions (for alimony, education expenses, and the like) could make household income lower than safe harbor income.  Accordingly, coverage that satisfies the affordability test for the employer mandate might not be affordable for purposes of the premium tax credit, and vice-versa.

An employee may not receive a premium tax credit for any person unless the person is his spouse or a dependent claimed on his federal tax return.  A person who is not the employee’s spouse or dependent might be able to claim the premium tax credit on his own behalf; but the person will not qualify for the premium tax credit if the person is eligible for affordable, minimum value coverage under an employer group health plan by reason of his relationship to the employee.  The affordability test in this case is the same as it is for the employee’s spouse and dependents, except that the test is based on the related individual’s household income rather than on the employee’s household income.  For example, if an employee’s adult child is eligible for minimum-value coverage under the employer’s group health plan, and the required contribution for the employee’s self-only coverage is not more than 9.5% of the adult child’s household income, the adult child will not be able to claim the premium tax credit if the child purchases individual coverage through an Exchange.

An employee, family member, or related person who is eligible to enroll in employer group health coverage that is affordable and provides minimum value will not be eligible for a premium tax credit, even if the person does not actually enroll in the employer’s plan.  (As in the case of the affordability exemption under the individual mandate, there is an exception to this rule for COBRA coverage: a person’s eligibility for COBRA coverage is ignored unless the person actually enrolls in COBRA coverage.)  If a person actually enrolls in an employer group health plan that provides minimum essential coverage, however, the person will not be eligible for premium tax credits even if the employer coverage is unaffordable or fails to provide minimum value.

When a person enrolls in coverage through an Exchange and applies for advance premium tax credits to help pay the cost of the coverage, the person must provide the Exchange with information about the employer group health coverage that is available to the person.  Under an “affordability safe harbor,” if the Exchange determines that the employer coverage is unaffordable when the person applies for premium tax credits, the employer coverage will be deemed to remain unaffordable for the rest of the plan year.  If the person becomes eligible for coverage under a different employer plan, however, the Exchange must make a new affordability determination.

Although the individual mandate and the premium tax credit do not directly affect the coverage that an employer offers to its employees and their family members under the employer’s group health plan, employers should be mindful of these rules as they design family coverage and as they communicate with their employees about the consequences of enrolling family members in the employer’s health coverage.  In some cases, an offer of coverage (or actual enrollment) under an employer group health plan might make lower-income individuals ineligible for premium tax credits and cost-sharing reductions that would make it possible for them to purchase more comprehensive coverage through an Exchange.  In addition, employees will wish to know whether the employer’s coverage is sufficient to satisfy the individual mandate (or, alternatively, whether the cost of the employer’s coverage will trigger the affordability exemption from the individual mandate).

Photo of Amy N. Moore Amy N. Moore

Amy Moore advises public and private companies and tax exempt organizations on a wide range of tax, ERISA, and employment law issues concerning all types of benefit programs.  Ms. Moore counsels some of the world’s largest multinational companies on the design and implementation…

Amy Moore advises public and private companies and tax exempt organizations on a wide range of tax, ERISA, and employment law issues concerning all types of benefit programs.  Ms. Moore counsels some of the world’s largest multinational companies on the design and implementation of innovative benefit strategies, including the restructuring of retirement programs to meet the needs of the modern work force; the use of surplus pension and insurance assets to provide non-traditional benefits; and the establishment of funding and security arrangements for welfare plans and executive compensation.  She represents clients in connection with pension fund investments in private equity funds, hedge funds, group trusts, and derivatives.  She also advises on benefits and compensation issues in acquisitions and divestitures, debt finance, joint ventures, and other corporate transactions.  Ms. Moore represents companies in audits and contested agency proceedings involving benefit plans and advises clients on employee benefits issues that arise in connection with ERISA litigation and settlements.  She also counsels employers on issues of plan administration and the correction of operational problems under government-sponsored remedial programs.