Employer Mandate, Employee Benefits Compliance, Individual Mandate, Subsidies, Taxes, Fees & Penalties

Confused about the Different “Household Income” Tests? Here’s Why!

home insurance

This is a re-post of my article from Sept. 26, 2013.  Confusion continues about the different “household income” tests, especially since the IRS recently issued Revenue Procedure 2018-34, which includes the various percentages for 2019.  See later article on this site regarding Rev. Proc. 2018-34.

The Affordable care Act (ACA) created three different “affordability” tests that apply for different purposes.  In all three tests, the  question of “affordability” applies to the cost of health coverage relative to an individual’s “household income” (or to a safe harbor instead of household income).   However, the three tests have different consequences for “applicable large employers” (ALEs)” and for individuals.  They determine whether an ALE faces a potential penalty, whether an individual faces a potential tax, and whether an individual is eligible for a subsidy to buy health insurance in the Marketplace.  The original amounts of 9.5% and 8% are adjusted annually for inflation, and the IRS publishes the adjusted amounts each year. Click here for the most recent article on this site that lists the adjusted affordability percentages.

There are two different purposes for which the “9.5% of income” test applies.  There also is an 8% test.

  • “9.5% of income” tests:
    • Whether a large employer is subject to a penalty if a full-time employee qualifies for a subsidy to buy individual health insurance in the Marketplace
    • Whether an individual is eligible for a subsidy
  • “8% of income” test:
    • Whether an individual is required to pay the “individual mandate tax”  – no longer in effect after 2018

TEST #1:  9.5% Test: Whether Large Employer is Subject to a Penalty

3 Safe Harbors:  A large employer who offers health coverage that provides at least minimum value will be subject to a “play-or-pay” penalty (under Internal Revenue Code section 4980H) if the coverage is not “affordable” for a full-time employee, and that employee buys health insurance in the individual Marketplace and qualifies for a subsidy.  Coverage is affordable only if the employee cost for employee-only coverage is not more than 9.5% (indexed for inflation) of one of the following three safe-harbors:

1.       W-2, Box 1 earnings

2.       Monthly rate of pay at the beginning of the plan year (hourly rate times 130, or monthly salary not times 130)

3.       100% of Federal Poverty Line (FPL) for one individual

The reason these three safe harbors apply for determining whether the employer will be subject to a penalty is because the employer would not know an employee’s “household income,” which was the original standard under the ACA itself.  This is an amount from the employee’s prior year tax return.

In most cases an individual’s “household income” will be the same or more than the individual’s W-2 earnings from the employer, but there are several situations in which it could be less.   One example is if the individual pays alimony, which is a tax-deductible expense.   Another example is if the employee and spouse file a joint return and the spouse is self-employed and had a business loss.

TEST #2: 9.5% Test:  Whether Individual is Eligible for a Subsidy  

9.5% Household Income Test:  Individuals whose “household income” is 100-400% of the Federal Poverty Line (FPL) may qualify for a subsidy if they buy individual insurance in the Marketplace, and if they are not eligible for government health coverage or for employer coverage that provides minimum value and is “affordable.” Employer coverage is affordable if the employee cost for employee-only coverage is less than 9.5% (indexed) of “household income.” The two types of subsidies are a premium tax credit and a cost-sharing reduction.  “Household income” is defined as Modified Adjusted Gross Income (MAGI) from the employee’s federal tax return for the prior tax year.  For open enrollment in November and to December of 2017 (for enrollment effective January 1, 2018), the most recent tax return was the 2016 return.

TEST #3:  8% Test:  Whether Individual is Subject to the Individual Mandate Tax

8% Household Income Test:  If an individual does not have “minimum essential coverage” (MEC) for any month during the taxable year, IRC section 5000A requires the individual to pay the individual “shared responsibility payment” (often referred to as the “individual mandate tax”) for failure to have MEC.  There are numerous exemptions and exceptions that apply.  One of the exceptions is that an individual will not be subject to the individual mandate tax for failure to have MEC if the cost for the lowest-priced bronze policy available to the individual (or to the family, if the individual has a family) would cost more than 8% of household income.

If an individual is subject to the tax, the monthly tax is 1/12 of the annual tax.  For 2018, the annual tax is the greater of $695 per person or 2.5% of household income above the yearly tax filing requirement amount.