May 13, 2022

On April 5, 2022, the Internal Revenue Service (IRS) issued a proposed rule to revise the current interpretation on how eligibility for premium tax credits is determined for family members of employees offered employer-sponsored health coverage. If finalized, the rule – formally titled “Affordability of Employer Coverage for Family Members of Employees” – would fix what has become known as the Affordable Care Act’s (ACA) “family glitch” by extending premium tax credits to potentially millions of people who are currently ineligible for subsidies on the ACA marketplaces. The IRS’ proposed rule was accompanied by a fact sheet released by the White House.

In the article below, we provide background on the “family glitch,” review the IRS’ proposed rule, and discuss the implications for employer-sponsored group health plans.

Background on the ACA “Family Glitch”

Under Section 36B of the Internal Revenue Code (IRC), individuals generally do not qualify for premium tax credits within the ACA marketplaces if they are eligible for another source of minimum essential coverage (MEC), including employer-sponsored coverage. The ACA provides two exceptions: (i) when the employer-sponsored coverage is not “affordable” or (ii) when the employer-sponsored coverage does not provide “minimum value.” If either is applicable, and the individual’s income is below a certain threshold, he/she will be eligible for premium tax credits.

The ACA defined that coverage is “affordable” if the employee contributes less than 9.5% of household income toward the total premium. (This affordability percentage was initially set at 9.5% and is adjusted annually. The threshold for 2022 is 9.61%, but this article will use the original 9.5% threshold throughout.) In implementing the ACA, the Department of Treasury and IRS moved away from a true assessment of household income and instead provided three affordability safe harbors that employers could follow and under which “affordability” would be determined. If an employer-sponsored plan is not “affordable,” an employee may qualify for premium tax credits through the marketplaces, and an employer may be subject to the employer shared responsibility penalties under the ACA’s employer mandate.

Under the IRS’ current interpretation dating back to 2013, employer-provided health coverage is considered “affordable” under the ACA (using the safe harbors) based on the cost of employee-only (or self-only) coverage – not the cost of family coverage. The IRS applied this determination to every family member who could have been enrolled by the employee in the employer’s plan, even if the family member were not enrolled, and if the additional cost of covering the family member(s) would not be considered “affordable” under any affordability safe harbor.

This interpretation resulted in the so called “family glitch”, because family members would be disqualified from premium assistance on the ACA marketplaces by the “affordability” of an employee-only offer of coverage, and not whether the family member was enrolled or if the additional coverage was affordable.

Overview of Proposed Rule

Citing an Executive Order issued by President Biden in January 2021 directing federal agencies to examine ways to strengthen Medicaid and the ACA, the proposed rule would amend the Internal Revenue Code (IRC) to create a separate affordability test for covered family members. Under the current interpretation, an offer of affordable employee-only coverage drives three related elements: (a) the employer satisfies the ACA affordability requirements to avoid a tax penalty under IRC Section 4980H(b); (b) the employee is prevented from receiving a premium tax credit for coverage in an ACA marketplace; and (c) the employee’s family members who could have enrolled in employer coverage (even if unaffordable for them) are also disqualified from receiving a premium tax credits for ACA marketplace coverage.

The proposed rule would separate the third element “(c)” – the family’s ACA marketplace premium tax credit eligibility determination – from the first two. The rule would change the definition used by the ACA marketplace for family members so that employer-provided coverage would only disqualify them from a premium tax credit if the employee’s portion of the annual premium for family coverage is “affordable” using one of the available affordability safe harbors (i.e., is less than 9.5% of household income, as amended). The proposed rule would not affect the employer’s penalty exposure in relation to the employee, as the employee’s eligibility for premium tax credits would remain based on the cost of the employee-only coverage tier.

The proposed rule also clarifies the ACA minimum value requirement with respect to family coverage. As defined by the ACA, an employer-sponsored plan provides “minimum value” if it covers at least 60% of total allowed costs. The IRS previously interpreted the minimum value requirement to apply to both employees and covered family members, meaning an employer-sponsored plan that did not provide minimum value would not be considered MEC, and both the employee and family members would be considered eligible for premium tax credits. However, this was not included in the original statute. The proposed rule would clarify that both employees and covered family members are subject to the ACA’s minimum value requirements, creating separate tests for employees and families like the two proposed affordability tests.

Along with these adjustments to the minimum value tests, the IRS is including in the proposed rule that the minimum value threshold of 60% of total allowed costs of benefits include substantial coverage of inpatient hospital services and physician services. The IRS initially proposed this change in 2015, but is formally withdrawing the older proposal to include in this new proposed rule in order to extend the substantial coverage requirements to both employees and covered family members.

The proposed rule was published in the Federal Register on April 7, 2022 with a 60-day public comment period (i.e., a June 6, 2022 deadline). The IRS will hold a hearing on the proposed rule on June 27, 2022. The regulatory change would apply for taxable years beginning after the date the rule is finalized. In the preamble to the proposed rules, the IRS indicated they expect to finalize the proposed rule this year, meaning this change would be effective January 1, 2023.

Employer Implications

The proposed rule closing the “family glitch” would not impact the ACA employer shared responsibility requirements (i.e., employer mandate). Applicable large employers (with 50 or more full-time and full-time equivalent employees) must continue to offer MEC that is affordable and meets minimum value to full-time employees and their dependents. The proposed rule does not change the affordability and minimum value tests for full-time employees – nor their associated employer mandate penalties (under IRC Section 4980H(b)) – maintaining their basis on employee-only, not family, coverage.

Although the employer’s ACA obligations are unchanged, the proposed rule may result in some enrollment migration of family-members-only (and likely to some lesser degree, both employees and family members) to the ACA marketplace, which may impact the employer’s premiums collected from employees and the plan’s risk pool. There may be circumstances where the employee remains in the employer’s plan while the remaining family members enroll in the ACA marketplace, i.e., “split coverage.” Practically, this may complicate a family’s use of the coverages, which would be subject to separate administrative rules as well as premiums, deductibles, and other cost-sharing. The IRS acknowledges in the proposed rules that while some families may see total costs reduced with this “split coverage” between employer-based coverage and ACA marketplace coverage, others may not benefit from the multiple deductibles and out-of-pocket maximums and would instead prefer the benefits and provider networks of employer coverage.

Employers should review the impacts of the proposed rule with legal counsel, consultants, third-party administrators, and eligibility vendors to discuss potential implications should the IRS finalize the proposed rules for plan years beginning January 1, 2023 (as they suggest in the preamble to the proposed rules). Business Group on Health will monitor and keep members informed of regulatory developments.

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Policy & Advocacy Affordable Care Act (ACA)