Policy & Advocacy

November 08, 2022

On October 11, 2022, the Internal Revenue Service (IRS) and the Department of the Treasury (Treasury) issued a final rule revising the interpretation of how eligibility for premium tax credits is determine for family members of employees offered employer-sponsored health coverage. The final rule, titled “Affordability for Employer Coverage for Family Members of Employees,” fixes what has become known as the Affordable Care Act’s (ACA) “family glitch” by extending eligibility for premium tax credits to many people currently ineligible for subsidies on the ACA marketplaces.

In the article below, we provide a background on the “family glitch,” review the IRS’ final rule and accompanying guidance for cafeteria plans 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 thresholds are 9.61% and 9.12% for 2022 and 2023, respectively, 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’ interpretation prior to publishing this final rule, which date 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 Final Rule

The IRS initially proposed revising the interpretation on premium tax credit eligibility in a proposed rule issued on April 5, 2022, which cited an Executive Order issued by President Biden in January 2021 directing federal agencies to examine ways to strengthen Medicaid and the ACA. This final rule retains most of the provisions in the proposed rule without change, with the IRS noting that most of the public comments received were overwhelmingly supportive of the proposal.

The final rule amends the Internal Revenue Code (IRC) to create a separate affordability test for covered family members. Under the prior 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 premium tax credits for ACA marketplace coverage.

The final rule separates the third element “(c)” – the family’s ACA marketplace premium tax credit eligibility determination from the first two elements. The final rule changes 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 final rule does 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 final rule adopts the clarifications to the ACA minimum value requirement with respect to family coverage outlined in the proposed rule without change. 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 statue. The final rule clarifies 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 affordability tests.

In conjunction with these adjustments to the minimum value tests, the IRS adopts in the final rule that the minimum value threshold of 60% of total allowed costs include substantial coverage of inpatient hospital services and physician services. This final rule formally withdraws a proposed rule related to this change from 2015, so that this substantial coverage requirement applies to both employees and covered family members.

The provisions of the final rule are effective December 12, 2022 – in practicality, however, the IRS notes rule that the Service is coordinating with the Department of Health and Human Services (HHS) to ensure the changes are implemented across the ACA marketplaces for the 2023 open enrollment period that began November 1, 2022.

Additional Guidance Issued for Cafeteria Plans

In conjunction with the published final rule, the IRS also issued Notice 2022-41 on October 11, 2022 providing flexibility for IRC Section 125 cafeterias. Under this voluntary guidance, plan sponsors are permitted (but are not required) to amend their plans to permit employees and their covered family members to prospectively drop their employer-sponsored coverage to enroll in ACA marketplace coverage during either the ACA marketplace’s annual enrollment period or a special enrollment period. Coverage can be discontinued for either the employee or some or all family members.

The guidance in Notice 2022-41 is effective for elections effective on or after January 1, 2023. Plan sponsors who wish to take advantage of this voluntary guidance must amend their written cafeteria plan documents to include these election changes. Plan documents must be amended on or before the last day of the plan year in which elections are allowed, and the amendment must be effective retroactively to the first day of that plan year. For a plan year that begins in 2023, an amendment may be adopted at any time on or before the last day of the plan year that begins in 2024.

An important note for cafeteria plan sponsors: although Notice 2022-41 appears to specify the guidance is applicable to non-calendar year cafeteria plans, there are potential scenarios where the flexibilities offered by this guidance would benefit calendar year plans as well. In the absence of published clarification from the IRS, Business Group on Health recommends employer plan sponsors discuss Notice 2022-41 and its implications with legal counsel whether they offer a calendar year or non-calendar year plan.

Employer Implications

The final rule closing the “family glitch” does 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 final 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.

The changes to premium tax credit eligibility in the final rule may result in enrolment migration of family members only (and likely to some lesser degree, both employees and family members) from employer-sponsored coverage to ACA marketplace coverage. This may in turn impact an employer’s premiums collected from employees and the plan’s risk pool. There may be circumstances where an employee chooses to remain on the employer 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 premiums, deductibles, and other cost-sharing. The IRS acknowledged receiving multiple comments to the proposed rule regarding “split coverage,” but stated that the possibility of “split coverage” is a choice individuals and families would need to make for themselves as they evaluate their health care coverage options.

The final regulations do not change the ACA information reporting requirements for employers under IRC Sections 6055 and 6056. The IRS states in the final rule that they do not intend to revise Forms 1095-B or 1095-C to require additional data elements related to the new rules, informing employers that they may continue to use the safe harbors for affordability under Section 4980(H).

Employers should review the impacts of the final rule with legal counsel, consultants, third-party administrators, and eligibility vendors to discuss potential implications for plan years beginning January 1, 2023. Plan sponsors who wish to take advantage of the optional Section 125 cafeteria plan guidance outlined in IRS Notice 2022-41 should discuss the implications and process for amending their cafeteria plan document with legal counsel, consultants, and applicable third-party administrators. Any changes to the terms of the plan must be appropriately communicated to employees. Business Group on Health will monitor and keep members informed of related regulatory developments.