ACA Affordability Rules in 2026: What Mid-Size Employers Must Know Before Setting Employee Premium Contributions

Many employers who offer health coverage to their workforce believe that simply offering a plan is enough to satisfy their obligations under the Affordable Care Act. It is not. The ACA requires not only that coverage be offered to full-time employees, but that the employee-only premium for the lowest-cost plan option fall below a federally defined affordability threshold. Employers who set employee contributions too high, even by a few dollars per month, can face penalties measured per full-time employee, per year.

For a company with 60 full-time employees where 15 workers purchase coverage through a state exchange and claim a premium tax credit, the annual penalty exposure under Section 4980H(b) can reach $67,500 or more, depending on the plan year.¹ The penalty is not triggered by offering bad coverage. It is triggered by making coverage technically available but not financially accessible by the IRS's definition of affordable.

Understanding the three safe harbor methods the IRS allows for calculating affordability, and how to apply them to your specific payroll and plan structure, is one of the most practical steps a mid-size employer can take before setting employee contributions at renewal. This guide explains the mechanics in plain language, with no compliance law degree required to follow along.

What Makes Health Coverage Affordable Under the ACA Affordability Rules

The Affordability Percentage and How It Works

Under the ACA employer shared responsibility rules, an applicable large employer, meaning a company with 50 or more full-time equivalent employees, must offer health coverage that meets two tests: minimum value and affordability. The minimum value test requires that the plan pay at least 60% of covered expenses on average. The affordability test requires that the employee-only premium for the lowest-cost minimum value plan not exceed a specific percentage of the employee's household income for that year.

The ACA affordability percentage is adjusted annually by the IRS. For 2025 plan years, the threshold is 9.02% of household income, as published in IRS Revenue Procedure 2024-35.² The IRS adjusts this threshold each year through a new Revenue Procedure, typically published in late summer or early fall. Employers finalizing contribution structures for the 2026 plan year should confirm the current threshold at IRS.gov or with their benefits advisor before the plan year begins.

The employer's challenge is that they typically do not know each employee's household income. Household income includes wages from all sources, spousal income, and other items the IRS includes in the definition, none of which the employer has access to at enrollment time. This is precisely why the IRS created three alternative safe harbor methods that use information employers actually have.

Who the ACA Affordability Rules Apply To

The employer shared responsibility rules under Section 4980H apply to applicable large employers (ALEs), defined as organizations that employed an average of 50 or more full-time equivalent employees during the prior calendar year. For employers approaching that threshold, the rules take effect in the year after first crossing 50 FTEs. The full framework for what changes when your company crosses 50 employees includes both the offer requirement and the affordability requirement as distinct compliance obligations.

Companies below the 50 FTE threshold are not subject to employer shared responsibility penalties, but many voluntarily structure their contributions to pass the affordability test anyway. Employees in affordable employer plans are generally not eligible for premium tax credits on the exchange, which simplifies the compliance picture. This is particularly relevant for employers with part-time and variable-hour workers who may move in and out of full-time status across the year.

The Three Safe Harbor Methods for Calculating ACA Affordability

The IRS allows employers to use any one of three safe harbor methods to determine whether their coverage is affordable. Each method produces a maximum employee contribution amount. If the employee-only premium for the lowest-cost minimum value plan is at or below that amount, the employer satisfies the affordability test under that safe harbor.

Safe Harbor 1: Form W-2 Wages

Under the W-2 safe harbor, coverage is affordable if the employee-only premium for the lowest-cost plan does not exceed the affordability percentage multiplied by the employee's Form W-2 Box 1 wages for the plan year. Using the 2025 threshold of 9.02%, an employee who earned $45,000 in W-2 wages would be subject to a maximum employee-only premium of $4,059 per year, or $338.25 per month.

The W-2 safe harbor is calculated after the plan year ends, using actual W-2 wages. Because an employer sets contributions at the beginning of the year and does not know final W-2 wages until January of the following year, this safe harbor requires estimated planning at the start of the year and a reconciliation at the end. Employers who use the W-2 method must apply it consistently across their workforce.

Safe Harbor 2: Rate of Pay

The rate of pay safe harbor calculates affordability based on the employee's hourly rate or monthly salary at the start of the plan year, not their actual annual earnings. For hourly employees, the calculation assumes 130 hours per month, regardless of actual hours worked. The maximum employee-only premium equals the affordability percentage multiplied by the monthly rate of pay amount.

For a full-time employee earning $20 per hour, the assumed monthly rate of pay is $20 multiplied by 130 hours, which equals $2,600. Multiplied by the 2025 affordability threshold of 9.02%, the maximum affordable monthly contribution is $234.52. If the lowest-cost minimum value plan's employee-only premium exceeds that amount, the employer fails the rate of pay safe harbor for that employee.

The rate of pay safe harbor is not available if the employee's hourly rate or salary decreases during the plan year. It is the most common choice for mid-size employers because it uses current payroll data the employer already has at the start of the plan year. Section 125 cafeteria plan structures can affect the effective contribution calculation under this method, and employers using pre-tax premium deductions should confirm how the safe harbor applies in their plan design.

Safe Harbor 3: Federal Poverty Level

The Federal Poverty Level (FPL) safe harbor is the simplest method and the one that produces the most predictable compliance outcome. Under this method, coverage is affordable if the employee-only premium for the lowest-cost minimum value plan does not exceed the affordability percentage multiplied by the federal poverty level for a single individual in the continental United States, as published by HHS for the relevant plan year.

For 2025 plan years, the HHS-published FPL for a single individual is $15,060, using the 2024 guidelines that apply to 2025 coverage. The 2025 affordability threshold is 9.02%. The resulting maximum monthly employee contribution under the FPL safe harbor is approximately $113.20 per month ($15,060 multiplied by 9.02%, divided by 12).³

This is the most restrictive cap of the three methods. An employer with employees across a wide range of wages will find that the FPL safe harbor requires setting one contribution limit low enough to cover all employees, regardless of their individual wages. But it is also the easiest to administer: the same calculation applies to every employee, and there is no per-employee wage lookup required.

2025 figures based on IRS Rev Proc 2024-35 and 2024 HHS FPL guidelines. Verify current-year thresholds before finalizing contributions for any new plan year.

How to Set Employee Contributions That Pass the ACA Affordability Test

Identifying Your Lowest-Cost Minimum Value Plan

The affordability calculation applies to the employee-only premium for the lowest-cost plan option that meets minimum value. If your company offers multiple plan tiers, the calculation uses the cheapest option that pays at least 60% of covered costs, not the plan the employee actually chooses. An employer who offers a $200-per-month plan that fails minimum value and a $350-per-month plan that meets minimum value calculates affordability based on the $350-per-month plan.

This matters when employers try to use a plan with very limited benefits as their anchor for affordability calculations. If that plan does not meet minimum value, it cannot serve as the affordability benchmark. The IRS provides a minimum value calculator, and most actuaries and benefits advisors can run a minimum value test on any plan design before it is used as the basis for contribution structure.

Common Mistakes That Trigger ACA Penalties

The most common contribution-setting mistake is applying the affordability percentage to the employer's own cost rather than the employee's cost. The test is about what the employee pays, not what the employer pays. An employer who contributes $400 per month toward a $600 plan and asks the employee to pay $200 has tested the affordability of the $200 employee contribution. If the employee earns $25,000 per year, $200 per month ($2,400 per year) represents 9.6% of income, which exceeds the 2025 affordability threshold of 9.02%.

The second most common mistake is assuming the affordability test only matters once the company has clearly been an applicable large employer for years. Companies approaching 50 FTEs who cross the threshold during the year may owe penalties for months after they became an ALE, even if they did not know they had crossed the threshold. Running an FTE count at least twice per year and understanding when you will cross 50 FTEs prevents retroactive penalty exposure. Employers moving to self-funded or level-funded structures should also re-evaluate their contribution strategy under the new plan design, since the lowest-cost minimum value plan may change.

What Happens If Your Plan Fails the ACA Affordability Test

The Section 4980H(b) Penalty Explained

A failed affordability test does not automatically result in a penalty. The penalty applies only if at least one full-time employee receives a premium tax credit for exchange coverage during the plan year. Full-time employees who are offered affordable, minimum-value coverage are generally not eligible for a premium tax credit, which is why the affordability test functions as a gateway to the credit eligibility determination.

When the penalty does apply, it is calculated as follows: for each full-time employee who receives a premium tax credit and for whom coverage was either not offered or not affordable, the employer owes up to $4,460 per year per affected employee (2025 figure, indexed annually).⁴ For an employer with 60 full-time employees where 10 receive tax credits due to an affordability failure, the potential annual penalty exposure is $44,600, which can arrive as a surprise letter from the IRS after the plan year ends and employee tax returns are processed.

Why the Penalty Arrives Late and How to Prepare

The IRS does not notify employers of a potential penalty during the plan year. The sequence is: employees file tax returns, the IRS identifies premium tax credit recipients, the IRS cross-references employer data from ACA reporting (Forms 1094-C and 1095-C), and the IRS then sends the employer a Letter 226-J proposing the penalty. This sequence typically takes 12 to 18 months after the close of the plan year. An employer who had an affordability issue in their 2025 plan year may not receive the Letter 226-J until late 2026 or early 2027.

Employers who receive a Letter 226-J have 30 days to respond and can dispute the penalty if they can demonstrate that coverage was in fact affordable under one of the safe harbor methods. Maintaining documentation of contribution amounts, plan minimum value status, and the safe harbor method used for each plan year is the practical defense. Mid-size employers who maintain this documentation annually have a clear record to reference if a letter arrives.

Frequently Asked Questions

What is the ACA affordability threshold for 2025 and where can I find the 2026 figure?

The 2025 ACA affordability threshold is 9.02% of household income, as published in IRS Revenue Procedure 2024-35. The IRS adjusts this percentage annually, typically publishing the following year's threshold in a new Rev Proc each summer or fall. Employers finalizing contribution structures for a 2026 plan year should confirm the current threshold at IRS.gov or with their benefits advisor before the plan year begins, as the 2026 figure will be in the most recently issued Rev Proc at the time of your renewal planning.

Which safe harbor method should a mid-size employer use?

The Federal Poverty Level safe harbor is the easiest to administer and produces a single contribution cap that applies uniformly to all employees, regardless of their wages. It is the safest choice from a compliance standpoint for employers who want a simple, consistent rule. The tradeoff is that it produces the most restrictive cap, which may require the employer to absorb more of the premium than the W-2 or rate of pay methods would require. Employers with higher-wage salaried workforces often find the W-2 or rate of pay methods allow a higher employee contribution that still passes the affordability test, reducing the employer's premium share. Consult a benefits advisor to model all three methods for your specific workforce before choosing.

Does the affordability test apply to dependent coverage as well?

No. The affordability test under Section 4980H only applies to the employee-only cost of the lowest-cost minimum value plan. There is no ACA requirement that family or dependent coverage be affordable by any specific percentage. However, employees who find dependent coverage unaffordable through the employer can purchase exchange plans for their dependents even if the employee's own employer coverage passes the affordability test. The interaction between employer coverage and exchange subsidies for dependents is a separate question that often benefits from a compliance advisor's review.

What are the ACA reporting requirements that support the affordability determination?

Applicable large employers must file Forms 1094-C and 1095-C with the IRS annually. Form 1095-C provides each full-time employee with information about what coverage was offered, the employee-only premium for the lowest-cost plan, and the safe harbor code used for that employee. The IRS uses this data, combined with employee tax returns, to identify potential affordability failures. Accurate 1095-C reporting is the first line of defense in a penalty audit. The compliance documentation requirements for employer health plans continue to expand annually, and the 1094-C and 1095-C filing process is one of the most time-sensitive annual obligations for ALEs.

Can a PEO help with ACA affordability compliance?

Yes. When an employer enters a PEO arrangement, the PEO typically assumes ACA reporting responsibilities, including filing Forms 1094-C and 1095-C on behalf of the employer. The PEO's compliance team stays current on annual threshold changes and handles the measurement period calculations for determining which employees are full-time under ACA rules. The PEO also typically structures its health plan contributions to meet ACA affordability requirements by default, reducing the risk that the employer's contribution structure triggers a compliance issue. For mid-size employers who find ACA compliance administration burdensome, the PEO model offloads this work to specialists handling it across thousands of employer clients.

What happens if we receive an IRS Letter 226-J proposing a penalty?

Do not ignore it. You have 30 days from the date on the letter to respond, and the response process requires you to verify or dispute the employee data the IRS has identified as receiving premium tax credits. If your plan was affordable under one of the three safe harbors and you have documentation, you can dispute the proposed penalty by demonstrating the affordability and minimum value of your plan for that period. Many employers successfully dispute penalties at this stage with proper documentation. If the penalty is valid, you can also request a payment plan. Engaging a benefits attorney or CPA with ACA compliance experience at this stage is advisable, as the letter response has procedural requirements that affect your ability to challenge the IRS's determination.

References

1. Internal Revenue Service. "Employer Shared Responsibility Provisions." irs.gov/affordable-care-act/employers/employer-shared-responsibility-provisions
2. Internal Revenue Service. "Rev. Proc. 2024-35: ACA Affordability Percentage for 2025." irs.gov/pub/irs-drop/rp-24-35.pdf
3. U.S. Department of Health and Human Services. "2024 Poverty Guidelines." aspe.hhs.gov/topics/poverty-economic-mobility/poverty-guidelines
4. Internal Revenue Service. "Questions and Answers on Employer Shared Responsibility Provisions Under the Affordable Care Act." irs.gov/affordable-care-act/employers/questions-and-answers-on-employer-shared-responsibility-provisions-under-the-affordable-care-act
5. Kaiser Family Foundation. "2024 Employer Health Benefits Survey: Premium Contributions and Employee Enrollment." kff.org/health-costs/report/2024-employer-health-benefits-survey/
6. SHRM. "ACA: Employer Shared Responsibility (Pay or Play Rules)." shrm.org/topics-tools/tools/toolkits/aca-employer-shared-responsibility-pay-play-rules

This analysis is provided for educational purposes and does not constitute financial or legal advice. Consult your compliance counsel and benefits advisor for guidance specific to your organization's situation.