The Affordable Care Act (ACA) requires applicable large employers (ALEs) to offer affordable, minimum-value health coverage to their full-time employees (and dependents) or potentially pay a penalty to the IRS. This employer mandate is also known as the pay-or-play rules. Small employers who are not ALEs are not subject to the ACA’s pay-or-play rules.
An ALE may be subject to a pay-or-play penalty if at least one full-time employee receives a premium tax credit for purchasing individual health coverage through an ACA Exchange and the ALE:
- Did not offer health plan coverage to at least 95% of full-time employees and their dependents;
- Offered health plan coverage to at least 95% of full-time employees, but not to the specific full-time employee receiving the credit; or
- Offered health plan coverage to full-time employees that was unaffordable or did not provide minimum value.
Here are some strategies for ALEs to use to help avoid penalties under the ACA’s pay-or-play rules.
Strategy: Accurately Track Employees’ Full-time Status
Accurately tracking who is full-time is essential to avoiding ACA pay-or-play penalties. ALEs must offer affordable, minimum-value health coverage to employees who average at least 30 hours per week or 130 hours per month, even if their internal definition of “full-time” is different.
Employers can determine full-time status in two ways:
- Look-back measurement method – reviews hours over a prior “measurement period” to set status for a future “stability period,” ideal for variable or seasonal schedules.
- Monthly measurement method – reviews hours each calendar month, best for workforces with consistent full-time hours.
If full-time status is tracked inaccurately, coverage can be missed and penalties may apply.
Strategy: Apply the Adjusted Percentage to Determine Affordability
Affordability is central to avoiding ACA pay‑or‑play penalties. Coverage is considered affordable when the employee’s cost for self‑only coverage under the lowest-cost minimum value plan does not exceed the IRS affordability percentage for that year (9.96% of household income for plan years beginning in 2026; 9.02% for 2025).
Before each plan year, ALEs should confirm that at least one plan option for full-time employees meets the current affordability threshold, using applicable IRS safe harbors.
Strategy: Utilize an Appropriate Affordability Safe Harbor
Because employers generally do not know an employee’s household income, the IRS offers three optional affordability safe harbors: Form W‑2, rate of pay, and federal poverty level (FPL). These methods let ALEs test affordability using data they already have and can shield them from pay‑or‑play penalties, even if an employee receives a premium tax credit.
Employers can apply one or more safe harbors to all employees or to reasonable employee groups, as long as they do so consistently. The right choice depends on your workforce and your goals for predictability and contribution levels.
| Safe Harbor | Quick Overview | Pros & Cons |
| Form W-2 | An ALE determines the affordability of its health coverage for each employee by looking at the employee’s wages reported in Box 1 of their Form W-2after the end of the year. | This safe harbor is the least predictable method for determining affordability because it is based on the actual amount of each employee’sW-2 wages, which is not known until after the end of the year. Due to this uncertainty, it works best for employees whose annual compensation can be predicted with accuracy before the start of the year. If employers are comfortable with this risk, this safe harbor potentially allows them to maximize employee contributions toward the cost of health coverage based on actual compensation. |
| Rate of Pay | An ALE determines the affordability of its health coverage for each employee by looking at the employee’s hourly rate multiplied by 130 hours (regardless of the number of hours worked). Monthly salary is used for salaried employees instead of the hourly rate. | This safe harbor provides a more predictable, design-based method for determining affordability. It is especially useful for ALEs with a significant number of hourly employees since it uses an assumed rate of 130 hours per calendar month, regardless of the actual number of hours worked by the employee. However, this safe harbor may not maximize employee contributions toward the cost of health coverage if hourly employees regularly work more than 130 hours per month. |
| FPL | An ALE determines the affordability of its health coverage for all employees by looking at the FPL for a single individual. | This safe harbor provides the most predictable, design-based method for determining affordability. It gives ALEs a predetermined maximum amount of employee contribution that, in all cases, will result in the coverage being deemed affordable. It is relatively easy to apply because it does not require any employee-specific data. However, it often requires the largest employer contribution toward the cost of health coverage. |
Strategy: Timely and Accurately Complete ACA Reporting
Each year, ALEs must file Forms 1094‑C and 1095‑C with the IRS, generally by March 31 (with an optional 30‑day extension via Form 8809). The IRS uses these forms, along with employees’ tax returns, to determine any pay‑or‑play penalties.
Accurate reporting on Form 1095‑C, especially the codes on lines 14‑16, is critical. Fully insured ALEs must file a form for each full‑time employee; self‑funded ALEs must file for every covered individual, not just full‑time employees.
Strategy: Promptly Respond to IRS Letter 226-J
The IRS sends Letter 226‑J when it believes at least one full‑time employee received a premium tax credit on an ACA Exchange, and the ALE may owe a pay‑or‑play penalty. It is an initial notice, not a bill, and typically requires a response within 90 days.
ALEs should review their offer of coverage and the Forms 1094‑C/1095‑C filed for that year, then respond agreeing or disputing the proposed amount. If Form 1095‑C data was incorrect, updated codes for lines 14‑16 should be submitted per IRS instructions.
Download the bulletin for more details.
Links and Resources
- IRS final regulations on the ACA’s pay-or-play rules
- IRS Revenue Procedure 2025-25, containing the affordability percentage for 2026 plan years
- Forms 1094-C and 1095-C (and related instructions) for ACA reporting by ALEs
