Small business owners frequently question whether federal law requires them to provide health insurance to their employees. Under the Affordable Care Act (ACA), the answer is generally no, meaning most small enterprises are not subject to a health coverage mandate. The ACA established a system of shared responsibility that only applies to businesses that meet a specific size threshold. Understanding this threshold is necessary to determine legal obligations regarding employee health benefits and avoid potential penalties.
The Key Threshold: Defining a Small Business for Health Insurance Mandates
The Affordable Care Act introduced the Employer Shared Responsibility Provision (ESRP), often called the employer mandate. This provision established a clear dividing line, applying only to businesses defined as an Applicable Large Employer (ALE). A business is designated an ALE if it employed an average of 50 or more Full-Time Equivalent (FTE) employees during the preceding calendar year. Businesses below this 50 FTE threshold are considered small employers under the ACA and are not subject to the federal ESRP. This classification is determined annually based on the prior year’s workforce data.
Businesses Below the Mandate Threshold
Businesses with fewer than 50 Full-Time Equivalent employees are not subject to the federal Employer Shared Responsibility Provision. These small businesses have no legal obligation under the ACA to offer health insurance coverage. Many owners in this category still choose to offer coverage to attract and retain talent.
If a business with fewer than 50 FTEs decides to offer a health plan, that plan must still comply with certain ACA requirements. These requirements include covering the ten essential health benefits and adhering to consumer protections, such as the prohibition of annual or lifetime benefit maximums. The decision to offer benefits for a small employer is driven by market competitiveness and employee welfare.
Calculating Full-Time Equivalent Employees (FTEs)
Determining a company’s ALE status requires calculating its Full-Time Equivalent employees for the previous calendar year. A full-time employee works at least 30 hours per week or 130 hours per month. The FTE calculation aggregates the hours worked by all part-time employees to determine how many full-time positions they collectively represent.
The calculation involves adding the total hours worked by all non-full-time employees each month, capping any single employee’s hours at 120 for the month. This aggregated part-time hours figure is then divided by 120 to convert those hours into a monthly FTE count. This monthly FTE count is then added to the number of full-time employees for that month.
To establish ALE status for the current year, the employer must sum the monthly combined full-time and FTE totals for all 12 months of the preceding year and divide that total by 12. This 12-month look-back period rule is the standard method used to determine if the business crosses the 50 FTE average threshold. If the resulting average is 50 or greater, the business is classified as an Applicable Large Employer for the current year and becomes subject to the mandate.
The Employer Mandate: Requirements for Applicable Large Employers (ALEs)
Businesses classified as Applicable Large Employers (ALEs) face requirements under Internal Revenue Code Section 4980H, which governs the Employer Shared Responsibility Provisions. The primary obligation is to offer Minimum Essential Coverage (MEC) to at least 95% of their full-time employees and their dependents. MEC refers to major medical health plan coverage that provides benefits like doctor’s visits, hospitalization, and prescriptions.
The coverage offered must satisfy two standards: minimum value and affordability. A plan meets the minimum value standard if it is designed to cover at least 60% of the total allowed costs of benefits expected to be incurred under the plan. This ensures the plan provides a substantial level of coverage.
The affordability standard is met if the employee’s required contribution for the lowest-cost, self-only coverage option does not exceed a specified percentage of their household income. The Internal Revenue Service (IRS) adjusts this percentage annually. Employers can use one of three IRS safe harbors—such as the W-2 wages or the Federal Poverty Level—to determine affordability without needing to know each employee’s actual household income. Failure to meet both the affordability and minimum value standards can expose the ALE to financial penalties.
Penalties for Non-Compliance
Applicable Large Employers that fail to meet the ESRP requirements are subject to financial penalties under Internal Revenue Code Section 4980H. The penalties are triggered only if at least one full-time employee receives a premium tax credit or subsidy for purchasing coverage through a Health Insurance Marketplace. The law details two primary types of penalties, commonly known as Penalty A and Penalty B.
Penalty A is levied if the ALE fails to offer Minimum Essential Coverage to at least 95% of its full-time employees and at least one employee receives a premium tax credit. This penalty is calculated based on the total number of full-time employees, minus the first 30 employees, making it often the more substantial financial consequence. Penalty B applies when an ALE offers coverage to the required 95% threshold, but the coverage is either unaffordable or does not provide minimum value, and an employee subsequently receives a premium tax credit. Unlike Penalty A, the Penalty B assessment is calculated only on the number of full-time employees who actually received the subsidy.
Voluntary Options for Small Businesses
For businesses that fall below the 50 FTE threshold, several voluntary mechanisms exist to help them provide health benefits without triggering the full compliance requirements of the ALE mandate.
Small Business Health Options Program (SHOP)
The Small Business Health Options Program (SHOP) is a federal and state Marketplace platform designed for small employers to purchase group coverage. Businesses purchasing coverage through a SHOP exchange may be eligible for the Small Business Health Care Tax Credit, an incentive under Code Section 45R. This tax credit can cover up to 50% of the employer’s premium contributions for a maximum of two consecutive years, provided the employer has fewer than 25 FTEs and pays average annual wages below a specific threshold.
Health Reimbursement Arrangements (HRAs)
Health Reimbursement Arrangements (HRAs) allow small employers to reimburse employees for individual health insurance premiums and medical expenses. These flexible arrangements are becoming popular alternatives to traditional group health insurance plans for small enterprises.
Qualified Small Employer Health Reimbursement Arrangement (QSEHRA): Available to businesses with fewer than 50 employees that do not offer a group plan. It allows employers to set aside a fixed, tax-free allowance for employees to buy their own coverage.
Individual Coverage Health Reimbursement Arrangement (ICHRA): Can be offered by businesses of any size and has no reimbursement caps, providing more flexibility than QSEHRA.
Both QSEHRA and ICHRA provide a way for small businesses to offer a defined contribution benefit, giving employees choice over their health plans.
State and Local Mandates
While federal requirements are governed by the ACA’s size-based mandate, small business owners must also consider state and local laws. Some jurisdictions have enacted mandates that impose requirements beyond the federal ESRP. These local regulations may include specific rules regarding health insurance coverage, paid leave, or other benefits that apply regardless of federal ALE status. The complexity of compliance increases when a business operates in multiple states or localities, as each location may have different employee thresholds or coverage requirements. Small businesses must check local jurisdiction laws to ensure full compliance, as federal law does not preempt all state-level obligations.