Setting a 2027 CHOICE Arrangement Allowance That Passes Affordability

For large employers, the monthly allowance is the compliance question. A CHOICE Arrangement, formerly called an ICHRA, satisfies the employer mandate only when the allowance is affordable for every full-time employee. Miss the mark for a handful of people and the exposure lands on the employer. The two names are used interchangeably here, and every rule below applies the same way under either one.

Why adoption is accelerating and why the math matters now

Large employers are moving to this model faster than before. According to the HRA Council's 2026 data report, adoption among applicable large employers (ALEs) grew 108% on an aggregated basis from 2025 to 2026. For many of these organizations, the appeal is a predictable benefits budget paired with more plan choice for employees.

The tradeoff is that predictability depends on getting the allowance right. Under the Affordable Care Act, an ALE is an employer with at least 50 full-time employees, counting full-time equivalents. Under Internal Revenue Code Section 4980H, those employers must offer full-time employees and their dependents minimum essential coverage that is affordable and provides minimum value, or they may owe a penalty.

Here's how a CHOICE Arrangement fits those two requirements. An offer of the arrangement counts as an offer of an eligible employer-sponsored plan under proposed IRS regulations that employers may rely on. Offering it to at least 95% of full-time employees and their dependents helps an ALE avoid the larger Section 4980H(a) penalty. The offer also has to be affordable for each full-time employee, and under the same proposed rules, an affordable CHOICE Arrangement is treated as providing minimum value.

That second requirement is where the allowance comes in. With a traditional group plan, affordability turns on what the employee pays toward the premium. With a CHOICE Arrangement, it turns on how the employer's allowance compares with the cost of a specific individual market plan available to that employee.

What the penalty looks like when an allowance falls short

An employee who accepts a CHOICE Arrangement can't also claim a premium tax credit for Marketplace coverage. If the offer is unaffordable, though, the employee can decline it and claim the credit instead. When a full-time employee does that, the employer may owe a Section 4980H(b) penalty for that person.

For 2027, the IRS has set that penalty at $5,670 per year, or $472.50 per month, for each affected full-time employee. The 2026 figure was $5,010. The numbers add up quickly. If 20 full-time employees receive an unaffordable offer and claim premium tax credits for all 12 months of 2027, the potential penalty reaches $113,400. The Section 4980H(b) penalty is capped at what the employer would have owed under Section 4980H(a), which is the ceiling to keep in mind when modeling worst-case scenarios.

The affordability formula in plain terms

The test compares two numbers for each full-time employee. The first is the employee's required contribution: the monthly premium for the lowest cost silver plan (LCSP) for self-only coverage available to that employee, minus the employer's monthly allowance. The second is the affordability threshold, which is a set percentage of the employee's household income divided by 12.

If the required contribution doesn't exceed the threshold, the offer is affordable for that person. Written out:

(LCSP premium – monthly CHOICE allowance) ≤ (affordability percentage × household income ÷ 12)

Two details trip people up. The test always uses the self-only premium, even when an employee buys family coverage. And it's measured employee by employee. An allowance that works for most of the workforce can still fall short for a few individuals, which is why class-wide averages aren't a defense on their own.

The 2027 percentage and why the plan start date matters

The IRS updates this affordability percentage, officially the required contribution percentage, each year. In Revenue Procedure 2026-26, the IRS set it at 10.22% for plan years beginning in 2027. For plan years beginning in 2026, the figure is 9.96%.

The percentage is tied to the year the plan year begins, not the calendar year you're budgeting in. A plan year that starts in November 2026 uses 9.96% for its full duration. That's a common source of error for employers with non-calendar plan years, so confirm the start date before you touch a single spreadsheet cell.

Safe harbors for location and timing

Employers rarely have real-time visibility into each employee's home address, the LCSP premium in every area, or how rates will shift before the plan year begins. The IRS built two CHOICE-specific safe harbors and a simplified age rule to make the test workable.

The location safe harbor

By default, affordability is measured against the LCSP where the employee lives. The location safe harbor lets the employer use the LCSP available at the employee's primary site of employment instead. This tends to suit employers whose staff commute into one office from several counties or rating areas, those with multiple stable worksites, and those dealing with frequent address changes that would otherwise force recalculations.

Defining the primary site takes some care. It's generally the location where the employer reasonably expects the employee to work on the first day of the plan year. For someone who works remotely with no assigned office or reporting location, the primary site is their residence, which means their LCSP may differ from what the office employees face. If an employee's work location changes permanently or indefinitely, the employer must update it no later than the first day of the second calendar month after the change.

The look-back month safe harbor

Individual market premiums change every year, and employers typically have to set allowances before new rates are published. The look-back month rule closes that gap. For calendar-year plans, the employer can use the LCSP premium from January of the prior calendar year, so a January 1, 2027 plan year uses January 2026 rates. For non-calendar plans, the employer can use January of the current calendar year, so a July 1, 2027 plan year uses January 2027 rates.

Once a look-back month is chosen, the proposed regulations don't require adjustments for premium changes during the plan year. That's a real simplification, but it also means a bad pick can't be fixed midyear.

How employee age enters the calculation

Premiums vary by age, so each employee's LCSP depends on how old they are. Under the proposed regulations, age is measured on the first day of the plan year, or on the date the CHOICE Arrangement first takes effect for employees who become eligible later in the year. A birthday partway through the year doesn't change that plan year's calculation.

To find the LCSP for a given location and year, the IRS publishes an Employer Lowest Cost Silver Plan Premium Look-up Table. Administrators typically pull this data automatically and run the test for every employee, which is worth confirming if you're doing it by hand.

Three household income safe harbors

The other half of the formula is household income, which employers can't see in full. Instead, ALEs may use one of three household income safe harbors. These are the same ones used for traditional group plans, and they apply to CHOICE Arrangements too.

Federal poverty line safe harbor

This is the simplest and most conservative option. The offer is affordable if the required contribution doesn't exceed 10.22% of the federal poverty line for a single individual, divided by 12. Employers may use the poverty guidelines in effect within six months before the plan year begins. For a calendar 2027 plan, that's the 2026 guideline of $15,960 for one person in the 48 contiguous states and D.C. The math works out like this: $15,960 × 10.22% ÷ 12 = $135.93, rounded down to $135.92 per month to stay under the limit. Alaska and Hawaii have separate, higher guidelines.

The appeal is certainty. The cost is that this safe harbor requires the largest allowance, because the required contribution can't exceed roughly $136 a month regardless of what the employee earns.

Rate of pay safe harbor

This one suits hourly workforces. For an hourly employee, the employer multiplies 130 hours by the lower of the employee's hourly rate on the first day of the coverage period or their lowest hourly rate during the month, then applies the percentage. An employee earning $22 an hour has a monthly benchmark of $2,860, and $2,860 × 10.22% comes to $292.29 per month.

For salaried staff, the benchmark is monthly salary as of the first day of the coverage period. If a salaried employee's pay is reduced, this safe harbor can't be used for that person, which matters if you run mid-year pay cuts.

Form W-2 safe harbor

This option uses the wages reported in Box 1 of the employee's Form W-2 from the employer. An employee with $52,000 in Box 1 wages has an annual threshold of $52,000 × 10.22% = $5,314.40, or $442.86 per month after the monthly division and rounding down.

The catch is timing. Box 1 wages aren't final until the year closes, so employers using this safe harbor need to estimate carefully and build in a margin for changes.

Choosing among them

The three options trade off differently. The poverty line safe harbor is predictable but expensive in allowance terms. Rate of pay works well for hourly or stable-salary groups but breaks down when salaries are cut. The W-2 approach fits employees with predictable pay but leaves you waiting until year end for final numbers. Employers can apply different safe harbors to different reasonable categories of employees, such as hourly and salaried staff, as long as each one is applied uniformly within its category.

A worked example for one employee

Consider a 45-year-old employee at the company's main office, with a calendar 2027 plan. Assume the LCSP for that age and location, using January 2026 rates under the look-back month, is $560 per month. The employer applies the location, look-back month, and poverty line safe harbors.

Under the poverty line safe harbor, the maximum required contribution is $135.92. Subtract that from the premium: $560 – $135.92 = $424.08. Round up, and the minimum compliant allowance is $425 per month. Any allowance of $425 or more makes the offer affordable for this employee.

Now swap in the rate of pay safe harbor for an hourly employee earning $22 an hour. The required contribution cap becomes $292.29, so the minimum allowance drops to $268 per month ($560 – $292.29 = $267.71, rounded up). The same premium supports a much smaller allowance for that worker, which is the practical reason the safe harbor choice matters.

Age-based and class-based allowances

Because LCSP premiums rise with age, a flat allowance that's affordable for a 30-year-old may fall short for a 60-year-old. CHOICE rules let employers vary allowances by age within a class, provided the amount offered to the oldest participants is no more than three times the amount offered to the youngest. If the youngest employees in a class receive $200 a month, the oldest can receive up to $600. Many ALEs use this structure to meet affordability across the workforce without overspending on younger staff.

Employers can also set different allowances for classes such as full-time and part-time staff, or for employees in different rating areas, as long as the allowance is offered on the same terms within each class. Affordability for Section 4980H purposes is still checked person by person, so a class structure that works on average can still leave individuals short.

Reporting the offer on Form 1095-C

ALEs report CHOICE offers on Form 1095-C each year, and the IRS uses those forms to evaluate potential penalties, so accuracy matters.

• Line 14 carries offer codes 1L through 1U. These show who received the offer, whether affordability was based on residence or primary site of employment, and whether the offer was unaffordable or made to someone who wasn't a full-time employee.
• Line 15 shows the employee's required contribution for the offer.
• Line 17 shows the ZIP code used for the affordability test. That's the residence for codes 1L, 1M, 1N, and 1T, and the primary site of employment for codes 1O, 1P, 1Q, and 1U.

If you applied the location safe harbor, both the offer code and the ZIP code should reflect the work location. Keeping your reporting consistent with the safe harbors you used to set allowances is the simplest way to avoid discrepancies later.

Mistakes that show up most often

Even experienced HR and benefits teams hit the same problems. Watch for these:

• Using the wrong percentage. A plan starting in late 2026 still uses 9.96%, not the 2027 figure.
• Testing against family premiums. The test always uses the self-only LCSP, even when employees buy family coverage.
• Overlooking remote staff. Someone with no assigned office has a primary site at home, and that LCSP may be very different.
• Missing relocations. A permanent location change must be reflected by the first day of the second calendar month after it happens.
• Forgetting midyear arrivals and status changes. New hires and employees who move into full-time status need an affordable offer starting in their first eligible month.
• Applying safe harbors unevenly. Household income safe harbors must be applied uniformly within each reasonable category of employees.

A pre-enrollment checklist for 2027

Before open enrollment, work through these steps:

• Confirm the plan year start date and the correct percentage, 10.22% for plan years beginning in 2027.
• Choose a household income safe harbor for each employee category.
• Decide whether to apply the location and look-back month safe harbors.
• Pull LCSP premiums for each employee's applicable location and age.
• Calculate the minimum compliant allowance for every full-time employee.
• Test age-based and class-based structures to confirm each full-time employee passes.
• Document the methodology so Form 1095-C reporting matches the calculations.
• Build a plan for midyear changes, including new hires, relocations, and status changes.

What to watch next

The formula itself is straightforward: compare the LCSP premium with what the employee pays after the allowance, and confirm that remaining amount stays under the IRS threshold. Most of the difficulty lies in choosing safe harbors, handling age and location data, and keeping records clean for reporting. Because the 2027 percentage and penalty amounts have already moved from their 2026 levels, employers who set allowances using last year's figures should recheck them before enrollment. The employers that will handle 2027 well are the ones that document their safe harbor choices now, while the decisions are still fresh, and build a process that catches midyear changes before they turn into penalty exposure.