Articles
Pushing Back on Proposed ACA Penalties
By Michael P. Duffy on January 8, 2020A significant number of 226-J Letters sent to large employers contain material errors. Don’t cut the IRS a check unless you’re sure the ESRP penalty being proposed is actually due.
The IRS requires that taxpayers annually file Forms 1095-C and 1094-C in order to self-report the total number of full-time employees they retain during the year. Individual employees are given statements concerning whether or not they were enrolled or offered the opportunity to enroll in an employer-sponsored ACA-compliant healthcare plan. The IRS began requesting this data from employers in 2015, and since late 2017 it began analyzing the employer data in order to identify errors and compliance gaps.
If the IRS identifies a possible ACA deficiency, it sends out a Letter 226-J to employers. What usually generates most of the calls to CPAs and attorneys is that the Letter 226-J usually proposes a six-figure penalty and is drafted to look like a formal IRS tax assessment.
What is important to remember is that the ESRP offer penalty is imposed on an employer that does not offer coverage to at least 95% of its full-time employees, regardless of the number of employees who may have been offered coverage and regardless of the number of employees who actually enroll in whatever employer-sponsored healthcare plan is being offered. For example, if an employer offers coverage to 94% of its full-time employees, the ESRP penalty counts the total number of the employer’s full-time employees, as opposed to just the employees not offered coverage. This fact comes as a surprise for employers that offer reasonably strong benefits but inadvertently fail to meet the 95% threshold. Conversely, if coverage is offered to all full- time employees but for whatever reason no employee actually enrolls, no ESRP offer penalty is due. Actual enrollment in the plan being offered is not relevant for the purposes of the ESRP penalties.
Whether adequate coverage is offered to employees is only half the requirement of either ESRP penalty, however. In order for the IRS to be able to assess an ESRP penalty, it must also show during the same period that at least one full-time employee enrolled in an Obamacare plan that was, at least in part, subsidized.2 If a large employer fails to offer any sort of employer-sponsored healthcare plan options but none of the employees actually get subsidized healthcare through a public option, then the IRS is unable to assess either ESRP penalty.
Although this limitation puts the possibility of an assessment out of the hands of an employer, the Obamacare subsidy requirement is an important limitation on the IRS’s power to impose the ESRP penalties. All 226-J Letters will contain a breakdown of the individual employees who received Obamacare subsidies during each month of the tax year. If one employee received Obamacare subsidies for a particular month, a 1/12 fraction of the ESRP annual penalty is assessed for that month, assuming the employer also did not offer adequate coverage options.
As such, complying with the ACA involves tracking and actively monitoring a good deal of employee data on a monthly basis. This significant burden is substantially compounded by the complexity of reporting all the relevant data to the IRS. The Forms 1094-C and 1095-C are difficult to understand, and the instructions are filled with jargon. For instance, on Form 1095-C, employers must populate for each separate employee and each month one of 18 different letter codes denoting employment status, status of coverage offers, and affordability data. Some letter codes combine multiple statuses into one field, whereas other employee statuses material to the employee’s access to coverage, such as whether he or she has waived employer-sponsored plan participation, contain no separate letter code at all.
The confusing format of Forms 1094-C and 1095-C is in all likelihood a material factor in generating a significant number of the 226-J Letters currently being sent out by the IRS. In some cases, an employer receiving one of these letters may simply be able to correct reporting errors and avoid an ESRP penalty altogether.
Recall that an ESRP penalty may not be assessed against an employer unless at least one of the employer’s full-time employees is also enrolled in a subsidized Obamacare plan. Before any penalty may be assessed, the ACA requires that an employer receive something called “Section 1411 certification” confirming one of its employees has enrolled in such a plan and was allowed a subsidy.
ACA regulations created by the Department of Health and Human Services in 2013 set forth how the Section 1411 certification process is supposed to work. The regulations provide that an employer is supposed to receive notice from an ACA exchange when one of its employees applies for subsidized Obamacare coverage. The notice gives employers an opportunity to challenge any incorrect assertions made by employees on their Obamacare applications, such as an erroneous claim that he or she was not offered employer-sponsored coverage or that the coverage offered by an employer is not affordable. The process further alerts employers that their penalty exposure may grow if they do not begin offering ACA-compliant benefits to enough of their employees. Presumably, if the potential ESRP exposure is high enough, an employer in receipt of a Section 1411 certification may reasonably opt to expand its healthcare plan offerings.
In reality, the ACA exchanges more often than not never issue any notices to employers. This failure significantly limits employers’ opportunities to contest erroneous employee claims, but perhaps more critically, causes the process to fall short of the Section 1411 certification requirement.
The IRS has attempted to gloss over the fact that the ACA exchanges in many cases have not issued valid Section 1411 certifications, by stating in the text of the standard 226-J Letter that the letter itself represents a Section 1411 certification. This statement is not consistent with the ACA’s regulatory framework, though, and potentially impacts the IRS’s ability to legally impose the ESRP penalties on employers.
If you’ve received a 226-J Letter threatening a large ESRP penalty, it is highly advisable that you obtain representation from someone who is familiar with ACA parlance and compliance procedure. The reality right now is that the ACA is here to stay, and while it is in effect, the IRS will not stop looking for easy ESRP penalty targets.
1 This number is increased each year with inflation.
2 An employee who is eligible to participate in an employer-sponsored healthcare plan can always elect to go to an ACA exchange and obtain Obamacare coverage. But if a valid employer-sponsored plan is available to the employee already, then the employee’s coverage is not eligible for any government subsidies. In almost all cases, the employer-sponsored plan will be cheaper than unsubsidized coverage available through Obamacare.
©2019. This material is intended to offer general information to clients and potential clients of the firm, which information is current to the best of our knowledge on the date indicated below. The information is general and should not be treated as specific legal advice applicable to a particular situation. Fletcher Tilton PC assumes no responsibility for any individual’s reliance on the information disseminated unless, of course, that reliance is as a result of the firm’s specific recommendation made to a client as part of our representation of the client. Please note that changes in the law occur and that information contained herein may need to be reverified from time to time to ensure it is still current. This information was last updated September 2019.
WHAT IS A 226-J LETTER?
As part of the Affordable Care Act (“ACA”), large employers are required to offer at least 95% of their full-time employees the opportunity to enroll in an employer-sponsored healthcare plan that provides standardized coverage at an affordable price. Failure to offer sufficient coverage to enough full-time employees can expose an employer to the ACA’s Employer Shared Responsibility Payment (“ESRP”) penalties. The IRS is tasked with monitoring whether employers are in compliance with the ACA and whether an ESRP penalty is due.The IRS requires that taxpayers annually file Forms 1095-C and 1094-C in order to self-report the total number of full-time employees they retain during the year. Individual employees are given statements concerning whether or not they were enrolled or offered the opportunity to enroll in an employer-sponsored ACA-compliant healthcare plan. The IRS began requesting this data from employers in 2015, and since late 2017 it began analyzing the employer data in order to identify errors and compliance gaps.
If the IRS identifies a possible ACA deficiency, it sends out a Letter 226-J to employers. What usually generates most of the calls to CPAs and attorneys is that the Letter 226-J usually proposes a six-figure penalty and is drafted to look like a formal IRS tax assessment.
WHAT IS THE ESRP PENALTY?
The ESRP penalties are supposed to coerce employers into sponsoring a healthcare plan for the benefit of essentially all their employees. The coercion is accomplished by assessing large employers with an annual ESRP offer penalty that can equal $2,000 per full-time employee1 if coverage is not offered to a large enough pool of employees. In the 2015 transition year, employers were required to offer coverage to 70% of their full-time employees, but for all subsequent years it’s 95%. Consequently, the penalty can easily reach hundreds of thousands of dollars. In the event an employer-sponsored healthcare plan is in place and offered to enough full-time employees but the monthly plan costs payable by employees are too high relative to their earnings, a different ESRP may be imposed. The ESRP offer penalty tends to be the biggest risk for large employers.What is important to remember is that the ESRP offer penalty is imposed on an employer that does not offer coverage to at least 95% of its full-time employees, regardless of the number of employees who may have been offered coverage and regardless of the number of employees who actually enroll in whatever employer-sponsored healthcare plan is being offered. For example, if an employer offers coverage to 94% of its full-time employees, the ESRP penalty counts the total number of the employer’s full-time employees, as opposed to just the employees not offered coverage. This fact comes as a surprise for employers that offer reasonably strong benefits but inadvertently fail to meet the 95% threshold. Conversely, if coverage is offered to all full- time employees but for whatever reason no employee actually enrolls, no ESRP offer penalty is due. Actual enrollment in the plan being offered is not relevant for the purposes of the ESRP penalties.
Whether adequate coverage is offered to employees is only half the requirement of either ESRP penalty, however. In order for the IRS to be able to assess an ESRP penalty, it must also show during the same period that at least one full-time employee enrolled in an Obamacare plan that was, at least in part, subsidized.2 If a large employer fails to offer any sort of employer-sponsored healthcare plan options but none of the employees actually get subsidized healthcare through a public option, then the IRS is unable to assess either ESRP penalty.
Although this limitation puts the possibility of an assessment out of the hands of an employer, the Obamacare subsidy requirement is an important limitation on the IRS’s power to impose the ESRP penalties. All 226-J Letters will contain a breakdown of the individual employees who received Obamacare subsidies during each month of the tax year. If one employee received Obamacare subsidies for a particular month, a 1/12 fraction of the ESRP annual penalty is assessed for that month, assuming the employer also did not offer adequate coverage options.
CHAOTIC REPORTING
For large employers, the number of full-time employees can fluctuate as additions and subtractions are constantly being made from payroll. Employers should obtain waivers from any employee declining coverage to ensure if the employee later applies for Obamacare through an ACA exchange that he or she does not erroneously receive any subsidies. Reporting issues can also arise when variable-hour employees begin averaging more than 30 hours per week, as the ACA considers these employees to be employed full time.As such, complying with the ACA involves tracking and actively monitoring a good deal of employee data on a monthly basis. This significant burden is substantially compounded by the complexity of reporting all the relevant data to the IRS. The Forms 1094-C and 1095-C are difficult to understand, and the instructions are filled with jargon. For instance, on Form 1095-C, employers must populate for each separate employee and each month one of 18 different letter codes denoting employment status, status of coverage offers, and affordability data. Some letter codes combine multiple statuses into one field, whereas other employee statuses material to the employee’s access to coverage, such as whether he or she has waived employer-sponsored plan participation, contain no separate letter code at all.
The confusing format of Forms 1094-C and 1095-C is in all likelihood a material factor in generating a significant number of the 226-J Letters currently being sent out by the IRS. In some cases, an employer receiving one of these letters may simply be able to correct reporting errors and avoid an ESRP penalty altogether.
FLAWED ASSESSMENT PROCESS?
Employers aren’t the only ones having difficulty getting their ACA compliance right. The IRS has additionally struggled with meeting the standards required to impose the ESRP penalties. In particular, the 226-J Letter process currently in place cuts an important corner.Recall that an ESRP penalty may not be assessed against an employer unless at least one of the employer’s full-time employees is also enrolled in a subsidized Obamacare plan. Before any penalty may be assessed, the ACA requires that an employer receive something called “Section 1411 certification” confirming one of its employees has enrolled in such a plan and was allowed a subsidy.
ACA regulations created by the Department of Health and Human Services in 2013 set forth how the Section 1411 certification process is supposed to work. The regulations provide that an employer is supposed to receive notice from an ACA exchange when one of its employees applies for subsidized Obamacare coverage. The notice gives employers an opportunity to challenge any incorrect assertions made by employees on their Obamacare applications, such as an erroneous claim that he or she was not offered employer-sponsored coverage or that the coverage offered by an employer is not affordable. The process further alerts employers that their penalty exposure may grow if they do not begin offering ACA-compliant benefits to enough of their employees. Presumably, if the potential ESRP exposure is high enough, an employer in receipt of a Section 1411 certification may reasonably opt to expand its healthcare plan offerings.
In reality, the ACA exchanges more often than not never issue any notices to employers. This failure significantly limits employers’ opportunities to contest erroneous employee claims, but perhaps more critically, causes the process to fall short of the Section 1411 certification requirement.
The IRS has attempted to gloss over the fact that the ACA exchanges in many cases have not issued valid Section 1411 certifications, by stating in the text of the standard 226-J Letter that the letter itself represents a Section 1411 certification. This statement is not consistent with the ACA’s regulatory framework, though, and potentially impacts the IRS’s ability to legally impose the ESRP penalties on employers.
RESPONDING AGGRESSIVELY
The failure of the ACA exchanges to send timely Section 1411 certifications to employers and the complexity of ACA information reporting makes responding to 226-J Letters challenging. Employers receiving 226-J Letters need to be prepared to provide detailed records to the IRS and push back on the specifics of each and every employee who may have enrolled in an Obamacare plan and claimed subsidies. Pushing back effectively means showing that the 95% offer-of-coverage threshold was met, that all employees who enrolled in Obamacare were not actually entitled to receive subsidies, or potentially arguing that the 226-J Letter does not constitute a valid Section 1411 certification.If you’ve received a 226-J Letter threatening a large ESRP penalty, it is highly advisable that you obtain representation from someone who is familiar with ACA parlance and compliance procedure. The reality right now is that the ACA is here to stay, and while it is in effect, the IRS will not stop looking for easy ESRP penalty targets.
1 This number is increased each year with inflation.
2 An employee who is eligible to participate in an employer-sponsored healthcare plan can always elect to go to an ACA exchange and obtain Obamacare coverage. But if a valid employer-sponsored plan is available to the employee already, then the employee’s coverage is not eligible for any government subsidies. In almost all cases, the employer-sponsored plan will be cheaper than unsubsidized coverage available through Obamacare.
©2019. This material is intended to offer general information to clients and potential clients of the firm, which information is current to the best of our knowledge on the date indicated below. The information is general and should not be treated as specific legal advice applicable to a particular situation. Fletcher Tilton PC assumes no responsibility for any individual’s reliance on the information disseminated unless, of course, that reliance is as a result of the firm’s specific recommendation made to a client as part of our representation of the client. Please note that changes in the law occur and that information contained herein may need to be reverified from time to time to ensure it is still current. This information was last updated September 2019.
