Understanding the IRS’ Affordable Care Act Penalty Letters
The Internal Revenue Service (IRS) has begun assessing Employer Shared Responsibility Payments (ESRP) for the 2015 tax year. The ESRP is assessed to applicable employers who either did not meet the Employer Mandate requirements to offer coverage to the required number of full-time employees, or offered coverage that did not meet affordability and adequacy standards under the Patient Protection and Affordable Care Act (ACA).
Penalties are payable when a full-time employee receives financial assistance through premium tax credits to purchase coverage, and no safe harbor or other relief applies to protect the employer from an assessment. After the IRS determines an ESRP is owed, it notifies the employer by issuing a series of letters and notices.
Two situations trigger a penalty:
- Failure to offer coverage to “Substantially All” full-time employees. This occurs when a large employer (at least 50 full-time equivalent employees) fails to offer coverage to at least 70% (after 2015, 95%) of full-time employees and their dependent children, and at least one full-time employee receives a premium tax credit to help with the cost of coverage.
- Offering inadequate or unaffordable coverage. This occurs when a large employer offers coverage to at least 70% (after 2015, 95%) of full-time employees and their dependent children, but at least one full-time employee receives a premium tax credit to help with the cost of coverage that was not offered, was inadequate, or was unaffordable.
Employers will have advance warning that an ESRP may apply before the IRS issues a demand for payment. The first notification is IRS Letter 226-J. Letter 226-J is the initial letter notifying an employer that a payment may be due. Liability is triggered by an IRS determination that, for at least one month in the applicable tax year, one or more full-time employees was enrolled in subsidized Exchange (Marketplace) coverage and the employer did not qualify for a safe harbor or other relief. Employers who receive a penalty notice should follow the steps in Letter 226-J to submit an Employer Shared Responsibility Response form (ESRP Response) using IRS Form 14764, either agreeing with the proposed penalty or disagreeing with the proposed amount. A response date, generally 30 days from the date of issuance, will be shown in the letter. Employers should take care to respond by the response date. If the employer does not respond, the IRS will issue a Notice and Demand for Payment (Notice CP 220-J) with instructions on how to pay the ESRP amount.
Employers can contest the proposed penalty by submitting Form 14764, noting any corrections that apply to individual employees on Form 14765, and providing supporting documentation by the deadline stated in the letter. The IRS will respond with yet another letter, Letter 227, describing additional steps the employer may need to take. Letter 227 may also contain further direction on how to appeal the proposed or revised penalty assessment. After responding, employers that still disagree can request a pre-assessment conference with the IRS and, following the conference, may appeal the penalty determination.
If you receive Letter 226-J, pay close attention to the ESRP Summary Table contained within the letter. This table explains how the IRS calculated the proposed penalty amount. If any of the information on the ESRP Summary Table is incorrect, the employer should submit information to explain why.
Following are a few common mistakes that can result in an erroneous proposed penalty:
- Incorrectly answering “No” on Part III, Column A of Form 1094-C. A “no” answer tells the IRS that your organization failed to offer coverage to substantially all full-time employees for a given month. If any full-time employee received a premium tax credit and no safe harbor or other relief applies, this is an automatic penalty trigger.
- Entering the wrong full-time employee count on Part III, Column B of Form 1094-C. The full-time employee count for each month is used to calculate the penalty amount due. If this count is wrong, it can impact the penalty calculation.
- Erroneously issuing a Form 1095-C to part-time, non-benefitted employees. Only employees with full-time status for at least one month in 2015 (as determined by the look-back measurement method, if applicable) should be sent Form 1095-C. (A narrow exception applies to self-insured employers, who issue a Form 1095-C with special coding to all employees enrolled in the self-insured coverage.)
- Problems identifying the employer’s full-time workforce. Some employers may have had difficulty applying the look-back measurement method rules to determine full-time status, or may have faced data limitations or technology challenges that resulted in forms being issued to part-time, non-benefit eligible employees. While space is available to enter Form 1095-C code corrections, there is no designated space on Form 14765 to let the IRS know that a particular employee should not have received Form 1095-C. If a penalty is proposed for an employee who was not full-time, the employer should check the box indicating “Additional Information Attached” and include a separate statement explaining that the form was issued in error.
- Entering the wrong offer code on Line 14 of the Form 1095-C. Certain codes are automatic penalty triggers if reported for a full-time employee receiving a premium tax credit where no safe harbor or other relief applies. This includes code 1H (no offer of coverage), codes 1B, 1D, and 1J (offer to employee did not include dependent children), and code 1F (coverage did not meet the ACA’s “minimum value” adequacy standard).
- Forgetting to enter a safe harbor on Line 16 of the Form 1095-C. In some cases, there was no offer but the employer is protected from a penalty assessment because a safe harbor applies. Leaving off the applicable safe harbor code may result in a penalty assessment. This includes code 2A (not employed), code 2B (not full-time), code 2C (enrolled in the coverage offered), code 2D (permissible waiting period or initial measurement period for a new part-time, seasonal or variable hour employee), code 2E (multiemployer interim rule relief for certain union plans), codes 2F, 2G, and 2H (affordability safe harbors), and code 2I (2015 non-calendar plan year transition relief).
- Failing to claim applicable transition relief. For 2015 and the months in 2016 that are part of the 2015 plan year, various forms of transition relief were available to eligible employers based on employer size and medical plan year start date. If your organization qualified, transition relief needed to be claimed on the Form 1095-C and/or Form 1094-C as applicable.
If an employer fails to respond to IRS correspondence, Notice CP 220J will issue automatically. By far the best time to deal with mistakes is while the penalty is still proposed and before the assessment of the ESRP is made. Employers are urged to pay close attention to IRS correspondence and to take care to submit all information by the stated deadlines.
If after submitting additional documentation and information in response to Letter 226-J and Letter 227, the IRS still believes that a penalty applies, employers can appeal. If an employer disagrees with the penalty proposed by the IRS following the response process outlined in Letter 226-J, it may request a pre-assessment conference with the IRS Office of Appeals. After the employer’s response is complete and the pre-assessment conference (if requested) concludes, the IRS will determine liability. If the IRS decides the employer owes a penalty, it will issue Notice CP 220J which is a demand for payment of the assessed ESRP. Notice CP 220J outlines additional procedures to submit questions about the ESRP calculations, request abatement, or challenge the assessment in court.
Frequently Asked Questions
I made a mistake when coding my 2015 Forms 1095-C. Can’t I just correct and re-file?
No, once the penalty notification process has begun, all corrections to Form 1095-C must be made using Form 14765, the Employee Premium Tax Credit (PTC) Listing. Employers should note all corrections to the Form 1095-C lines 14 and 16 codes on Form 14765, and may attach additional information as necessary.
The summary of information reported to the IRS is wrong. Can I amend my organization’s 2015 Form 1094 to correct it?
No, but employers can note the necessary corrections on the summary table, and may attach additional information to their response to Letter 226-J. This is your opportunity to explain any corrections that need to be made to your organization’s Form 1094-C. Carefully review the “ESRP Summary Table” contained in Letter 226-J and note any corrections. Attach additional documentation as needed. Some employers have discovered discrepancies in the information reported. This can lead to a penalty being proposed where none is owed.
Where can I get more information?
In addition to Q&As 55-58 in its Questions and Answers on Employer Shared Responsibility Provisions Under the Affordable Care Act, the IRS released a guide to help employers understand Letter 226-J called “Understanding your Letter 226-J”.
- Consider engaging qualified tax and legal counsel. ACA penalties can be significant, and ACA rules are complex. Employers may need to hire expert assistance.
- Respond timely to all correspondence. Failure to timely respond may result in a notice and demand for payment.
- Request an extension if necessary. If you need more time to gather information and put together a thorough, well-thought out response, contact the IRS at the number listed on Letter 226-J and request an extension of time as soon as possible.
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