In 2015 alone, the IRS issued nearly $4.5 billion in penalties to employers who did not comply with the Affordable Care Act (“ACA”) employer mandate. That number is expected to grow to $228 billion by 2026. Despite the 2019 repeal of the individual mandate, larger employers are still required to comply with the employer mandate and failure to comply can be costly. For employers receiving the dreaded Letter 226J (a proposed assessment of ACA Employer Shared Responsibility Payments (ESRP)), panic may set in at the sight of the often substantial fines the IRS proposes. However, a timely and appropriate response to the IRS can drastically reduce, if not eliminate, the proposed assessment.
A. The Nature of the Employer Penalties
Under the ACA’s employer mandate, an Applicable Large Employer (ALE) is an employer with 50 or more employees, including full-time equivalent employees. ALEs are required to offer Minimum Essential Coverage (MEC) to at least 95% of their full-time workforce. Coverage provided by ALEs must meet Minimum Value (MV) and be affordable for the employee. ALEs that fail to offer coverage that is both affordable and provides MEC may be subject to an IRS penalty known as an Employer Shared Responsibility Payment (ESRP).
ALEs may be subject to one of two types of penalties for their failure to offer minimum essential coverage (MEC) or failing to offer MEC that provides minimum value (MV). An employer subject to one type of ESRP will not be subject to the other type of ESRP.
- Employer Shared Responsibility Payment for Failure to Offer Minimum Essential Coverage (4980H(a) penalty)
An ALE may owe an ESRP if, for any calendar month, MEC is not offered to at least 95% of its full-time employees and, as a result, at least one employee receives a premium tax credit for purchasing individual coverage via the Health Insurance Marketplace. Part-time and full-time equivalent employees are not included in the payment calculation. If an ALE is subject to this type of ESRP, the fine will be $2,000 per full-time employee (calculated on a month-by-month basis), minus the first 30 employees. The $2,000 fine is indexed annually for inflation to the following amounts:
For calendar year 2018, the adjusted $2,000 amount is $2,320
For calendar year 2019, the adjusted $2,000 amount is $2,500
For calendar year 2020, the adjusted $2,000 amount is $2,570
This penalty is commonly referred to as the “sledgehammer” penalty, because it is usually the larger of the two potential penalties.
- Employer Shared Responsibility Payment for Failure to Offer Affordable Minimum Essential Coverage that Provides Minimum Value. (4980H(b) penalty)
Even if an ALE offers MEC and is not determined to be liable for the ESRP described above, the employer may still owe an ESRP should an employee receive the premium tax credit for purchasing coverage through the Health Insurance Marketplace. This penalty is calculated for each full-time employee who qualifies for a subsidy because the coverage offered by the ALE was not affordable or did not provide minimum value.
If an ALE owes this type of ESRP, the annual penalty will be $3,000 (calculated on a month-by-month basis) for each full-time employee who received the premium tax credit. Again, the penalty is indexed annually for inflation to the following amounts:
For calendar year 2018, the adjusted $3,000 amount is $3,480
For calendar year 2019, the adjusted $3,000 amount is $3,750
For calendar year 2020, the adjusted $3,000 amount is $3,860
This penalty is known as the “tack hammer” penalty, as it is usually much less than the penalty for failing to offer minimum essential coverage.
To ensure it is not subject to the “tack hammer” penalty, an offer coverage to at least 95% of full-time employees that meets both the Affordability Test and Minimum Value (MV) Requirement. The affordability test is met if coverage does not exceed 9.86% (for 2019) of the employee’s household income. As employers typically do not know their employees’ household incomes, ACA regulations allow employers to judge affordability using one of the following “safe harbors” instead of household income:
- W-2 Method: The employee’s W-2 (Box 1) income from the employer for the current year.
- Rate of Pay Method: 130 x the lower of the employee’s hourly rate of pay as of the first day of the plan year or the hourly rate during any subsequent month. For salaried employees, employers should use the monthly earnings as of the first day of the plan year, not multiplied by 130. As a “best practice,” Employers should perform this safe harbor test for each full-time employee, every month.
- Federal Poverty Line: 100% of the Federal Poverty Line (FPL) for an individual. For 2019, the FPL is $12,490 for a household size of 1. To meet the FPL Safe Harbor, an employer must show that the full-time employees were offered self-only coverage that did not exceed the product of the FPL multiplied by 9.86% and then divided by 12 ($12,490 x 9.86% / 12 = $102.63). If the employee contribution for self-only coverage meets or is below this amount, then the FPL safe harbor is met.
The Minimum Value (MV) requirement is met if the plan covers at least 60% of the total allowed cost of benefits that are expected to be incurred under the plan. This includes employee cost-sharing, deductibles, coinsurance, co-payments, and out-of-pocket maximums.
B. Avoiding and Mitigating ACA Penalties
Obviously, avoiding the above penalties is the goal for all ALE’s. There are some practical steps ALE’s can undertake throughout the year to avoid or reduce ACA penalties:
- Ensure the health plan offers minimum essential coverage;
- Confirm that the coverage offered provides minimum value;
- Take into consideration the lowest-paid employees to determine if coverage is affordable under one of the safe-harbor methods; and
- Track employee’s hours of service to determine who are considered full-time employees or full-time equivalents.
But what happens if you’ve already received a Letter 226J from the IRS? How do you respond? First, review the letter carefully to determine the response date. Time is of the essence, as a response is typically due within thirty (30) days of receiving the letter. If an ALE fails to timely respond, the IRS may issue a Notice and Demand for the ESRP payment that was proposed, and the IRS may begin enforcement actions (including liens) to collect the penalty. If the ALE cannot respond within the IRS’ stated timeframe, then the ALE should immediately request a 30-day extension to provide its response.
The next step when responding to a Letter 226J is to determine why your company received the ESRP in the first place. It’s possible that the IRS is correct in its penalty assessment. In that case, the company need only complete and sign the ESRP Response form and return it to the IRS along with the requested penalty payment. On the other hand, if your company disagree with the assessment, it’s important to identify the specific inaccuracies and submit the corrected information to the IRS as part of your response. Accurate record-keeping throughout the year can be a great help in providing relevant, supporting documentation to bolster the company’s position. Be prepared for the penalty assessment and dispute process to last several months. The IRS often requests additional information and the agency is notoriously slow to respond. But being patient can pay dividends, as the IRS will reduce or eliminate penalties if the ALE can demonstrate that all or a portion of the proposed penalty is unwarranted.
Much remains unresolved about enforcement of the ACA and its accompanying penalties. Several federal lawsuits are still pending that could invalidate all or at least some portions of the law. But so long as the ACA’s employer penalty provisions remain intact, ALE’s will still need to comply with its requirements and the IRS will continue to enforce the penalties. On the front end, ALE’s should do their best to provide employees with minimum essential coverage that meets the ACA’s affordability and minimum value criteria. Doing so will alleviate the need to haggle with the IRS about penalties on the back end. Yet, even if your company receives an ESRP penalty letter from the IRS, don’t automatically assume the IRS is correct (they often are not). Take the time to evaluate the basis for the penalty and, where appropriate, challenge the IRS’ determination. While you may not always be successful in getting the IRS to eliminate the entire penalty, diligent communication with the agency and appropriate supporting documentation will help in getting them significantly reduced.
C2 provides strategic HR outsourcing to clients who want to develop optimal workforce strategies and solutions to allow them to be more competitive and profitable. C2 blog posts are intended for educational and informational purposes only.