The last several years have been difficult for the IRS, but now that the agency is almost through its historic backlog, it is making significant progress on a long list of to-do items, including issuing ACA penalties.
Over the last month or so, we’ve heard from our partners, brokers, and new clients about the flurry of ACA penalties being issued from the IRS, namely, the notorious Letter 226J. It appears at this time that the agency is sending out Letter 226J ACA penalties for the 2020 tax year, as well as previous years.
If you’re unfamiliar with Letter 226J, it’s the penalty the IRS issues to organizations that fail to comply with the ACA’s Employer Mandate.
The ACA’s Employer Mandate section of the healthcare law requires ALEs or employers with 50 or more full-time employees and full-time equivalent employees to:
- Offer Minimum Essential Coverage (MEC) to at least 95% of their full-time employees (and their dependents) whereby such coverage meets Minimum Value (MV); and
- Ensure that the coverage for the full-time employee is affordable based on one of the IRS-approved methods for calculating affordability.
If the IRS believes an organization did not comply with the aforementioned requirements, and they have an employee receive a Premium Tax Credit (PTC) from a state or federal health exchange, it will issue Letter 226J.
Since the signing of the Inflation Reduction Act earlier this year, the IRS has received an additional $80 billion in funding for tax enforcement, including the ACA. With increased PTC eligibility guaranteed through 2025 as a result of the law as well, employers must prepare for increased enforcement efforts.
To help you prepare, we’ve outlined details relating to Letter 226J below:
How is Letter 226J assessed?
Depending on the type of infraction, the agency will issue either a 4980H(a) or 4980H(b) penalty via Letter 226J, but never both, at least not for the same reporting year. Below we discuss the differences between the two.
What is the 4980H(a) penalty?
The 4980H(a) penalty has a greater potential of carrying steep fines. It’s assessed when an organization doesn’t offer MEC to 95% of its full-time workforce, including their dependents. The 4980H(a) penalty for the 2019 tax year is an annualized $2,500 per employee.
What makes the 4980H(a) penalty so damaging is that it is assessed on a pass/fail basis. If an organization simply doesn’t offer MEC to 95% of its workforce, then the $2,500 is applied to all the organization’s full-time employees, minus the standard 30 exemption.
Here’s an example:
Johnny’s Pizza Parlor employs 200 full-time employees and 180 received an offer of MEC. That’s only 90% of the company’s full-time workforce and therefore does not meet the 95% pass/fail threshold.
If Johnny’s Pizza parlor has one full-time employee receive a PTC from the state health exchange, the IRS will issue the Parlor a Letter 226J for the 2019 tax year. The Letter 226J penalty amount would be in the amount of $425,000, assuming each of the company’s full-time employees worked there for the entire year. Here’s the formula:
What is the 4980H(b) penalty?
The IRS imposes the 4980H(b) penalty when an employer offers unaffordable coverage that also doesn’t meet MV. Unlike the 4980H(a) penalty, the 4980H(b) penalty is applied on a per-case basis. For the 2019 tax year, the annualized 4980H(b) penalty is $3,750 per employee.
The penalty is applied to every employee who receives a PTC from a state or federal health exchange. When the employee receives the PTC, the IRS then cross-references the information with the organization’s 1094-C and 1095-C filings to verify if the employee rightfully obtained the credit. If the employee receives the PTC properly, the employer is subject to a penalty. This happens for every employee who received a PTC for the particular tax year.
Here’s an example:
Sandra’s Sandwich Shop has 100 full-time employees, and 96 of them receive an offer of MEC. The coverage is unaffordable for 10 of them. Instead of accepting the coverage, they obtain a PTC from the federal health exchange platform, healthcare.gov.
Sandra’s Sandwich Shop is subsequently hit with a Letter 226J penalty in the amount of $37,500 since all 10 of the employees who obtained the PTC received unaffordable offers of coverage for the entire year. Here’s the formula:
Responding to Letter 226J
The ACA penalties contained in Letter 226J can be challenging to respond to, largely because of the documentation needed for disputing the claims, but also because of the in-depth calculations needed for verifying full-time employee status across the applicable time frames for which healthcare must be offered.
If you haven’t received Letter 226J, don’t assume you’re in the clear. Keep an eye out for some of the other penalty notices that are sometimes sent in advance of a Letter 226J, like an exchange notice or Letter 5699.
If your organization receives a Letter 226J, it’s best to consult an expert in ACA compliance and one that has an established relationship with the IRS. At Trusaic, we’ve helped our clients prevent over $1 billion in ACA penalties. We can help you address Letter 226J and other related ACA penalties. Contact us to learn more about our ACA software and services.
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For more information on Letter 226J, including best practices for responding to the penalty notice, download our white paper.