IRS Letter 226J Penalty Notices for 2016 May Contain Higher Penalties
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Starting this fall, employers should expect Letter 226J penalty notices to be issued to organizations determined by the IRS to have failed to comply with the Affordable Care Act (ACA) for the 2016 tax year. You should expect more of these notices to be issued and for them to contain much higher penalty assessments than that levied by the IRS for the 2015 tax year.
The primary reason for the likely higher penalty assessments is the more stringent regulatory requirements in 2016 to have employers 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 is affordable for the employee or be subject to IRS 4980H penalties. The requirement in 2015 was to offer such coverage to at least 70% of the full-time employees and their dependents.
For an example, let’s look at an employer with 500 full-time employees.
In 2015, this employer offered Minimum Essential Coverage (MEC) to 400 full-time employees, at least 80% of its full-time workforce and their dependents whereby such coverage met Minimum Value (MV) and was considered affordable for the employee. This was well within the 70% offer rate that was required for the 2015 tax year.
One hundred full-time employees did not receive offers. They decided to seek health insurance plans from a government exchange.
Only one of these 100 employees qualified for a Premium Tax Credit (PTC), a government subsidy that would make the health insurance premiums lower than what that employee would pay under the employer’s health insurance plan. The employee receiving a PTC would trigger an IRS audit and, in this example, the issuance of a Letter 226J penalty notice.
Because the employer achieved an offer rate of 80%, exceeding the 70% offer rate required for 2015, the penalty assessment would be for 4980H(b), also known as the “B” penalty, rather than for the more expensive “A” penalty. Employers can only be assessed penalties under either the A or B penalties, not both. The B penalty can never be higher than what the A penalty could have been.
The B penalty is assessed on every full-time employee that received a PTC for that month that either (1) did not receive an offer of coverage or (2) received such an offer, but the offer was either unaffordable or did not provide Minimum Value (MV) or both.
Under the B penalty in 2015, the employer would be assessed a penalty of $3,120 for each employee receiving a PTC for 12 months. In this example, only one employee received a PTC for all 12 months, resulting in a penalty assessment of $3,120.
However, the rules changed for 2016 and subsequent years. The new threshold for employers in 2016 was to offer Minimum Essential Coverage (MEC) to at least 95% (instead of 70%) of their full-time workforce and their dependents. If that employer maintained the same percentage offer rate of 80% in 2016, that employer would face a significantly increased risk of financial penalties issued by the IRS.
Let’s look at what happens in 2016 to this same ALE with 500 full-time employees. This ALE made offers of ACA qualified insurance to 400, or 80%, of those full-time employees during the course of 2016. One hundred employees did not receive offers and again sought health insurance plans from a government exchange. Again, only one of these 100 employees qualified for a Premium Tax Credit (PTC). The employee receiving a PTC would trigger an IRS audit of the employer. The employer is issued a Letter 226J penalty notice for not complying with the ACA in 2016.
However, because the ALE has not met the 95% offer rate required for 2016, the penalty assessment would be for 4980H(a), also known as the “A” penalty. For 2016 and onwards, if the 95% offer threshold is not met, the A penalty is assessed on every full-time employee, even including those who received a qualified offer of insurance from the ALE.
Under the A penalty in 2016, the employer would be assessed a penalty for each of the 500 full-time employees for each month if at least one employee received a PTC for that month. In this instance, one employee receives a PTC for 12 months. As a result, the penalty assessed against the employer would be $2,160 for each of the 500 full-time employees minus 30 of those employees under the IRS A penalty formula ($2,160 x 470). The 2016 penalty assessment, therefore, would be $1,015,200, for that same company.
You can see from this example how one employee receiving a PTC from a government exchange can significantly increase the penalty exposure for employers in 2016. In this example, the penalty for this same employer under the same circumstances increased from $3,120 in 2015 to $1,015,200 in 2016, an increase of $1,012,080!
Here is how the ACA penalties might look for other employers facing a similar scenario of having achieved an 80% offer of insurance to their full-time workers in 2015 and 2016, and having one employee receive a PTC all 12 months in each of those years.
ALE Full-Time Workforce | 2015 ACA | 2016 ACA |
50 | $ 3,120 | $ 43,200 |
100 | $ 3,120 | $ 151,200 |
250 | $ 3,120 | $ 475,200 |
500 | $ 3,120 | $ 1,015,200 |
1,000 | $ 3,120 | $ 2,095,200 |
2,000 | $ 3,120 | $ 4,255,200 |
5,000 | $ 3,120 | $10,735,200 |
10,000 | $ 3,120 | $21,535,200 |
You can see the significantly increased financial risk to employers for having failed to comply with the ACA in 2016 if they did not offer health insurance to 95% of their full-time workers.
The IRS has started to lay the groundwork for issuing Letter 226J penalty notices to employers that the agency believes are ALEs, employers with at least 50 full-time or full-time equivalent employees required to make annual filings of ACA-related information to the IRS.
The agency has started issuing Letter 5699 to employers that the IRS believes were ALEs that failed to file ACA information returns for the 2016 reporting year. Letter 5699, officially titled, “Request for Employer Reporting Offers of Health Insurance Coverage (Forms 1094-C and 1095-C),” asks employers to confirm the name the ALE used when filing its ACA information, returns provide the Employer Identification Number (EIN) submitted, and the date the filing was made.
Once the IRS has gone through this Letter 5699 exercise, we can expect the agency to start issuing Letter 226J penalty notices to those employers that are determined to be non-compliant for the 2016 tax year. It’s anticipated that the new Letter 226J notices will be issued starting this fall.
Employers with 50 or more full-time or full-time equivalent employees that have not filed their 2015, 2016 or 2017 tax year ACA information returns with the IRS should file as soon as possible using IRS Schedules 1094-C and 1095-C to minimize potential IRS penalties. The IRS has made it clear that there will be no waivers provided for ALEs that have not filed their ACA information returns.
For employers who have filed their 2016 information returns with the IRS, but are unsure that they have met the 95% offer threshold, it might be prudent for them to review their 2016 and 2017 filings to determine their potential penalty exposure. Consider seeking the assistance of an outside expert to help in this evaluation, preferably one that will provide this type of ACA penalty risk assessment at no cost. If it is determined that there are errors in your IRS filings, you have the opportunity to correct those filings with the IRS before receiving a Letter 226J penalty notice and having to go through the process of responding to it.
There is too much at stake financially for employers not to be confident that they are in compliance with the ACA.
To learn more about ACA compliance in 2018, click here.
For ACA reporting in 2019, organizations should review this link for important dates and requirements.
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