December 10, 2024
This is part two of a four part series. Please use the links below to view the other parts of the series. Part One – Part Two – Part Three -Part Four (coming soon)
This is an update to an issue we originally wrote about on October 6, 2022. This article reexamines the issue on the only affordability test employers must pass to have their offer of coverage deemed affordable under the Affordable Care Act and expounds on myriad related issues I have seen in private practice since the release of the original article. With an administration change advocating for efficiency coming in January 2025, I am hopeful the IRS will begin to apply the law as clearly written.
In the first part of this series regarding issues plaguing employers almost a decade in to reporting, we explored some of the intricacies of Affordable Care Act (ACA) reporting where employers are falling short. Employers must be aware of these pitfalls. On the other side of the equation the IRS has to start following the rules of the ACA. While the IRS was extremely lenient with employers over the first couple of years of the employment shared responsibility provisions (ESRP) enforcement, the IRS has aggressively pivoted its enforcement strategy in recent years to positions that go against the clear language of the law. This is disappointing as it wastes the resources of the IRS and employers. The only real winners with this strategy are attorneys like me, but there are other opportunities I would prefer to pursue than having ridiculous disputes with the IRS regarding clear language. The following explores the absurd positions the IRS has taken as it has sadly bungled the enforcement of the ESRP penalties to the detriment of employers.
Before delving in to the positions the IRS has taken, a brief exploration of the pertinent Internal Revenue Code (IRC) sections would be beneficial. As a result of the IRC language so strongly supporting the positions discussed later and to assure readers these sections are not being taken out of context, the next section quotes verbatim the pertinent Code provisions and regulations.
IRC section 36B(c)(2)(C) states the affordability standard for an employer’s offer of coverage. That provision states:
(C)Special rule for employer-sponsored minimum essential coverage. For purposes of subparagraph (B)—
(i)Coverage must be affordable Except as provided in clause (iii), an employee shall not be treated as eligible for minimum essential coverage if such coverage—
(I) consists of an eligible employer-sponsored plan (as defined in section 5000A(f)(2)), and
(II) the employee’s required contribution (within the meaning of section 5000A(e)(1)(B)) with respect to the plan exceeds 9.5 percent of the applicable taxpayer’s household income (emphasis added).
This clause shall also apply to an individual who is eligible to enroll in the plan by reason of a relationship the individual bears to the employee.
After reading this section of the Code it is clear that an employee who is offered minimum essential coverage at an affordable price based on the employee’s household income is not eligible to receive a premium tax credit. Furthermore, if an employee is not eligible for a premium tax credit, the employee cannot trigger a penalty under IRC section 4980H.
Similarly, the applicable regulation at section 1.36B-2(c)(3)(v)(A)(1) states:
(v) Affordable coverage - (A) In general - (1) Affordability for employee. Except as provided in paragraph (c)(3)(v)(A)(3) of this section, an eligible employer-sponsored plan is affordable for an employee if the portion of the annual premium the employee must pay, whether by salary reduction or otherwise (required contribution), for self-only coverage does not exceed the required contribution percentage (as defined in paragraph (c)(3)(v)(C)of this section) of the applicable taxpayer's household income for the taxable year. See paragraph (c)(5) of this section for rules for when an HRA or other account-based group health plan described in paragraph (c)(3)(i)(B) of this section is affordable for an employee for a month. (emphasis added)
Both the statute and the regulation make it clear that an employee’s household income is what is used to measure if an employer’s offer of coverage was affordable. Unfortunately, most employers will not have access to the data necessary to accurately determine an employee’s household income. Consequently, the IRS created three affordability safe harbors for employers. The preamble to the final regulations for the Shared Responsibility for Employers Regarding Health Coverage states “Because an employer generally will not know the taxpayer employee’s household income, the proposed regulations under section 4980H set forth three separate safe harbors under which an employer could determine affordability based on information that is readily available to the employer.” The three safe harbors offer employers the opportunity to have their offer of coverage deemed affordable so long as the requirements of the affordability safe harbor are satisfied.
However, just because an individual does not qualify for an affordability safe harbor or has a Form 1095-C with a blank line 16 does not necessarily mean that the employer did not offer affordable coverage under the ACA. Affordability under Internal Revenue Code (IRC) section 36B is determined by reference to the taxpayer’s household income. It was only in light of the employer generally not knowing the employee’s household income that the IRS created the three affordability safe harbors. There are myriad ways an individual could have a higher income than the wages paid by an employer such as income from another job, a spouse’s income, or a dependent child’s income to list just a few.
Over the past several years many employers have received Letters 226J with the Form W2 affordability safe harbor disallowed. This is shown by the IRS inserting an “XF” on the Form 14765 for the month in question where the IRS has deemed the employer was not eligible to use the Form W2 affordability safe harbor. I have had several IRS agents tell me this process has been automated by the IRS by looking at three inputs: (1) the employee in questions box 1 Form W2 wages, (2) the amount the employer entered on line 15 of the Form 1095-C for the employee in question, and (3) the affordability threshold for the year in question (e.g. 8.39 percent for 2024). With these numbers a computer program can be written and, if done properly, can tell with exact precision who is eligible for the affordability safe harbor and who is not.
The IRS created this computer program and, to date, it has been close to 100 percent accurate in my experience reviewing ESRP penalties on behalf of clients. I celebrate the IRS creating an efficient tool to help the IRS accurately assess who is eligible to use the Form W2 affordability safe harbor! However, just because an employer falls short of the Form W2 affordability safe harbor does not mean that the employer can be assessed an ESRP penalty for that particular employee. Unfortunately, the IRS is inexplicably drawing that conclusion which contradicts the clear language of the law for anyone who falls short of the Form W2 affordability safe harbor.
As discussed above, the Affordable Care Act makes abundantly clear in the statute, the only way to tell if an employer’s offer of coverage to an employee is affordable is to review the employee’s household income. The IRS continues to not review the employee’s household income before sending out ESRP penalties! This is abhorrent to anyone who believes in a just application of the law and must be corrected immediately.
I have been told by a number of IRS employees who state that the Internal Revenue Manual, which is what the IRS employees administrating the ESRP penalties are required to follow when assessing penalties, states that the employee will only check the household income of the individuals listed on the Form 14765 if the employer requests the household income be checked! In other words, the IRS will only follow the law as clearly written in the statute if the employer is knowledgeable enough to know the law and request the law be followed. That’s ridiculous and well beneath the standards for the application of law in any functional society.
There are several things that are problematic about this approach by the IRS. First, the IRS is penalizing employers who do not owe a penalty to the IRS. If the IRS wants to penalize employers for filing incorrect returns in these circumstances, it would be in-line with the text of the Code to do so under IRC section 6721. However, by electing to propose penalties under IRC section 4980H, it is holding employers to a higher standard than the ACA allows. In the worst-case scenario, the employer who receives the proposed penalty actually pays the penalty when the employer owed no penalty. In the best-case scenario, the employer appeals the decision (most likely using an attorney), and receives a revised, accurate proposed penalty, if they are lucky, through a new Letter 226J. However, in the best-case scenario, the employer has wasted valuable company resources defending itself against a standard that is higher than allowed by the language of the ACA.
The IRS has created an unnecessary, wasteful game employers have to play. The game starts with the IRS sending the employer a Letter 226J with an accompanying Form 14765. Frequently, as discussed above, the employers Form 14765 will have several months for which the IRS disallowed the Form W2 affordability safe harbor which is designated with an “XF”. However, an employee may be listed on the Form 14765 for other reasons such as line 16 being left blank by the employer because it knew it did not meet any of the affordability safe harbors.
The onus is then shifted to employers to respond to the IRS and ask the IRS to review the affordability of the employer’s offer of self-only coverage in light of the employee’s household income. It is only at this time that the IRS theoretically checks the household income of the employees listed on the Form 14765 and I have become increasingly skeptical that this is being done accurately. Furthermore, multiple IRS employees have told me this calculation is being performed by humans and to-date the IRS has not created an automated process to perform the calculation. The fact the IRS does not have a computer program to automate the household income calculation is inexcusable and it is leading to human error costing employers money.
My skepticism in the IRS accurately determining an individual’s household income is rooted in cases which I have first-hand knowledge. In the most egregious case I have seen to date an employer asked the IRS to review the household income six separate times and received responses from the IRS with six different ESRP amounts with the penalty slowly being reduced over a period of two years. What makes this case even worse than receiving six different answers is I have no confidence that the calculation is being performed correctly given the demographic information accessible to the employer.
While an employer will never know with exact certainty the amount of an employee’s household income, an employer can make an educated guess if the employee’s household income is more than the amount the employer reports in box 1 of the Form W2. For example, an employer may know that an employee is married and a presumption could be made that a married employee making a certain income likely is married to a working spouse which would increase the employee’s household income. Or, alternatively, if an employee only works part of the year for an employer, it is safe to presume that the employee may have had another employment opportunity for the other parts of the year particularly if the employee’s income amount is at a certain level. The cases I see in private practice typically involve employee demographics where presumably the employees are working all 12 months of the year as opposed to the scenario where an employee may work for some months of the year and then vacation in the south of France for the remainder of the year.
The irony of the situation the IRS has created cannot be overstated. As discussed above, the IRS created the three affordability safe harbors “Because an employer generally will not know the taxpayer employee’s household income…(see Shared Responsibility for Employers Regarding Health Coverage 79 Fed. Reg. 8563-8564 (February 12, 2014))". The affordability safe harbors were intended to protect employers. However, the IRS has used the affordability safe harbors as an excuse to not enforce the law as clearly written in the statute. Through numerous conversations with IRS employees, none of whom are the true decision makers of the policy and frequently who don’t have an expertise to talk about the basics of what the statute even says, it is my understanding that the IRS’s position is once an employer elects a safe harbor it is bound by the parameters of that safe harbor. In other words if an employer elects the Form W2 affordability safe harbor and the IRS checks the numbers and it turns out the employer was ineligible to use the Form W2 affordability safe harbor, the IRS will propose a penalty to the employer without checking the household income of the individuals triggering the penalty.
Unfortunately, the IRS’s position is crazier than the previous paragraph indicates. While we don’t recommend this strategy, an employer should be able to leave line 16 blank on every Form 1095-C it completes and still not receive a Letter 226J penalty even if certain employees erroneously receive a premium tax credit so long as the employer’s offer of self-only coverage meets the requirements of IRC section 36B. Unfortunately, this is not the case. I was told by multiple IRS employees that in this scenario the employer would receive a proposed penalty for those employees because the employer has not indicated that the employer would like to have the employee’s household income checked.
For those less familiar with line 16 of the Form 1095-C there are only four options an employer has when a full-time employee declines coverage:
- 2F – Form W2 Affordability Safe Harbor
- 2G – Federal Poverty Line Affordability Safe Harbor
- 2H – Rate of Pay Affordability Safe Harbor
- Leave Blank – This is the only other option that is available for employers who offer health insurance that is not accepted by a full-time employee
Regardless of which of the four options is pursued by an employer none of them give the employer the full protection of the employee’s household income which is far more expansive than any of the three affordability safe harbors. The IRS’s logic is so perplexing that I have been told multiple times by IRS employees that the IRS proposes penalties before checking household income because the employer has not indicated they want the employee’s household income checked. However, the Form 1095-C, which was created by the IRS, does not even allow an employer the option to indicate it would like the employee’s household income checked. Unquestionably, employers would be in a better position if the affordability safe harbors never would have been created and the IRS actually checked the household income of individuals before assessing ESRP penalties as required by the law. Alternatively, the IRS should create a household income code for the Form 1095-C and literally every single employer will complete line 16 with that code should a full-time employee decline coverage. The logic behind the IRS’s assessment strategy is indefensible.
By taking ridiculous positions like the one discussed in this paper, it makes sense that the trust in our government institutions has never been lower. It may be possible that the IRS cannot accurately calculate an individual’s household income. If that is the case, the leadership at the IRS should go to Congress and tell them the law needs to be amended so accurate enforcement is possible.
The IRS ignoring the clear language set out in the statute is infuriating and a waste of valuable company resources. However, it is in line with other highly questionable positions the IRS has taken with its enforcement of the ACA as our previous publication discussed (who is ready for part 3?). I have certainly benefitted from these aggressive IRS positions, but I would strongly prefer to have my practice focused on proactively protecting clients from the IRS. In our view, the IRS needs to be more forward thinking with the perception it is creating with the trustworthiness of the Service through its positions. Regardless, with the IRS taking these aggressive positions, accurate, meticulous ACA reporting is imperative. As always, if you have any questions regarding ACA reporting or would like to learn how Accord Systems can assist you with your ACA reporting needs, please don’t hesitate to contact us. If you or any of your clients have paid an ESRP penalty in the past and want to discuss ways you may be able to recover the penalty amount, please contact me personally.
About the author – Ryan Moulder serves as General Counsel at Accord Systems, LLC. Ryan received his LL.M. from Georgetown University Law Center and his J.D. from Saint Louis University School of Law. He has distinguished himself as a leader in the Affordable Care Act arena and has written and spoken on a variety of ACA topics as it relates to compliance for companies.
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