March 14, 2019
The IRS recently sent a wave of Letters 226J to employers the IRS believes owe a section 4980H penalty. As we discussed in our most recent article, often times the employer’s service provider has made an error completing the Forms 1094-C and 1095-C which has led to the employer receiving a Letter 226J. By far the most prevalent error that leads to an employer receiving a Letter 226J is the employer checking the “No” box or forgetting to check the “Yes” or “No” box on line 23 (or, alternatively, on some of the lines from line 24 through line 35). This article explains why making this mistake leaves employers exposed to the section 4980H penalty even for employees whom the employer has coded with a seemingly protective offer code (1A, 1C, 1E, etc.) and an affordability safe harbor (2F, 2G, or 2H).
To review, by checking the “Yes” box on line 23 an employer is telling the IRS that it offered 95 percent of its full-time employees and their dependents minimum essential coverage for each calendar month of the year. Shockingly, many employers, or the service providers filing on an employer’s behalf, forgot to check the “Yes” box when an employer offered 95 percent of its full-time employees and their dependents minimum essential coverage. This is problematic, as for any month which the “No” box is checked or neither the “Yes” nor “No” box is checked, the employer will be subject to the exponentially larger section 4980H(a) penalty should an employee trigger a penalty. Exasperating the issue further, is the fact that for any month which the “No” box is checked or neither the “Yes” nor “No” box is checked, the employer will not have the benefit of the protections of the affordability safe harbors (codes 2F, 2G, or 2H). This is a big reason many employers who have submitted the Form 1094-C without the “Yes” box checked on line 23 have received a Letter 226J.
Consider this example I recently saw in private practice where an employer’s service provider forgot to check the “Yes” box in column (a) of the Form 1094-C for certain months. As a result of that large, egregious oversight on the part of the service provider, the employer received a Letter 226J with a proposed Employer Shared Responsibility Payment (ESRP) for more than $1,000,000. What made this Letter 226J even more interesting is the Form 14765 which only included code combinations of 1C/2F and 1E/2F. To a novice, or even to those with a good understanding of the ACA, this may be confusing as these code combinations for an employee (1C/2F or 1E/2F) should protect the employer from a section 4980H penalty with respect to that employee for that month. To understand why the IRS is taking the position that an employer in this situation owes a section 4980H(a) penalty requires a thorough understanding of the regulations.
The IRS position relies on two different provisions in the regulations. First, one of the two conditions an employer must satisfy to use any of the three affordability safe harbors is the employer must offer its full-time employees and their dependents the opportunity to enroll in minimum essential coverage (see section 54.4980H-5(e)(2)(i)). Prior to that provision, the regulations discuss the details of the 95 percent rule in two sentences. The regulations state an employer is treated as offering minimum essential coverage to its full-time employees (and their dependents) “for a calendar month if, for that month, it offers such coverage to all but five percent (or, if greater, five) of its full-time employees (provided that an employee is treated as having been offered coverage only if the employer also offers coverage to that employee’s dependents)” (see section 54.4980H-4(a)).
The plain language rule that is created by the second statement is an employer will be treated as having offered minimum essential coverage to its full-time employees if coverage is offered to at least 95 percent of its full-time employees. This rule is commonly referred to as the 95 percent rule. The 95 percent rule provides context to the first condition an employer must satisfy to use any of the three affordability safe harbors. With the context of the 95 percent rule, an employer can satisfy the first of the two conditions necessary to utilize the affordability safe harbors by offering 95 percent of its full-time employees and their dependents the opportunity to enroll in minimum essential coverage (see sections 54.4980H-4(a) and 54.4980H-5(e)(2)(i)). By not checking the "Yes" box in column (a) of the Form 1094-C, the employer is telling the IRS it did not offer 95 percent of its full-time employees and their dependents the opportunity to enroll in minimum essential coverage. In doing so, the employer is telling the IRS it is not eligible to use the affordability safe harbors.
Now that we have provided context to the regulations, it is easier to see why an employer who incorrectly completes column (a) on the Form 1094-C is causing the employer to fail the first condition necessary to use the affordability safe harbors (codes 2F, 2G, or 2H). Therefore, by not checking the “Yes” box in column (a) of the Form 1094-C in certain months the employer will make the affordability safe harbors unavailable to itself for those months. If an employer completes line 16 with any of the affordability safe harbor codes (codes 2F, 2G, and 2H), the IRS will ignore the affordability safe harbor code for that month. According to the IRS’ current position this makes it so the only thing that needs to occur for an employer to receive a proposed ESRP (a Letter 226J) for that month is for a full-time employee who declined coverage to receive a premium tax credit!
One interesting aspect regarding the IRS’ position in sending out the Letter 226J is there does not appear to be any inquiry regarding the affordability of the plan offered to the employees listed on the Form 14765. One item that makes an individual ineligible for a premium tax credit is an employee being eligible for an employer’s minimum essential coverage plan that provided minimum value and is offered at an affordable price (see section 1.36B-2(c)(3)(i)).
The regulations further explain that coverage is affordable for an employee if the portion of the annual premium the employee must pay for self-only coverage does not exceed 9.5 percent of the employee’s household income for the taxable year (see section 1.36B-2(c)(3)(v)). The 9.5 percent number is adjusted each year using an inflation like number which has risen to 9.86 percent for 2019. Importantly, it is the employee’s household income, a term much broader than the employee’s income from a particular employer, that is relevant to determine if an employee should be eligible for a premium tax credit. An employee’s household income can include income from other jobs or from a spouse.
Therefore, in most cases an employee’s household income is higher than an employee’s income with a particular employer. Regardless, an employee who received a Form 1095-C which was correctly and accurately coded with 1A, 1C, or 1E on line 14 and 2F, 2G, or 2H on line 16 most likely is not eligible to receive a premium tax credit as a result of the definitions provided in sections 1.36B-2(c)(3)(i) and 1.36B-2(c)(3)(v). And, an employee who is not eligible to receive a premium tax credit cannot trigger a section 4980H penalty. After reviewing many Letters 226J in private practice, it does not appear that the IRS has completed a thorough review of the premium tax credit eligibility for the employees listed on the Form 14765. In the event a Letter 226J becomes more litigious, each employee’s premium tax credit eligibility should be inspected closely.
Any employer who has received a Letter 226J must consider the impact the incorrect filing (assuming that is the reason it received the Letter 226J) will have on it receiving a penalty under section 6721 in the future (and/or section 6722). While each filing year to date has included a good faith efforts standard, if the employer continually files incorrectly with the IRS, the employer may be falling short of that standard. An employer could be fined up to $540 per return (assuming it provides an inaccurate return to the employee and the IRS) for an incorrect filing. Therefore, an employer with 100 incorrect Forms 1095-C could be penalized $54,000. Employers who have filed incorrectly in the past cannot take this unnecessary risk.
If you received a Letter 226J as a result of the column (a) Form 1094-C error discussed in this paper or any other error committed by your service provider, it is time to change providers. Accord Systems has automated tools in place to alert its clients to potential problems to the codes it submits to the IRS. To date we have a perfect record with our clients avoiding the dreaded Letter 226J which is a testament to our client’s compliance efforts and the Accord software. Please contact me personally if you have any questions concerning a Letter 226J you received and please contact us at Accord Software if you need assistance tracking your workforce’s hours of service for ACA purposes, reporting on the Forms 1094-C and 1095-C, or if you have any further questions regarding ACA reporting. Filing incorrectly is a risk no employer should be taking during the fourth season of ACA reporting.
About the author – Ryan Moulder serves as General Counsel at Accord Systems, LLC and is a Partner at Health Care Attorneys P.C. 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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