August 5, 2021
Recently, the IRS sent out another round of employer mandate penalties for the 2018 tax year. Some of the latest round of penalties I have reviewed and am assisting employers appeal through my private practice, disallowed the employer from utilizing the affordability safe harbors. This article briefly discusses what is occurring and the issues evolving from the IRS penalizing an employer after it has fallen short of the affordability safe harbor.
According to Internal Revenue Code (IRC) section 36B(c)(3)(v)(A)(1) an 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 (9.56 percent in 2018) of the applicable taxpayer’s household income for the taxable year. An individual’s household income is the taxpayer’s modified adjusted gross income plus the aggregate modified adjusted gross income of all other individuals who are included in the taxpayer’s family who are required to file a tax return (see section 1.36B-1(e)). The IRS recognized that an employer would have no way to determine an individual’s household income so as a result the IRS created three affordability safe harbors that an employer can use to satisfy the employer’s affordability threshold.
The points made in the previous paragraph could not be clearer. The preamble to the final regulations state: “Affordability under section 36B is determined by reference to the taxpayer’s household income. 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 (emphasis added).” So long as one of the three affordability safe harbors is satisfied, the employer’s offer of coverage will be deemed affordable for purposes of the ACA. However, and absolutely critically, just because an employer fails one, or even all three, of the affordability safe harbors, does not mean that the employer's offer of coverage does not meet the ACA’s affordability standard. The IRS appears to be ignoring the clear standard set by IRC section 36B(c)(3)(v)(A)(1) with its latest round of employer mandate penalties.
A brief example will help illustrate a scenario we have come across repeatedly in the latest round of employer mandate penalties. Let’s assume McGee accumulates 2,000 hours of service during the 2018 tax year at an hourly rate of $15 an hour. McGee has $30,000 of box 1 form W2 income. The required contribution percentage in 2018 was 9.56 percent meaning the employer could charge McGee no more than $2,868 ($30,000 * 0.0956) in health insurance premiums for self-only coverage for the year and still utilize the Form W2 affordability safe harbor. The employer could not utilize the Form W2 affordability safe harbor if the employer charged McGee more than $239 per month ($2,868/12) in 2018.
Unfortunately, due to an administrative error, the employer charged McGee $250 per month for health insurance in 2018. McGee declined the health insurance and went to the exchange where he and his family enrolled in health insurance and received a premium tax credit. On the Form 1095-C the employer put 1E on line 14, $250.00 on line 15, and 2F (the Form W2 affordability safe harbor) on line 16. Recently, the employer received a letter 226J from the IRS proposing a penalty under IRC section 4980H(b) for all 12 months of the 2018 tax year. The employer reviewed the letter 226J packet and saw the IRS had rejected the employer's use of the 2F code by placing an XF for the line 16 input. As a result, the IRS proposed a penalty to the employer of $290 per month for all 12 months in 2018.
Many employers have received proposed penalties under IRC section 4980H(b) in the last few months with a fact pattern similar to the example above. This is problematic as the IRS is ignoring the clear affordability standard set out by IRC section 36B(c)(3)(v)(A)(1). As discussed above, that section clearly states that affordability is based on an individual’s household income. There are myriad other income sources that would make McGee’s household income in the example above higher than the amount reported on box 1 of the Form W-2. And, in the case of the example above, McGee would only need a household income of $31,381 ($3,000 self-only annual premium cost/0.0956) for the coverage to be deemed affordable under IRC section 36B(c)(3)(v)(A)(1). This would mean McGee’s household income would only need to be $1,381 more than what McGee was being paid by the employer. McGee’s household income could be higher from income he earned from another employer, his spouse’s income, or a dependent child’s income to list just a few possibilities. However, the IRS appears to be ignoring the clear language of IRC section 36B(c)(3)(v)(A)(1) and penalizing any employer it deems failed the Form W2 affordability safe harbor claimed on line 16 of the Form 1095-C.
The IRS’s position to penalize employers who fail the Form W2 safe harbor is disappointing. However, employers who planned properly should be able to avoid this issue entirely moving forward. The final regulations specifically allow an employer to base an employee’s contribution amount on a “consistent percentage of all Form W2 wages…” (see section 54.4980H-5(e)(2)(ii)(A)). Therefore, an employer could guarantee that it will always meet the Form W2 affordability safe harbor by utilizing a consistent percentage that is less than or equal to the required contribution percentage (9.56 percent in 2018) for the applicable tax year. If an employee of any employer rejects coverage and signs the offer clearly rejecting the affordable coverage offered, any appeal for that particular employee will be easy. Many employers have fallen short when it comes to recording offers of health coverage making the appeals process more challenging. Employers who have not kept meticulous records in the past need to begin doing so for future reporting years.
The IRS position of penalizing employers who fail to satisfy the Form W2 affordability safe harbor goes directly against the clear language of the IRC. The entire purpose of the three affordability safe harbors was to provide an employer assurance that it could satisfy the affordability standard with data it controlled. However, just because an employer fails to meet one of the affordability safe harbors does not mean that the employer failed to meet the affordability threshold set by the ACA. The standard of affordability could not be more clearly based on an individual’s household income. The IRS needs to reassess how and to whom it is proposing penalties. If you received a letter 226J or need assistance filing the Forms 1094-C and 1095-C in the future, please contact us.
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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