Table of Contents
IRS Letter 226J is a penalty notice issued by the IRS to Applicable Large Employers (ALEs) or organizations with 50 or more full-time employees and full-time equivalent employees who have had a full-time employee receive a Premium Tax Credit (PTC) from a state or federal health exchange. When the employee receives a Premium Tax Credit, the IRS will evaluate the employer’s ACA compliance in accordance with the Employer Shared Responsibility Provision of the ACA, commonly referred to as the Employer Mandate.
To comply with the ACA’s Employer Mandate, ALEs are required to offer Minimum Essential Coverage (MEC) to at least 95% of their full-time workforce (and their dependents) whereby such coverage meets Minimum Value (MV) and is Affordable for the employee or be subject to IRS 4980H penalties, known as Employee Shared Responsibility Payments (ESRPs), issued to employers by the IRS in Letter 226J penalty notices. The IRS requires ALEs to file information returns with the agency and provide statements to their full-time employees relating to whether they were offered health insurance and coverage to the employees (and their dependents), and if so, certain details about that health insurance coverage.
For any month in which an employer is assessed a penalty because a full-time employee obtained a PTC, if the organization did not offer health coverage to at least 95% of its full-time workforce (and their dependents) for that month, the penalty will be a 4980H(a) penalty (the “A” penalty). Conversely, if the organization did meet the 95% threshold for that month, but the full-time employee who obtained the PTC was not offered coverage, the coverage was not Affordable and/or did not meet Minimum Value (MV), then the penalty assessed will be a 4980H(b) penalty (the “B” penalty).
IRS Letter 226J contains:
- An Employee Shared Responsibility Payment summary table itemizing the proposed payment by month and indicating for each month if the liability is under Section 4980H(a) or Section 4980H(b) or neither.
- An Employer Shared Responsibility Response Form, Form 14764, “ESRP Response.”
- An employee PTC list, Form 14765, “Employee Premium Tax Credit (PTC) List.” These lists, by month, the ALE’s assessable full-time employees (individuals who for at least one month in the year were full-time employees allowed a PTC for one or more months and for whom the ALE did not qualify for an affordability safe harbor or other relief – see instructions for Forms 1094-C and 1095-C, Line 16), and the indicator codes, if any, as reported by the ALE reported on lines 14 and 16 of each assessable full-time employee’s Form 1095-C.
- A description of the actions the IRS will take if the ALE does not provide a timely response to Letter 226J.
The objectives of this page are to outline how the IRS issues Letter 226J, the penalty assessment, what triggers it, and how to respond.
2. History of 226J
Employers first started receiving IRS Letter 226J in late 2017 for the 2015 tax year. It caught many organizations by surprise because they did not think the Employer Mandate would be enforced by the IRS. The IRS identified 49,259 employers at risk for compliance action for the 2015 tax year. So far, more than 30,000 Letter 226J penalty notices have been sent for the 2015 tax year. Under the statute of limitations, ACA penalties can be assessed by the IRS up to three years from the filing date or due date, whichever is later. The IRS will have until mid-2019 to continue issuing 2015 Letter 226J penalty notices.
More than $4.4 billion in penalties have been issued to employers so far.
In March 2018, the Treasury Inspector General for Tax Administration (TIGTA) issued a report on the ACA. The report stated that the IRS has the data and processes in place to begin the analysis to calculate the potential penalties for the 2016 tax year to be assessed against those organizations determined not to be in compliance with the ACA.
In August of 2018, the IRS started laying the groundwork for 226J penalty notices for the 2016 tax year by issuing Letter 5699 to organizations the IRS believed were ALEs that failed to file ACA information returns (forms 1094-C and 1095-C) for the 2016 tax year. In Letter 5699 – the IRS form titled, “Request for Employer Reporting Offers of Health Insurance Coverage (Forms 1094-C and 1095-C)” – the federal tax agency asks employers to confirm the name the ALE used when filing its ACA information, provide the Employer Identification Number (EIN) submitted, and the date the filing was made.
As of October 2018, the IRS began issuing Letter 226J Penalty Notices for the 2016 tax year. The agency is anticipated to continue enforcing the ACA for the foreseeable future.
3. How ACA Penalties are Assessed
Penalties are assessed to Applicable Large Employers (ALEs) – those organizations with 50 or more full-time or full-time equivalent employees – to notify them of a proposed ESRP for failing to comply with the ACA for a specific tax year.
They are assessed via annual ACA information filings to the IRS using forms 1094-C and
1095-C. If your organization had one or more employees who received a PTC, the IRS will use your annual ACA filings to calculate penalties.
In the latest Treasury Inspector General for Tax Administration (TIGTA) report, the IRS has mentioned the use of its Affordable Care Act Compliance Validation (ACV) system which automatically identifies non-compliant ALEs.
Below is how the two penalties that are assessed in IRS Letter 226J are determined:
The “A” Penalty
This penalty will be triggered if the employer failed to offer Minimum Essential Coverage (MEC) to at least 95% of its full-time workforce and their dependents and at least one full-time employee receives a PTC.
Here is an example for a 2018 monthly penalty calculation:
$2,320/12 per month x (the total number of full-time employees – 30 employee exemptions)
The “B” Penalty
If the employer met the 95% offer threshold, the penalty assessed will be a “B” penalty instead of an “A” penalty.
This penalty is triggered for each full-time employee who receives a PTC when purchasing health insurance from a government exchange (like HR.gov) because he or she indicated to the exchange that they were not offered coverage by the employer, or the coverage they were offered was unaffordable and/or did not meet Minimum Value (MV).
Here is an example for a 2018 monthly penalty calculation:
$3,480/12 x (number of full-time employees receiving PTCs for each month)
4. Exchange Notices
An Exchange Notice is issued to employers by state and federal health exchanges notifying them that at least one employee applied for health coverage through a federal or state health exchange and was deemed eligible to receive a PTC. A PTC is a refundable tax credit designed to help eligible individuals and their families with low or moderate income afford health insurance purchased through the health exchange marketplace exchange. The employee is deemed eligible for a PTC because he or she met the income requirements and claimed that he or she did not receive an offer of Minimum Essential Coverage (MEC) from his or her employer or did not receive an offer of coverage that was Affordable and met Minimum Value (MV).
When an employee obtains a PTC, the Exchange issue notices to employers notifying them that the employee received a PTC and the organization will then have 90 days from the date of issue to contest why that is inaccurate or unjustified.
Failure to successfully appeal an Exchange Notice will likely result in the Exchange sending notice to the IRS, which then triggers the IRS Letter 226J, the IRS’s penalty notice for ACA non-compliance.
It is important to note that currently, the only trigger for an organization receiving Letter 226J is when a full-time employee goes to a federal or state health exchange and receives a PTC.
Upon receipt of an Exchange Notice, employers have two options:
- Attempt to appeal the notice.
- Ignore it and wait until your organization receives IRS Letter 226J.
In order to successfully appeal the Exchange Notice, an organization must have documentation readily on hand. The offer of coverage and the details of that coverage are important facts to use to successfully appeal the notice. The employer will need to prove that the employee received an offer of coverage from the employer that met Minimum Value (MV), Minimum Essential Coverage (MEC) and allowed dependents to enroll.
A company has 90 days from the date of the notice to request an appeal. In appealing the notice, an organization must prepare an appeal packet that will demonstrate it had offered the appropriate health care insurance coverage to its eligible employees. includes:
- A summary of benefits and coverage, a short plain-language summary of your health plan’s benefits
- An enrollment/waiver form
- Proof of offer of coverage to full-time employees and their dependents
- Proof of affordability
Failure to successfully appeal an Exchange Notice will likely result in receiving IRS Letter 226J, the IRS’s penalty notice for ACA non-compliance.
5. How to respond to IRS Letter 226J
The first thing you must do in responding to IRS letter 226J is to review carefully the penalty notice, the relevant summary table, the types of penalties being assessed, and how many employees received a PTC.
After this review, the organization must take the following steps:
- Provide information to the IRS by the response date shown in the letter, which will be 30 days from the date the letter was issued. The letter will contain the name and contact information of a specific IRS employee that the ALE should contact if the ALE has questions about the letter.
- Respond in writing, either agreeing with the proposed Employer Shared Responsibility Payment or disagreeing with part or all of the proposed penalty assessment. The notice will provide instructions on how the ALE should respond.
6. How the IRS acknowledges your 226J response
An ALE has 30 days to respond from the date of the Letter 226J Penalty Notice. If the ALE does not respond, the IRS will assess the amount of the proposed ESRP shown in Letter 226J and will issue a Notice and Demand for Payment (Notice CP 220J). The notice offers directions and alternatives to pay the penalty.
The IRS will issue one of five different versions of IRS Letters 227 to employers in acknowledgement of their 226J response. The different versions describe additional actions that may be required of an employer to address its proposed ESRP. They are listed here:
Letter 227K: This is the letter that you hope your client receives. It means that the case has been resolved in the employer’s favor. Essentially, 227K acknowledges that the information in the employer’s response to Letter 226J was accepted, the employer does not owe an ESRP, and the IRS has closed its inquiry.
Letter 227L: While not as thrilling as receiving Letter 227K, receiving this version of Letter 227 is still a plus. The IRS sends this version of the letter when it agrees with the employer that the amount of the ESRP owed should be reduced. While the employer will still have to make a payment, it won’t be as much as originally requested.
Letter 227M: This version of the letter is not one that you want your client to receive. This is the version the IRS sends when it disagrees with the employer’s response to Letter 226J and reiterates its demand for the original penalty assessment.
Letter 227J: This acknowledges the receipt of the signed response to Letter 226J Form 14764 in which an organization agrees to pay the ESRP as assessed. After you receive this letter, the case will be closed. No response is required other than to complete payment of the penalty.
Letter 227N: This acknowledges the decision reached in Appeals and shows the ESRP based on the Appeals review. After issuance of this letter, the case will be closed. No response is required.
After receiving the IRS’ response, if the client still disagrees with the proposed or revised penalties, the employer may request a pre-assessment conference with the IRS Office of Appeals. This is done in accordance with the instructions for requesting a conference provided in Letter 227 and in IRS Publication 5, “Your Appeal Rights and How to Prepare a Protest if You Don’t Agree.” The conference should be requested in writing by the response date shown on Letter 227, which usually will be 30 days from the date of the letter.
It’s important that your organization respond to all IRS notices. Failing to reply to a Letter 226J or any of the variants of Letter 227, where appropriate, will likely prompt the IRS to formally assess the amount of the proposed ESRP and issue the employer a Notice and Demand for Payment, Notice CP 220J.
7. Possible Penalties for Not Complying With the ACA
Besides adhering to the Exchange Notice if you received one, you should also make sure you are taking the following steps to comply with the ACA to reduce the risk of receiving IRS Letter 226J.
A good place to start is the ACA annual filings with the IRS. Review them to make sure you haven’t made these common mistakes that can weigh significantly on the amount the IRS proposes in their Letter 226J to your organization.
4980H Transition Relief Box:
On Line 22, Section C on the 1094-C, there was a box to be marked to indicate Section 4980H Transition Relief. For 2015, there were two primary reasons that could allow employers to check this box.
- ALEs with 50-99 full-time and full-time equivalent employees were not subject to any 4980H penalties for any calendar month of 2015.
- ALEs with 100 or more full-time and full-time equivalent employees could take advantage of an increased number of the allocated reduction of full-time employees of 80.
After checking the box that your organization qualified for 4980H Transition Relief, employers needed to indicate which type of transition relief for which they qualified. This had to be indicated in Part III, lines 23-35 of the 1094-C. Code “A” had to be entered if you qualified for 50-99 transition relief and code “B” if your organization had 100 or more full-time and full-time equivalent employees for the applicable months. If employers did not do this correctly, they received a penalty assessment for 2015.
Full-Time Status Overstated
This error is probably the most significant because it directly relates to the ACA penalty amount proposed in IRS Letter 226J. Understanding the ACA is no easy undertaking. The most critical component of doing so is being able to correctly identify your full-time workforce. Any “A” penalties assessed are based on the stated full-time counts for each month of the reporting year provided on Form 1094-C. If these numbers were stated incorrectly, the proposed penalty amount could be significant.
In determining the full-time employee count, an organization may use one of the two IRS approved measurement methods to prove employment status for recipients of PTCs. The IRS may also require additional information from employers, which may include the following:
If the Look-Back Measurement Method was used, a statement explaining how that method was applied to assess the employee in question, whether the employee was full-time or not, whether the employee was in a limited non-assessment period, whether the employee was offered coverage that met Minimum Value and whether the amount of the self-only monthly contribution rate satisfied affordability.
Similar to your full-time counts, the codes on the 1095-C schedule ultimately determine if and for what month(s) your organization may be subject to 4980H penalties. Line 14 identifies information about the health coverage offered, if any, to the employee, spouse and dependents. Line 15 identifies the lowest cost contribution for self-only coverage IF the plan did not meet the Federal Poverty Level safe harbor. Line 16 indicates why a penalty could not be assessed for a particular month because a safe harbor applied. If you enter the wrong code combinations, you could have end up with a significant penalty assessment.
Minimum Essential Coverage Offer Box (95% threshold attestation)
If your organization offered Minimum Essential Coverage to at least 95% (70% for 2015 only) of full-time employees for all 12 months, employers should have checked the “All 12 Months” box on the 1094-C transmittal. Failing to do so immediately indicates to the IRS that, for certain months, you did not offer coverage that met the requirements of the ACA. Again, this will result in significant penalty assessments.
How to Avoid Receiving Letter 226J and IRS Penalties
Organizations should consider having a Penalty Risk Assessment performed on their previous years ACA filings. Doing so will allow you to identify errors and make necessary filing corrections. Doing so could help your organization minimize exposure to Letter 226J.
An ACA Penalty Risk Assessment should include the following:
Calculate Potential Risk Exposure
A penalty risk assessment requires methodology that will calculate a total penalty exposure amount in the same way the IRS should. For instance, analyzing the previous years’ ACA 1094-C and 1095-Cs will help verify the accuracy of full-time counts over a 12-month period. A review of IRS code combinations on the 1095-Cs can be assessed to identify which employees pose a 4980H penalty risk.
In addition, the potential 6721/6722 penalty exposure also can be determined. If the code combinations on a particular 1095-C are nonsensical, a $260 penalty per schedule can be assessed for submitting “non-accurate” filings. An example would be if there is a code 1H (No Offer) on Line 14 for all 12 months and a 2G (FPL Safe Harbor) on Line 16. Not only does this not make sense because a Safe Harbor cannot be claimed when no offer of coverage is extended (subjecting you to a 6721/6722 penalty for inaccurate filing), but it also subjects your organization to potential 4980H(a) penalty for failing to offer coverage to a full-time employee.
Identify Errors in Previous ACA Filings
Reviewing the data submitted in your ACA filings will help to identify errors in the submission. Errors such as a disconnect between the total number of 1095-Cs and the ful-time count listed on 1094-C, incorrect EINs, and incorrect 4980H Transition Relief and Minimum Essential Coverage indicators should be checked. In the event these types of mistakes are present, they can be corrected.
Correct Previous Years filings
A well-done Penalty Risk Assessment will allow your organization to make corrections to previous years’ filings before being issued a Letter 226J by the IRS. Making changes to identified errors in your 1095-C filings, such as offer of coverage coding, relevant dependent listing, affordability coding, and full-time count, can be submitted to the IRS as part of a corrected filing. Corrected filings sent before receiving a Letter 226J mean less penalty exposure for your organization.
Creating a Process for Better ACA Compliance
This comes with the territory of identifying your previous ACA compliance mistakes. Once you have identified and fixed previous mistakes, review your current ACA compliance process to determine if there is a need to implement new practices, educate old and new staff on their ACA compliance responsibilities, and create a better, more efficient process moving forward. Practices such as extending offers of coverage, benefits structure, proper implementation of the right IRS approved measurement method, affordability determination, and tracking offers of coverage are just a few things to consider. Making improvements to your current process will reduce the risk of receiving Letter 226J in the future.
By correcting the full-time count, coding on the 1095-C schedules, and implementing a better process for ACA compliance, there is less risk for your organization, more savings, and peace of mind knowing that your ACA process has been handled effectively.
An organization can also better reduce the risk of receiving IRS 226J by having good ACA compliance.
Good ACA Compliance practices include: