Responding to IRS Letter 226J
By Brian Gilmore | Published February 4, 2021
Question: How should employers respond to the Letter 226J from the IRS?
Short Answer: IRS Letter 226J informs employers of a proposed ACA employer mandate penalty assessment. Employers agreeing with the assessment should timely respond with the required payment, but employers disagreeing with the assessment can engage with the IRS in a process designed to determine whether the assessment is appropriate. Depending on the circumstances, employers may be able to reduce or eliminate the initial penalty assessment.
General Rule: ACA Employer Mandate Penalties
There are two potential ACA employer mandate penalties:
a) IRC §4980H(a)—The “A Penalty”
The larger penalty is the §4980H(a) penalty—frequently referred to as the “A Penalty” or the “Sledge Hammer Penalty.” This penalty applies where the applicable large employer (ALE) fails to offer minimum essential coverage to at least 95% of its full-time employees (and their children to age 26) in any given calendar month.
The 2021 A Penalty is $225/month ($2,700 annualized) multiplied by all full-time employees (reduced by the first 30). It is triggered by at least one full-time employee who was not offered minimum essential coverage enrolling in subsidized coverage on the Exchange. The IRS posts the annual increases to the employer mandate penalties on its ACA employer mandate FAQ website.
b) IRC §4980H(b)—The “B Penalty”
The smaller penalty is the §4980H(b) penalty—frequently referred to as the “B Penalty or the “Tack Hammer Penalty.” This penalty applies where the ALE is not subject to the A Penalty (i.e., the ALE offers coverage to at least 95% of full-time employees). It applies for each full-time employee enrolled in subsidized Exchange coverage who was a) not offered minimum essential coverage, b) offered unaffordable coverage, or c) offered coverage that did not provide minimum value.
Only those full-time employees who enroll in subsidized coverage on the Exchange will trigger the B Penalty. Unlike the A Penalty, the B Penalty is multiplied by all full-time employees.
The 2021 B Penalty is $338.33/month ($4,060 annualized) per full-time employee receiving subsidized coverage on the Exchange. The IRS posts the annual increases to the employer mandate penalties on its ACA employer mandate FAQ website.
For more details on the ACA employer mandate generally, see our Newfront ACA Employer Mandate and ACA Reporting Guide.
ACA Employer Mandate Penalty Assessments: IRS Letter 226J
If the IRS determines that the employer is subject to an ACA employer mandate penalty based on the information filed on its Forms 1094-C and 1095-C, the employer will receive an IRS Letter 226J describing the proposed §4980H penalty assessment.
The letter will include the proposed penalty assessment for each month of the calendar year, including a list of each full-time employee who triggered a penalty by receiving subsidized Exchange coverage for the applicable months. The letter also includes the name and contact information of an IRS representative to contact with any questions.
Employers respond via Form 14764 (ESRP Response) agreeing or disagreeing with the penalty amount assessed by the listed response date. The deadline is generally 30 days from the date of the Letter 226J.
Employers disagreeing will include Form 14765 (PTC Listing) with their response indicating any changes needed to the Form 1095-C for employees who received Exchange subsidies, as well as any supporting statement and/or documentation (e.g., employment or offer of coverage records) the employer would like to provide.
Employers that offered minimum essential coverage that was affordable and provided minimum value to any of the employees listed as triggering a penalty will generally want to respond disagreeing with the assessment.
Additional Notes:
Prior to receiving a Letter 226J, employers should have advance notice of a potential ACA employer mandate penalty in the form of the Exchange Notice. Employers receive the notice upon the employee initially applying for subsidized coverage on the Exchange. The Exchange Notice serves as the initial opportunity to appeal and remove the subsidy—and thereby also remove the potential employer mandate penalty trigger. For more details, see: When to Appeal Exchange Notices.
The ACA affordability determination generally rests upon whether the employer’s offer of coverage met one of the applicable affordability safe harbors. For more details, see: How the ACA Affordability Rules Apply to Employers.
In many cases, IRS Letters 226J are triggered by simple ACA reporting errors. The most common “A Penalty” reporting error is failing to check “Yes” in column (a) of Part III of the Form 1094-C to confirm that the employer offered coverage to at least 95% of full-time employees and their dependents. The most common “B Penalty” reporting errors are failing to enter the appropriate code on Line 16 to of the Form 1095-C to indicate when an employee terminated (“2A”), transitioned to part-time (“2B”), was in a waiting period or initial measurement period (“2D”), or declined the offer of coverage that met an affordability safe harbor (“2F”, “2G”, or “2H”). In those situations, the employer will want to complete the Forms 14764 and 14765 disagreeing with the penalty assessment.
IRS Materials:
Letter 226J
IRS Letter 226J Overview: https://www.irs.gov/individuals/understanding-your-letter-226-j
IRS Sample Letter 226J: https://www.irs.gov/pub/notices/ltr226j.pdf
Letter 226J Response Forms
IRS Form 14764: https://www.irs.gov/pub/irs-pdf/f14764.pdf
IRS Form 14765: https://www.irs.gov/pub/irs-pdf/f14765.pdf
IRS Response to Employer Penalty Assessment Response: IRS Letter 227
The IRS will respond to the employer response via a Letter 227, which comes in five different forms (227-J through 227-N). The Letter 227 will acknowledge the employer’s response and describe the applicable next steps in the process.
Employers disagreeing with the Letter 227 IRS response will have the opportunity to request a conference with the supervisor of the IRS contact assessing the penalty and/or the IRS Independent Office of Appeals. The deadline to request a conference will generally be 30 days from the date of the Letter 227.
IRS Materials:
IRS Letter 227 Overview: https://www.irs.gov/individuals/understanding-your-letter-227
An Overview of the five different IRS Letters 227.
IRS Letter 227-J: https://www.irs.gov/pub/notices/ltr227j.pdf
Acknowledges receipt of the signed agreement Form 14764, ESRP Response, and that the ESRP will be assessed. After issuance of this letter, the case will be closed. No response is required.
IRS Letter 227-K: https://www.irs.gov/pub/notices/ltr227k.pdf
Acknowledges receipt of the information provided and shows the ESRP has been reduced to zero. After issuance of this letter, the case will be closed. No response is required.
IRS Letter 227-L: https://www.irs.gov/pub/notices/ltr227l.pdf
Acknowledges receipt of the information provided and shows the ESRP has been revised. The letter includes an updated Form 14765 (PTC Listing) and revised calculation table. The ALE can agree or request a meeting with the manager and/or appeal.
IRS Letter 227-M: https://www.irs.gov/pub/notices/ltr227m.pdf
Acknowledges receipt of information provided and shows that the ESRP did not change. The letter provides an updated Form 14765 (PTC Listing) and revised calculation table. The ALE can agree or request a meeting with the manager and/or appeal.
IRS Letter 227-N: https://www.irs.gov/pub/notices/ltr227n.pdf
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.
IRS Notice and Demand for Payment: IRS Notice CP220J
If the IRS ultimately determines at the end of the correspondence and/or appeals conference(s) that the employer owes the employer mandate penalty, the IRS will issue a Notice and Demand for payment via Notice CP220J. Interest will be charged on any outstanding balance until the amount is paid in full.
IRS Materials:
Notice CP220J
IRS Notice CP220J Overview: https://www.irs.gov/individuals/understanding-your-cp220j-notice
IRS Sample Notice CP220J: https://www.irs.gov/pub/notices/cp220j.pdf
IRC §6056 Non-Filer and IRC §4980H Compliance Process
IRS Internal Revenue Manual for Agents (25.21.4): https://www.irs.gov/irm/part25/irm_25-021-004
Late/Incorrect ACA Reporting Penalties: Different Penalties Apply
The IRS penalty scheme is different for an employer’s failure to timely or correctly complete its ACA reporting via Forms 1094-C and 1095-C. Those penalties are generally $280 for the late/incorrect Forms 1095-C furnished to employees, and $280 for the late/incorrect Forms 1094-C and 1095-C filed with the IRS. However, multiple potential modifications and exceptions to those penalties may apply.
For full details, see our prior post: ACA Reporting Penalties.
For more details on the ACA employer mandate generally, see our Newfront ACA Employer Mandate and ACA Reporting Guide.
Regulations
IRS ACA Employer Mandate FAQs Addressing Penalty Amounts:
Does the per-employee amount of the employer shared responsibility payment increase over time? (updated August 19, 2020)
Yes. The employer shared responsibility provisions provide for an inflation adjustment beginning in calendar years after 2014.
In the case of any calendar year after 2014, the applicable per-employee dollar amounts of $2,000 and $3,000 are increased based on the premium adjustment percentage (as defined in section 1302(c)(4) of the Affordable Care Act) for the year, rounded to the next lowest multiple of $10.
For calendar year 2015, the adjusted $2,000 amount is $2,080 and the adjusted $3,000 amount is $3,120.
For calendar year 2016, the adjusted $2,000 amount is $2,160 and the adjusted $3,000 amount is $3,240.
For calendar year 2017, the adjusted $2,000 amount is $2,260 and the adjusted $3,000 amount is $3,390.
For calendar year 2018, the adjusted $2,000 amount is $2,320 and the adjusted $3,000 amount is $3,480.
For calendar year 2019, the adjusted $2,000 amount is $2,500 and the adjusted $3,000 amount is $3,750.
For calendar year 2020, the adjusted $2,000 amount is $2,570 and the adjusted $3,000 amount is $3,860.
For calendar year 2021, the adjusted $2,000 amount is $2,700 and the adjusted $3,000 amount is $4,060.
Brian Gilmore
Lead Benefits Counsel, VP, Newfront
Brian Gilmore is the Lead Benefits Counsel at Newfront. He assists clients on a wide variety of employee benefits compliance issues. The primary areas of his practice include ERISA, ACA, COBRA, HIPAA, Section 125 Cafeteria Plans, and 401(k) plans. Brian also presents regularly at trade events and in webinars on current hot topics in employee benefits law.
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