Calling All ALEs: Be Prepared for IRS Letter 226-J
Let’s say you’re an employer with at least 50 employees or 50 full-time equivalents — otherwise known as an applicable large employer (ALE). You’ve been doing your best to comply with the Affordable Care Act (ACA), but then one day it happens: The dreaded IRS Letter 226-J lands on your desk.
What does it mean? What do you do? Should you open it? Yes, of course you should open it. But feel free to take a deep breath before reading.
Letter 226-J is the IRS’s way of telling you that it believes, but has not yet firmly concluded, that you have failed to comply with the ACA’s employer mandate. The letter is generated by data you provided on Forms 1094-C and 1095-C, but that doesn’t guarantee that you’ve done anything substantively wrong.
The ACA contains two employer mandate standards that, if the IRS believes you failed to meet, will trigger a Letter 226-J. Penalties under Internal Revenue Code Section 4980H subsection (a) involve a two-pronged test. They kick in if you:
- Didn’t offer minimum essential coverage to at least 95 percent of your full-time employees and their dependents (but not necessarily their spouses), and
- At least one of your employees received a tax credit by securing health coverage via a Health Insurance Marketplace (commonly known as an “exchange”).
The penalty under subsection (a) is the most severe: It’s assessed based on the total number of employees for each month of your violation status. This formula is an annualized inflation-adjusted penalty amount ($2,320 for 2018) for each full-time employee you have, minus 30. So, if you had 80 employees and you were in violation under subsection (a) for an entire year in 2018, your potential penalty would be 80 – 30 = 50 × $2,320 = $116,000.
Sec. 4980H subsection (b) applies if you did offer minimum essential coverage to at least 95 percent of your employees, but at least one full-time employee received a tax credit for coverage bought from a Health Insurance Marketplace because either:
- He or she wasn’t offered coverage, or
- Coverage offered failed to meet the ACA’s affordability or minimum value test.
The subsection (b) penalty is based on an inflation-adjusted amount ($3,480 in 2018) for each employee who fell into this category. If you had 100 employees, it would be mathematically impossible for more than five employees to trigger a subsection (b) penalty, because you wouldn’t have flunked the 95 percent coverage requirement that would otherwise have made you subject to the harsher subsection (a) penalty.
You need to read your Letter 226-J carefully to learn why the IRS believes you have gone astray. A 30-day clock starts ticking when the letter is issued, and you need to respond before the clock stops to avoid making matters worse.
Common errors that trigger the letter include:
- Failing to fill in a safe harbor code on line 16 of Form 1095-C
- Inadvertently reporting a failure to cover substantially all full-time employees
- For self-insured plans, failing to include all former employees on Part III of Form 1095-C
- Missing the deadline for filing Forms 1094-C and 1095-C
The source of such errors could be you or your service provider because of either manual mistakes or system errors. But the IRS itself isn’t infallible; it too may have made a mistake. For example, you might have filed a corrected Form 1094-C, but the IRS only used the original filing. Regardless of who’s at fault, you need to move promptly to get to the root of the problem and resolve it.
The Letter 226-J itself should be clear about what triggered it and whom to call with questions. The IRS’s advice on how to respond consists basically of commonsense tips such as “read your letter and attachments carefully.” But the package also includes a response form in which you indicate whether you agree with the agency’s findings or not — and if not, why not.
If you do agree with them, “Follow the instructions to sign the response form and return with full payment,” the IRS asks. If you disagree and respond to the letter with a detailed explanation of the basis of that disagreement, eventually you’ll receive a letter back from the IRS stating its final determination and your rights to appeal the verdict.
Enforcement activity seems to be ramping up now that transitional relief available for 2015 filings is no longer available. So, ALEs that might not have received a Letter 226-J in the past could stand a better chance of getting one now.
As always, it’s better to be prepared than to be caught off guard. Keep an eye out for the letter and lay the groundwork for a defense just in case. And if you do receive a Letter 226-J, run it by your CPA to formulate a proper response.