In some cases, the IRS appears to be taking the new action of comparing affordability safe harbor codes to other employer information on file to determine if an employer is liable for an employer shared responsibility payment (ESRP), often referred to as the ACA employer mandate penalty. This apparent level of review indicates that the IRS has been increasing, and will continue to increase, enforcement of the Affordable Care Act (ACA).

Background

Under IRC Section 4980H, applicable large employers (ALEs) can be responsible for one of two types of ESRPs for any given month: (A) when an ALE fails to offer at least 95% of its full-time employees essential minimum coverage (the A Penalty) and (B) when an ALE either fails to offer a full-time employee essential minimum coverage or offers coverage that is unaffordable to an employee (the B Penalty). In both cases, an ESRP is only triggered when a full-time employee enrolls in coverage through a state-provided or federal health care marketplace qualifying for premium support in the form of a premium tax credit (PTC) under IRC Section 36B.

Employees (and dependents) qualify for PTCs to the extent that (1) household income does not exceed 400% of the federal poverty line (FPL); (2) the employee and dependents are not covered by a health plan that is outside of the exchange and meets the requirements for minimum essential coverage (e.g., an employer group health plan); and (3) the employee receives an offer of minimum essential coverage from an ALE that meets certain affordability and minimum value standards. The American Rescue Plan Act (ARPA) expanded the availability of PTCs for 2021 and 2022 by removing the requirement for an employee's household income to be 400% or less of the FPL.

ALEs have three "affordability safe harbors" to show their coverage is "affordable": (1) rate of pay (based on hourly rate or monthly salaried rate); (2) W-2 (based on gross income); and (3) FPL (based on household income). If the amount an ALE charges an employee for self-only coverage satisfies an affordability safe harbor, the ALE will not be liable for an ESRP based on an unaffordable offer of coverage even if its employee qualifies for a PTC.

ESRP process

For an ALE that fails to offer minimum essential coverage to at least 95% of its full-time employees in any month, the A Penalty is determined based on the total number of the ALE's full-time employees in that month, as long as any of its full-time employees qualifies for the PTC. For an ALE that fails to offer coverage to an employee or offers unaffordable coverage, the B Penalty is based on the number of full-time employees who are certified as qualified for the PTC. As such, the ESRP for those ALEs cannot be determined until there is an exact count of how many employees are entitled to the PTC.

For the IRS to determine if any and how many full-time employees received a PTC, the agency must cross-reference (1) Forms 1094-C, Transmittal of Employer-Provided Health Insurance Offer and Coverage Information Returns, and Forms 1095-C, Employer-Provided Health Insurance Offer and Coverage (which an ALE must file for each of its full-time employees), with (2) Forms 1040 (filed by the full-time employees). When an ALE files its Forms 1095-C for its full-time employees, it can include a code on Line 16 for each month indicating reasons why it is not liable for ESRPs in the event one of its employees received coverage in a marketplace and qualified for a PTC. The reasons corresponding to the codes include, for example, that the employee was not employed during a specific month, was not a full-time employee in a given month, was in a permissible waiting period in a given month or received an offer that met an affordability safe harbor.

The IRS then calculates the potential ESRP liability and, if applicable, sends Letter 226J to the ALE, proposing the assessment. The IRS also sends Form 14765, Employee Premium Tax Credit (PTC) Listing, showing the months that are penalized and the codes that are triggering the penalty. The Form 14765 will reflect any line 16 code used by the ALE for the employee on the Form 1095-C. The ALE can revise the Form 14765 with new valid line 16 codes that will mitigate the penalty, along with a written explanation on why the penalty should be reduced or removed.

Addition to Form 14765

For Letters 226J received for the 2018 tax year, the IRS has added the following to the top of Form 14765:

Any month that shows XF, XG, or XH is due to a determination that you do not qualify for the safe harbor being claimed (2F, 2G, or 2H). If you still think the safe harbor applies, you may provide your computation with your written request for reconsideration.

Forms 14765 received in prior years did not have this language. This revision seems to indicate that the IRS is now comparing affordability safe harbor codes 2F (W-2 safe harbor), 2G (FPL safe harbor) or 2H (rate-of-pay safe harbor) to other data it has on file. This countering of a line 16 code is a new development by the IRS in processing 2018 ESRP assessments. In the past, we only encountered challenges to the code on line 16 (indicating why the ALE is not liable for ESRPs) when ALEs "corrected" the employee's code to that of "never employed during a calendar year," but the IRS received a W-2 for that employee indicating the ALE paid that employee compensation in that calendar year.

The IRS can easily compare FPL affordability (code 2G) with the employee's lowest-cost premium on Line 15 of Form 1095-C because FPL is published for each year and does not vary by individual. Likewise, the W-2 safe harbor (code 2F) can easily be compared with the employee's W-2. What is unclear is how the IRS would review rate-of-pay affordability (code 2H). We are not aware of any information sent to the IRS that provides an hourly rate-of-pay per individual.

Next steps

Some ALEs may receive a Letter 226J with a Form 14765 indicating codes shown as XF, XG or XH, indicating those individuals do not meet the affordability safe harbor. ALEs should first review the data for that individual to confirm whether the individual meets the originally reported safe harbor. If the individual does not meet affordability, the ALE may be liable for an ESRP for that employee. If other data supports a different code (e.g., an employee was terminated for the month of the proposed assessment), the ALE can update Form 14765 to show the correct code for that month. To proactively avoid these potential issues, ALEs should work with ACA reporting vendors so data is as accurate as possible before furnishing Forms 1095-C or filing them with the IRS. Review processes should also be in place when Forms 1094-C and 1095-C are produced to furnish and transmit accurate information to individuals and the IRS.

As the IRS has stated previously in Notice 2020-76, Reporting Year 2020 was the last year that would include accuracy-related penalty relief if an ALE furnished and timely filed Forms 1094-C and 1095-C (see Tax Alert 2020-2401). With that notice and this change to the Form 14765, it is clear the IRS is reviewing ACA returns more carefully. In addition, the IRS concluded in Chief Counsel Memorandum 20200801F that no statute of limitations applies to assessing ESRPs (see Tax Alert 2020-0475). This means that the IRS could seek ESRPs indefinitely. It also may mean that correcting the codes to mitigate ESRPs on the Form 14765 may set ALEs up in future years for the assessment of reporting penalties for filing inaccurate Forms 1095-C.

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