Tax News Update    Email this document    Print this document  

EY has become aware that several employers have received ACA audit letters (Letters 226-J) from the IRS with higher ESRP assessments for the 2021 tax year as compared to prior years. This could be due to more employees participating in the ACA health insurance marketplace program over the last four years and receiving a premium tax credit (PTC).¹ Employers with health plan offerings that do not meet an affordability safe harbor could see increased exposure to ESRP IRC Section 4980H(b) assessments if the premium they offer for coverage does not meet one of the ACA affordability safe harbors.

Background

IRC Section 4980H, which was added by the ACA, imposes excise taxes in the form of ESRPs on applicable large employers (ALEs) if their employees receive PTCs for the purchase of health care coverage from one of the health insurance marketplace programs. Under IRC Section 36B, PTCs generally are available to individuals if they are not offered affordable coverage from their employer and their household income does not exceed 400% of the federal poverty limit. The American Rescue Plan Act (ARPA), however, expanded the eligibility for PTCs to all income levels for the 2021 and 2022 plan years and capped medical premiums for marketplace benchmark plans at 8.5% of household income. The expanded PTC eligibility was then extended to 2025 under the Inflation Reduction Act (see Tax Alert 2022-1238). The IRS updated its frequently asked questions to reflect these PTC-related developments in February 2024.

Employers can be responsible for ESRPs for any given month when (1) an ALE fails to offer minimum essential coverage (MEC) to at least 95% of full-time employees (the "A Penalty"), or (2) ALEs offer MEC meeting minimum value to full-time employees and their dependents that is unaffordable or the ALE fails to make an offer to an eligible employee (the "B Penalty"). In both cases, an ESRP is only triggered when a full-time employee enrolls in coverage through a federal or state-sponsored health insurance marketplace and qualifies for premium support in the form of a PTC under IRC Section 36B.

From an employer's standpoint, affordability is based on the employee-only premium rate paid by the employee. Beginning in 2023, eligibility for PTCs was expanded to take into account family members of covered employees (the so-called family-glitch fix); this change, however, did not impact the employer safe harbor calculations (see Tax Alert 2022-1549).

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. 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 as reported in Box 1 on the Form W-2); and (3) the federal poverty line (FPL).

After the IRS calculates the potential ESRP liability, it sends Letter 226-J to the ALE, proposing the assessment. The IRS also sends Form 14765, Employee Premium Tax Credit (PTC) Listing, showing the months for which the ALE is penalized and the codes that are triggering the penalty. The ALE can pay the penalty or return the Form 14765 with a written explanation on why the penalty should be reduced or removed (see Tax Alert 2021-1193).

226-J letters for 2021

The IRS began sending out Letters 226-J assessing penalties for the 2021 tax year in December 2023. EY has become aware that some ALEs that regularly receive Letters 226-J have seen an increase of 20% or more in the penalties assessed. The increased penalties reflect the higher number of full-time employees who are not offered affordable coverage and receive PTCs after obtaining coverage from the marketplace. There are several reasons for this: (1) more employees are eligible for PTCs because the income cap has been eliminated; (2) there is increased awareness and acceptance of health insurance marketplace plans; and (3) PTCs can make marketplace plans more affordable than employer plans. As employers are either well into developing their health care plans for the upcoming year or already in open enrollment by the time ACA affordability percentages are released, it may be difficult for them to take these percentages into account.

Trend could continue

Since 2021, the ACA affordability percentages have decreased, which in turn lowers the level at which a premium is considered affordable. The affordability percentage is 8.39% for 2024 employer health care plans, which is the lowest affordability percentage since the ACA's inception (see Tax Alert 2023-1444). This means that the lowest cost of coverage for a single employee cannot exceed 8.39% of an employee's total household income. See the following chart for how the decrease affects affordability:

Employers that use the FPL safe harbor will need their premium for employee-only coverage to be $101.94 or less per month (for plans beginning in 2024 for the lower 48 states and Washington, D.C.), without any other considerations. Employers that offer employee self-only coverage above this rate will need to consider an employee's rate of pay or W-2 to confirm they do not exceed the 8.39% of income threshold.

Implications

Employers should be aware that tax year 2021 ESRP letters are beginning to circulate and could contain larger assessments than in prior years. Going forward, employers should consider:

• Their potential exposure to ESRPs (i.e., how many full-time employees are not offered coverage or not offered coverage that meets an affordability safe harbor)
• New affordability percentages when they are released (generally in August) to determine the impact on ACA reporting and the potential for future ACA penalties
• The cost of meeting an affordability safe harbor