A Comprehensive Look at the Employer Mandate Penalty Assessment – Options, Real Examples, and Lingering Problems

December 18, 2017

In November the IRS began to slowly leak the process by which it will penalize Applicable Large Employer members (ALE members) under the employer mandate provision of the Affordable Care Act.  First, the IRS updated its Questions and Answers on Employer Shared Responsibility Provisions Under the Affordable Care Act to expound upon the questions related to Making an Employer Shared Responsibility Payment (see questions 55 through 58).  Next, the IRS issued a sample Letter 226J, Form 14764, and Form 14765 which provide greater detail as to the penalty process and the options for an employer who receives a penalty.  This article explains the details of the Q&A and sample forms, then discusses some of the reasons we have seen that employers have been inaccurately assessed a penalty.  It should be noted that the penalties we have seen to date have been concentrated to the northeast and largely limited to the section 4980H(a) penalty.  We anticipate employers in other regions of the country as well as the section 4980H(b) penalty to be enforced in the weeks and months to come.  The article concludes with discussing some changes the IRS needs to make to the Forms 1094-C and 1095-C to ensure a more accurate assessment of the employer mandate penalty moving forward.

If the IRS believes an ALE member owes an employer mandate penalty, the ALE member will receive a Letter 226J. The IRS plans to provide a Letter 226J to each ALE member who had a full-time employee receive a premium tax credit so long as the ALE member did not qualify for an affordability safe harbor or one of the relief provisions discussed in the final regulations.

The Letter 226J will include Publication 1 and Notice 609 which describe rights entitled to taxpayers. The Letter will also include Form 14764. Form 14764 is the vehicle ALE members will use to respond to the Letter 226J regardless of whether the ALE member agrees or disagrees with the proposed penalty amount. Additionally, the IRS package will include Form 14765 which will contain a list of the ALE member’s assessable full-time employees for the year in question. The Form 14765 will also include the code combinations the ALE member entered on lines 14 and 16 of the Form 1095-C for each assessable full-time employee. Finally, the IRS package will contain an envelope for use in the ALE member’s response.

If the ALE member is having the section 4980H(a) penalty assessed against it for any month of the year, it should start by reviewing the Form 1094-C.  The IRS has taken several default positions that could subject the employer to a section 4980H(a) penalty so understanding the Form 1094-C will be important if the section 4980H(a) penalty is being assessed.  If an ALE member left column (a) of Part III of the Form 1094-C blank for any month, the IRS is taking the position that the employer answered “No”. The IRS taking this position means the ALE member will be liable under section 4980H(a) for any month the ALE member has an assessable full-time employee.  We have seen a case where an ALE member accidently left column (a) blank which led to an inaccurate assessment of the section 4980H(a) penalty.  A simple correction to column (a) of part III can absolve an ALE member from the section 4980H(a) penalty (although as discussed below a thorough review of each assessable full-time employee should still be performed).

Additionally, if an ALE member did not complete column (b) of Part III of the Form 1094-C for all the months, the full-time employee count reflected in column (b) of the “ESRP Summary Table” will be the total number of Forms 1095-C the ALE member filed. This total likely significantly overestimates the ALE member’s full-time employee count for the month. However, if an ALE member did not complete column (b) in Part III of the Form 1094-C for certain months for the year in question, the full-time employee count reflected in column (b) of the “ESRP Summary Table” will be the greatest number of full-time employees the ALE member reported for any one month of the year in question. This is a generous position by the IRS and it could, although it is not likely, work in favor of ALE members who left column (b) in Part III of the Form 1094-C blank for certain months. Knowing these default positions, it is critical that a thorough review of each ALE member’s Form 1094-C be performed before paying any proposed section 4980H(a) penalty amount.

The next step in the process if an ALE member is being assessed a penalty under section 4980H(a) or section 4980H(b) is to review the individuals the IRS has labeled assessable full-time employees on the Form 14765.  To be an assessable full-time employee listed on the Form 14765, the individual will need to satisfy each of the following three conditions:

  1. The ALE member filed a Form 1095-C on behalf of the full-time employee;
  2. The employee received a premium tax credit for one or more months for the tax year in question; and
  3. The ALE member did not report on the Form 1095-C an affordability safe harbor or another relief provision from the employer mandate penalties for one or more of the months the employee received a premium tax credit.

If the three conditions are satisfied, the employee and the last four digits of the employee’s SSN will be listed in the first two columns of the Form 14765. The Form 14765 will be partially completed by the IRS, but also will serve as the place an ALE member can dispute and make corrections to the assessable full-time employees the IRS has identified.  An ALE member only needs to be concerned with the months of an assessable full-time employee which are not highlighted on the Form 14765.

To the right of the initial two columns, the Form 14765 has 13 columns which are divided into 2 rows. The first of these columns is an all 12 months column and will only be used if the ALE member entered the same line 14 and 16 code combinations for all 12 months. The next 12 columns will be for each calendar month in the year and will be used if the ALE member entered more than one code combination on line 14 and 16 for the tax year in question. The IRS will complete the first row for the appropriate columns using the line 14 and 16 code combinations the ALE member entered for the assessable full-time employee for the tax year in question.

In the Forms 14765 we have reviewed, the errors have been endless.  However, the underuse of the limited non-assessment period code (code 2D) has been a common theme.  The underuse of the limited non-assessment period code can lead to individuals triggering the section 4980H penalty who, if coded properly, would not.  Additionally, the underuse of the limited non-assessment period code can increase the amount of the section 4980H penalty.  The limited non-assessment period code can even be used in one circumstance to reduce an employer’s section 4980H(a) penalty even if no coverage was offered!  Having an expert review the codes used for the various employees on the Form 14765 can eliminate or, at the very least, reduce the ALE member’s section 4980H exposure.

If the ALE member determines that the code combination in the first row does not accurately reflect the employee’s situation, the ALE member will insert the new correct code combination in the second row for the calendar month. However, the sample Letter 226J instructs that if more than one code combination for lines 14 and 16 could apply, the ALE member is required to list the employee’s name, the applicable months, and the additional code combinations that could apply for each month in a signed statement. This is a departure from the Form 1095-C instructions and will add a great deal of complexity as a month will frequently have several line 16 codes that could apply.  If the ALE member is attaching any additional information for the particular assessable full-time employee, the box in the far right column should be checked.

The instruction’s requirement to provide each potential code combination if more than one line 14 and 16 code combination can apply is particularly cumbersome.  Fortunately, the ALE members we have assisted have had recurring alternative potential code combinations which should be a common theme for most employers.  It is critical that each code combination corrected on the Form 14765 for each assessable full-time employee is thorough and accurate.  Even if an ALE member has been assessed a section 4980H(a) penalty, each and every assessable full-time employee should be evaluated and corrected if necessary.  In a majority of the cases we have dealt with to date, we have been able to find errors in the previous code combinations for some of the assessable full-time employees.

Exasperating the situation further for some ALE members are scenarios where coding the Forms 1095-C without exposing the employer to the section 4980H penalties is impossible.  We have seen multiple situations where an ALE member offered a plan that technically met the minimum value requirements for 2015, but did not offer in-patient hospital services.  The IRS became aware of this strategy late in 2014 and subsequently released Notice 2014-69 and then regulations to address the issue and quash the strategy.  However, if certain criteria was satisfied, the employer’s offer of coverage that did not provide in-patient hospital services would still count as satisfying minimum value from the employer’s perspective in 2015.  Unfortunately, the 2015 instructions to the Form 1095-C make it clear that “an offer of coverage under a plan that fails to provide substantial coverage of inpatient hospitalization and physicians services should be reported on Form 1095-C as not providing minimum value, even if an employer qualifies for the section 4980H transition relief under Notice 2014-69 (emphasis added).”

The position taken in the 2015 instructions left numerous employers in the uncomfortable position of having to report on line 14 using code 1F rather than 1C or 1E despite having complied with the conditions discussed in Notice 2014-69.  Code 1F leaves an ALE member exposed to the section 4980H(b) penalty and, even more troubling, prevents the employers from using the limited non-assessment period code, code 2D, for any reason other than a new employee’s first partial month of employment (meaning the new employee’s start date was on any day other than the first of the month).  This often left the ALE member, who correctly followed the instructions, in the position to use code 1H for line 14 and leave line 16 blank.  Furthermore, code 1F prevents the employer from using any of the affordability safe harbor codes (codes 2F, 2G, and 2H).  This left the ALE member, who correctly followed the instructions, in the position to use code 1F for line 14 and leave line 16 blank if an employee declined coverage.  Both of these results portray to the IRS that the ALE member could be subject to the section 4980H(b) penalty, a portrayal that is inaccurate in light of Notice 2014-69.

Other scenarios have left ALE members in a similar, precarious position. For example, many staffing agencies frequently encounter employees who return from work after being “terminated.”  However, these employees frequently have not spent the requisite 13 weeks away from the employer to be considered a new employee when he/she is rehired and thus the individual is treated as a continuing employee under the final regulations.  This is problematic for staffing agencies attempting to code the Form 1095-C.  Unfortunately, under a strict reading of the limited non-assessment periods, code 2D would never be appropriate in this situation when the continuing employee was previously treated as a full-time employee.  Under a strict reading of the instructions, this leaves the staffing agency with no other option than inserting code 1H in line 14 and leaving line 16 blank.  This result portrays to the IRS that the ALE member could be subject to the section 4980H(b) penalty.  This portrayal is inaccurate as the final regulations require a continuing employee be offered coverage “as soon as administratively practicable.”

Additionally, ALE members who were hoping to use code 2F and code 2C in the same calendar year, a scenario that occurs sometimes when the ALE member has elected the form w-2 affordability safe harbor, may also encounter problems.  As explained more thoroughly in our previous publication, when discussing line 16 code 2F, the form w-2 affordability safe harbor code, the 2015 instructions state “If an ALE Member uses this safe harbor for an employee, it must be used for all months of the calendar year for which the employee is offered health coverage (emphasis added).” This is a strong statement and under a strict reading prevents the ALE member from using code 2F for any year in which code 2C is also entered for an individual.

This is problematic as the 2015 instructions are clear that code 2C should supersede all of the affordability safe harbor codes by stating “Enter code 2C for any month in which the employee enrolled in health coverage offered by the employer for each day of the month, regardless of whether any other code in Code Series 2 (other than code 2E) might also apply (for example, the code for a section 4980H affordability safe harbor)(emphasis added).”  Therefore, if a scenario occurs, such as a cancellation of coverage midyear by an employee, the ALE member cannot use code 2F according to the rules of the 2015 instructions (and subsequent iterations).  This would leave the ALE member with no other code 16 option forcing the ALE member to leave line 16 blank.  Like the examples discussed above, this result portrays to the IRS that the ALE member could be subject to the section 4980H(b) penalty.  And, again, this portrayal is inaccurate as nothing in the final regulations requires the form w-2 affordability safe harbor to be “used for all months of the calendar year for which the employee is offered health coverage” as the 2015 instructions (and subsequent iterations) to the Form 1095-C require.

There are myriad reasons an ALE members can be incorrectly assessed a penalty under section 4980H, some of which are entirely the ALE’s fault.  However, certain circumstances leave ALE members no alternative but to portray an inaccurate picture to the IRS on an individual’s Form 1095-C.  For months this has occurred and the employee has received a premium tax credit, the employer is being assessed a section 4980H penalty.  This forces the employer to respond to a Letter 226J in order to avoid a section 4980H penalty assessment.  That is ridiculous.  Moving forward the IRS needs to write the instructions to the Forms 1094-C and 1095-C in a way as to not put ALE members in an unfair position.

Regardless whether the ALE member agrees or disagrees with the penalty assessed by the Letter 226J, it will use the Form 14764 to respond.  If an ALE member agrees with the proposed penalty amount, an individual will print his/her name and position and sign and date the Form 14764. Before signing and consenting to any penalty payment it is prudent to contact an attorney as there are valid arguments that no employer mandate penalties can legally be assessed in 2015. Alternatively, if the ALE member disagrees in whole or in part with the Letter 226J proposed penalty amount, it should check the corresponding box.

We anticipate ALE members around the country to continue to receive the Letter 226J as the 2017 calendar year closes and the 2018 year begins.  It is critical that every ALE member who receives the letter takes immediate action and complies with the deadlines discussed on the Letter.  We highly recommend contacting an attorney who is an expert in the Forms 1094-C and 1095-C to assist you with your response to the Letter 226J.  Please feel free to contact us at rmoulder@healthcare-attorneys.com or call us at 314-698-9057 if you have any questions or if you are looking for assistance.

About the author – Ryan Moulder serves as General Counsel at Accord Systems, LLC and is a Partner at Health Care Attorneys P.C. Ryan received his LL.M. from Georgetown University Law Center and his J.D. from Saint Louis University School of Law. He has distinguished himself as a leader in the Affordable Care Act arena and has written and spoken on a variety of ACA topics as it relates to compliance for companies.

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