Preparing for and Responding to IRS Penalty Notices for Employer Health Coverage Requirements

The Affordable Care Act established employer shared responsibility provision (ESRP) penalties that encourage employers to provide affordable healthcare coverage to employees. Under these rules, applicable large employers (ALEs) – generally employers with more than 50 full-time employees on average during the prior calendar year – must offer affordable minimum essential coverage that provides minimum value to substantially all their full-time employees and their dependents. Employers who do not comply could face ESRP penalties.

The IRS determines ESRP liability based on information returns filed by the employer – Form 1094-C, Transmittal of Employer-Provided Health Insurance Offer and Coverage Information Returns, and Form 1095-C, Employer-Provided Health Insurance Offer and Coverage – as well as individual tax returns of employees who claimed a premium tax credit (PTC). Small errors and miscodes on Forms 1094-C and 1095-C can result in the proposal of ESRP penalties.

ESRP penalties can arise in two ways:

• Failure-to-Offer Penalty. If an ALE fails to offer minimum essential coverage to at least 95 percent of its full-time employees (and their dependents) and at least one full-time employee receives a PTC through the health insurance marketplace, the ALE owes a penalty calculated on a per-full-time employee basis. These penalties can be significant because they are assessed based on the total of the ALE's full-time employees, even those employees who received healthcare and did not qualify for the credit.
• Failure to Offer Adequate Coverage Penalty. If an ALE offers coverage but that coverage is unaffordable or does not provide minimum value and a full-time employee receives a PTC, the ALE may owe a penalty calculated on a per-employee basis for each employee who received the credit. Three affordability safe harbors may provide relief, depending on the cost of the employer's coverage.

An employer is not an ALE subject to the ESRP if it employs fewer than 50 full-time employees, including full-time equivalent (FTE) employees, on a nonseasonal basis. Further, a seasonal worker exception provides that an employer whose workforce exceeds 50 FTE employees for 120 days or less during the calendar year is not an ALE. Businesses that employ a large number of part-time or seasonal employees who receive W-2s should be alert to the possibility of the IRS incorrectly classifying them as ALEs based on total employee headcount.

The IRS Penalty Notice

The IRS sends an initial notice (known as Letter 226-J) proposing penalties. It is important to understand that this notice is not a bill but rather a proposed assessment that can be contested. However, employers who receive a notice should act quickly to preserve their rights to challenge the proposed assessment.

The letter includes the proposed penalty amount, a summary table showing which penalty is being imposed, a response form and a listing identifying which employees received a PTC and the months for which a penalty is proposed.

In Holland & Knight's experience, the IRS is likely to send these penalty notices for Tax Year 2024 at the end of 2026. If an employer believes they may be liable for an ESRP or discovers mistakes on their information returns that they believe may result in the proposal of ESRP penalties, they should begin preparing for a potential notice now.

Preparing Early

Employers can prepare before receiving an initial notice by gathering data and assessing potential exposure. Proactive preparation is critical because the response window is short and the data needed can be time-consuming to locate and compile, particularly if a business has undergone changes to its structure, ownership or software systems since the tax year in question.

Businesses looking to prepare for a potential notice should consider pulling together a record that contains the following information:

• employee start and end dates
• number of hours worked per month for all employees
• wage or W-2 data for all employees
• records of health coverage offers made to each employee
• benefit guide showing whether health care offered met minimum essential coverage and minimum value standards
• healthcare premium information (as calculated by the IRS)
• copies of Forms 1094-C and 1095-C as originally filed

Responding to the IRS Notice

In the event a business receives an initial notice, there are certain steps that should be taken to resolve the matter as quickly and effectively as possible:

1. Review the Notice. The notice will provide all the information a business needs to determine whether the penalty is actually owed, including the type of penalty, employees for whom the penalty has been proposed and whether any affordability safe harbor has been applied. It also sets forth taxpayer rights, including the right to provide additional information in the event of an inaccurate proposed assessment.
2. Review Information on the Notice for Accuracy. Compare the information on the notice against internal employment records. Many penalties result from errors on the forms rather than an actual failure to offer required coverage.
3. Compile Internal Records. If not done already, compile employment records, which are critical to demonstrating compliance or identifying the basis for an incorrect assessment.
4. Make Payment or Submit Response. If a taxpayer disagrees with the proposed penalty, it may submit a response that includes:

• the ESRP Summary form included with the notice, which tells the IRS whether or not the business agrees with the proposed assessment
• a revised Employee PTC Listing, correcting employee coding to reflect employees' dates of service, full- or part-time classification, offer of healthcare coverage and any affordability safe harbor
• narrative explaining any corrections to the proposed ESRP, including, if applicable, clarification of ALE status

A business should consider hiring outside tax or Employee Retirement Income Security Act (ERISA) counsel to prepare the response, which involves analysis and application of complicated Treasury Regulations to employee data, and serve as contact with the IRS.

5. Respond Within the Deadline – or Request an Extension. In general, the IRS does not provide much time to respond to a penalty notice, usually 30 to 90 days. The response deadline is printed on the top of the notice. If additional time is needed, the IRS will usually grant an automatic extension over the phone. Responding within the deadline is key to preserving the employer's right to challenge the proposed assessment.

Holland & Knight Insight

Holland & Knight has had considerable success in reducing or eliminating these penalties through targeted outreach to the IRS' ESRP division. Our team understands the procedural intricacies of the process and has developed effective strategies for challenging proposed penalties. Whether the issue involves incorrect Forms 1094-C or 1095-C, misclassification of employees as full-time or errors in the IRS' own calculations, our attorneys have the experience to help employers navigate this process.

For more information regarding employer health coverage penalty notices or ESRP penalties, contact the authors of this alert or your Holland & Knight representative.

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.