Over the past year, the IRS has ramped up enforcement of the Affordable Care Act’s mandate that large employers provide affordable health coverage to their full-time employees. Applicable large employers (“ALEs”) that fail to comply with the mandate are liable for Employer Shared Responsibility Payments (“ESRP”) – effectively a punitive tax imposed under the Affordable Care Act. When the IRS sends an employer form letter 226J, this signals that the IRS has taken the first step toward enforcing the ACA mandate and imposing liability for ESRPs. In other words, if you are an employer that received such a letter, it may be the start of an extremely expensive problem.
Nature of the Mandate and Liability for Payment
While Congress, the President, and most federal regulators have each recently demonstrated disdain for some marquee features of the ACA, the statutory mandate that ALEs provide qualifying health benefits coverage to all or nearly all full time employees or face severe penalties remains in effect. Most pertinent to this article, the IRS has recently started enforcing this mandate, and all indications point toward increasing and more stringent enforcement going forward.
Letter 226J is effectively a first notice from the IRS that it seeks to enforce the ACA’s large employer mandate against an employer it believes has failed to comply with the mandate. By way of background, the large employer mandate requires that any employer of fifty (50) or more persons (or “full-time equivalents”) must offer at least 95% of its full time employees with health coverage. This mandate can be broken down into several elements. First, the mandate applies only to “applicable large employer or “ALEs” . The rules governing who constitutes an ALE can themselves be difficult to interpret and apply. Second, the mandate requires only that an “offer” of coverage be made to 95% of full-time employees, not that coverage be accepted by such employees. Third, the mandate requires that the coverage offered provide both “minimum essential coverage” and “minimum value.” Fourth, and perhaps most difficult to apply and problematic for employer, the coverage offered must be “affordable” to the employees.
The penalty for not providing health coverage in accordance with the large employer mandate is the “Employer Shared Responsibility Payment” or “ESRP.” The ESRP is triggered if coverage is not offered to at least 95% of full time employees OR, even if the coverage is offered, it is not “affordable” to even one employee, and the employee receives a premium tax credit to buy individual coverage on an applicable healthcare exchange (i.e., “Obamacare”). An employer’s receipt of Letter 226J from the IRS means that the IRS has reviewed the employer’s offer of coverage and its employees’ claim(s) (or lack thereof) for a premium tax credit, and has determined that the employer owes ESRP. However, a careful examination of the IRS’s assertion of the ESRP may reveal that the employer’s ESRP obligation is substantially overstated, or perhaps not owed at all. The IRS’s assertion of ESRP liability can potentially be refuted on several bases.
Determining Whether ESRP Is Actually Owed
To determine whether ESRP is genuinely owed by an employer, one must review what benefits must actually be offered by the employer’s health benefits plan. The benefits offered by the employer provide “minimum essential coverage” or “MEC.” MEC must include the ten “essential health benefits,” which are effectively a list of services prescribed by the ACA that must be covered by the employer’s health benefits plan. Additionally, MEC must have minimum value (“MV”), which means that the health plan offered by the employer must cover the cost of least 60% of the healthcare services covered by the plan. Finally, the health benefits plan offered by the applicable large employer to its employees must be affordable. That is, the total cost to the employee to enroll in the plan must not be more than 9.56% of the employee’s household income.
Letter 226J explains why the IRS has asserted ESRP liability against a particular employer. In cases where the IRS asserts that an employer has failed to offer minimum essential coverage to at least 95% of its full time employees, there are potential errors in the IRS’s assertion that can be addressed in a response to the letter. For example, the IRS may assert that the coverage offered by employer fails to offer the 60% minimum actuarial value. This is more likely to be an issue with self-insured health benefit plans frequently sold by employee benefit brokers as a package of TPA services and stop-loss insurance. Circumstances can arise when the plan designer’s actuarial projections do not match claims experience and employees are paying more in co-pays, co-insurance and premium than expected.
The far more likely basis for the IRS to assert ESRP liability is that the employer has allegedly failed to satisfy the affordability requirement of the large employer mandate. This requirement, unfortunately, is ripe for employee fraud to the detriment of the employer. If an employee understates his or her household income on personal income tax returns, or overstates the cost of health benefits coverage offered by the employer, the employer’s offer of coverage can fail the affordability requirement that coverage not cost the employee more than 9.56% of household income. If an employee misstates either income or the cost of coverage for the purposes of obtaining a premium tax credit to purchase individual health coverage on an applicable state or federal individual health insurance exchange, ESRP liability for the employer is trigger. In such circumstances, the employer bears the burden of proof to demonstrate that the employer not owe the ESRP stated in Letter 226-J.”
Developing a Response to Letter 226J
There are several potential defenses to IRS assertion of liability for the ESRP. First, and most obviously, is that the employee who claims the tax credit did so based on a misrepresentation of their income or the cost of their employer-provided coverage. Second, there are numerous nuances to the definition of “applicable large employer” and determining whether an employer is even subject to the mandate. Third, there two very different calculation methodologies for ESRP depending on which prong of the test for coverage the employer failed. One calculation imposes a $2000 penalty per employee per plan year, for all employees, and the other imposes a $3000 penalty but only for the specifically effected employee(s) who failed to receive an affordable offer of coverage. Fourth, in plan years 2015 and 2016, for which the IRS continues to send Letters 226J to employers, there are “transition relief” programs that can reduce the total ESRP liability.
Upon receipt of Letter 226J, an employer has a short window of time (30 days) to develop a comprehensive response to the IRS’s assertion of liability. Employers in receipt of such letters may turn to the employee benefit brokers for aide in response, and by then such brokers will have even less time to facilitate a response. All of these issues identified, and frankly more, should be specifically and carefully addressed in the response to the IRS letter 226-J. For large employers, enforcement of the health benefits mandate is expected to be a significant source of revenue for the IRS and federal government going forward. For the 2015 plan year, the IRS sent approximately 30,000 letters seeking to collect approximately $4.4 billion in ESRP payments. The Congressional Budget Office anticipates that for the 2018 plan year, the IRS will assert over $12 billion in ESRP liability against employers. This mandate of ACA, therefore, appears here to stay for the long term. Consultation with a broker or other insurance professional with plan design expertise and ACA compliance counsel should be considered if an employer receives an a Letter 226J. Please contact Michael Morris with questions.