Understanding Affordable Care Act penalty risks for employers

By David S. Horvath, CPA, and Allen Tobin, J.D.
| 4/23/2019
Understanding Affordable Care Act Penalty Risks for Employers
The Internal Revenue Service is on its first wave of issuing penalties to applicable organizations that are not in compliance with the employer shared responsibility payment (ESRP) mandate of the Affordable Care Act (ACA). While 2015 was the first year employers had to file forms related to the ESRP mandate, that was essentially a grace period, meaning for tax years 2016 and onward, employers risk costly penalties if they do not comply with ACA rules that apply to them.

Many healthcare organizations meet the IRS definition of an “applicable large employer” (an organization with 50 or more full-time equivalent employees), meaning most of these organizations need to comply with the ACA’s ESRP mandate, often referred to as the employer mandate. The IRS can assess two major penalties to noncompliant healthcare employers, and those employers should understand how to be compliant or respond to the IRS should the organization receive a notice.

The “A” penalty: Internal Revenue Code (IRC) Section 4980H(a)
Also known as the “pay or play penalty,” this penalty is assessed when an applicable large employer fails to offer minimum essential coverage, as defined by the ACA, to at least 70 percent of its full-time employees and their dependents, and at least one of those full-time employees was allowed a premium tax credit (PTC) after getting coverage through a state health insurance marketplace. (Beginning in 2016, the percentage of employees receiving an offer of coverage was raised to 95 percent from 70 percent.) The PTC is a subsidy the individual receives for the cost of insurance purchased on a state exchange.1

The “B” penalty: IRC Section 4980H(b)
Even if an applicable large employer has made an offer of coverage to its employees, the IRS will assess this penalty if the following conditions exist:
  • The coverage is unaffordable to at least some of those employees based on ACA definitions.
  • At least one employee with an unaffordable coverage offer enrolls in coverage through the state exchange and receives a premium tax credit.

For the 2019 tax year, the IRS set the affordability threshold at 9.86 percent of an employee's household income, which is an increase from 9.56 percent for the 2018 tax year.2 To determine affordability, an employer would assess whether the premium required to be paid by an employee for self-only coverage under the lowest-cost option is less than 9.86 percent of the employee’s adjusted gross income (AGI). If the premium exceeds 9.86 percent of AGI, it would not be considered affordable per ACA requirements.

It can be difficult for an employer to calculate an employee’s AGI, given that it most likely does not have information pertaining to that employee’s income from other sources, such as a spouse. To accommodate this, many employers set the cost of their offered insurance premiums such that an employee could afford them based on salary earned from the employer only.

ESRP penalty notices explained
If the IRS believes an employer owes an ESRP for failure to comply with the ACA employer mandate, it will send to the employer a Letter 226-J containing the amount the employer owes. Proposed IRS penalties can be significant, amounting to more than $3,000 per employee per year.3

Letter 226-J does not clearly explain why the IRS is instituting the penalty. However, an ESRP summary table in the letter, along with Form 14765, “Employee Premium Tax Credit (PTC) Listing,” which accompanies the letter, provide insight into which penalty the employer is subject to.

Responding to a penalty notice
If an employer receives a Letter 226-J, it must respond to the IRS by the listed response date, which is typically 30 days after the letter’s date. An employer may ask for an extension to respond to the penalty notice.

Many times, when the IRS issues a penalty, the employer may find that the initial forms it completed – Form 1094-C, “Transmittal of Employer-Provided Health Insurance Offer and Coverage Information Returns,” sent to the IRS with the employer’s Form 1095-C, “Employer-Provided Health Insurance Offer and Coverage” – were filled out incorrectly. For example, the employer may have indicated that an employee did not receive an offer of coverage for all 12 months when in fact he or she did. Or, an employee, when applying for coverage through a state insurance exchange, may have indicated that the offer of coverage from the employer was unaffordable when it in fact was affordable per ACA guidelines. In situations such as these, taxpayers may have success getting the penalty removed with an explanation of the error.

In addition to submitting a written response explaining why the employer believes the penalty does not apply, the employer also will need to complete Form 14764, “ESRP Response.” On the form, the employer can indicate its contact information and the contact information of a tax specialist or attorney whom the IRS can follow up with if additional information is required.

On Form 14765, an employer can indicate changes and corrections that need to be made to its PTC listing, which indicates which employees received a premium tax credit (and, effectively, triggered an IRS penalty for the employer). For example, an employer, on its previously filed Form 1095-C, may have indicated that an employee received an offer of coverage but elected not to be covered under the employer’s plan. If the employer later finds out that the employee did in fact accept the offer of coverage from the employer, and therefore there should be no penalty assessed, the employer can indicate this on Form 14765. This action amends the employer’s previously filed Form 1095-C.

In its initial written response to the IRS disputing a penalty, an employer can indicate that it reserves all administrative and appeals rights. If the IRS responds to the employer that upon review it believes a penalty still applies, the employer reserves its rights to negotiate with the IRS about how the penalty will be applied or disposed of.

Seek help from tax specialists
As initial penalties related to the ESRP portion of the ACA are hitting applicable employers, it’s a good idea to review the laws and verify that the organization is properly reporting information about its employee health insurance coverage. Because these laws and the required responses to a penalty notice can be complicated, healthcare organizations should refer to their tax specialists for help navigating the waters and to avoid risks and potential penalties.


1 “The Premium Tax Credit – The Basics,” Internal Revenue Service,  March 28, 2019, https://www.irs.gov/affordable-care-act/individuals-and-families/the-premium-tax-credit-the-basics
2 Stephen Miller, “ACA’s Affordability Threshold Rises in 2019,” SHRM Online, May 30, 2018, https://www.shrm.org/resourcesandtools/hr-topics/benefits/pages/aca-affordability-threshold-rises-in-2019.aspx
3 Ibid.


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