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The Dreaded IRS "226-J" Letter – Why an Employer Might Get One and How To Respond

December 8, 2020

In this industry, particularly during the 4th quarter and a global pandemic, LOTS of things make us reach for our phones to text each other something roughly equivalent to "oh dear!"  One that never fails to provoke our dismay is hearing about an applicable large employer (ALE) that got a Letter 226-J (or really any ESRP enforcement letter) from the Internal Revenue Services (IRS), and either: (1) ignored it; (2) didn't take it seriously; or (3) replied to the IRS without thinking it through.  We've had a couple of cases like this cross our desks lately, so we thought the dos and don'ts of 226-J letters might be worthy of a discussion amongst friends.

What Is A Letter 226-J?

First, let's back up a minute and review what a Letter 226-J is, and more importantly, what it is not.  The IRS sends 226-J letters to ALEs when they believe that the ALE may have failed to meet the employer-shared responsibility requirement to offer specified employees health coverage for a given tax year.  Put another way, it's the first letter the IRS sends to a company if they think the ALE might owe an employer mandate penalty. The letter explains the IRS believes that at least one of their employees who should have been offered employer coverage qualified for an individual market premium tax credit through a health insurance exchange.  A 226-J letter delineates why the IRS believes the company may owe an employer shared responsibility penalty. 

While a 226-J letter contains a proposed penalty amount, it is not a bill.  It's merely an estimate of what the IRS thinks a business might owe. If a company agrees with their assessment, they can pay it right away, but the proposed penalty amount is not final. The information and estimates offered in 226-J letters are also not guaranteed to be accurate.  Proposed penalty amounts are often wrong, and there is a straightforward process for employers to respond to the IRS.  Getting a 226-J letter is not a reason to panic, but it's not a joke either.  Every business subject to the ACA's employer responsibility requirements should be aware of what a 226-J letter is and also know that it needs to be taken seriously if they get one.

A few other critical things to know about IRS 226-J letters:

  1. They always arrive via the U.S. mail.  A business that gets an initial phone call or an email from "the IRS" telling them that they owe employer mandate penalty money is being scammed.

  1. The letter will be addressed to the contact person that was listed on Form 1094 for the affected tax year.  Sometimes, particularly this year, with so many pandemic-related workforce changes, the person named on the letter no longer is an employee or might not work at the physical location where the letter arrives.  That's why everyone who processes the mail at an ALE should know to always be on alert for correspondence from the IRS!

  1. The response deadline is only 30 days after the date on the letter.  This is a VERY short turnaround time. So, if you are a broker, make sure all clients subject to the employer mandate know to notify you right away upon receipt.

226-J Letter Dos and Don'ts

If you or a client gets a 226-J letter from the IRS, the first thing to do is stay calm.  Then, read the letter very thoroughly.  It will explain precisely why the IRS thinks you might owe an ERSP penalty for the year in question. The letter will also detail all of the response options available.  

It's also critical to prioritize your response and dedicate time to its preparation.  The letter will generally require a response within 30 days.  DO NOT miss this deadline! If you don't get back to the IRS timely, they will turn your proposed assessment into a tax bill via a separate notice. The penalty amount could then be subject to interest, liens, and enforcement action if you do not pay it. So, no matter what your planned course of action is, you'll need to act quickly!

Next, look through all of the supporting materials the IRS sent along with your letter.  You should have:

  • An explanation of the employer shared responsibility provisions; 
  • An ESRP summary table itemizing your proposed penalty by month and a document that explains the enclosed table;
  • A copy of Form 14765, which lists any employees who received a premium tax credit for the tax-year at hand; and 
  • Form 14764, which is what you should use to prepare your ESRP Response. 

Then, dig out a copy of the Forms 1094-C and 1095-C that your company filed for the tax year in question.  You also might want to review the IRS web pages on Form 226-J and preparing a response. Using all of these documents as a reference, see if you can find any mistakes.  These errors could on the part of the IRS.  Or, mistakes on your employer reporting forms might have led the IRS to believe that someone should have been offered coverage when they were not eligible, or that someone's coverage offer was "unaffordable" or did not meet the "minimum value" standard.  

Once you've identified any discrepancies and understand why the IRS thinks you could owe a penalty, begin the process of completing your Form 14764 response.  When doing so, you must FOLLOW EVERY INSTRUCTION!  Please do not give them more information than they've asked for, and complete every step in the process as directed.  The letter allows you to provide additional documentation if needed, but if you do, make sure it is the relevant documentation and determine if the IRS requires a copy.  Many times, particularly under the current administration, all the IRS wants is their Form 14764 and appropriately completed attachments!

While you are doing all of this work, don't take the fact that your company got a 226-J letter personally.  ESRP processing is a relatively new system for the IRS, and they built it in a hurry.  It generates lots of errant penalty assessments.  Some are completely wrong, and the ALE does not owe a thing. In many other instances, the actual penalty due is far less than what was proposed initially.  Often, minor and unintentional employer reporting errors throw the entire system off, and just proving the IRS with a simple correction is all that you need.  Getting a letter does not mean that your company is flawed or in trouble.  It also doesn't necessarily mean that your employer reporting vendor did a lousy job.  Many companies receive assessment letters or inaccurate penalty proposals due to human and computer-based errors.

Also, resist the temptation to reach out to anyone you might know at the IRS for help.  The department that handles ESRP is entirely independent of all other IRS operations, and the left hand often has NO IDEA what the right hand is doing.  Involving another contact seldom helps in these cases, and we have seen it unintentionally make things much worse.  Instead, focus all of your attention on just completing your response exactly as instructed. 

Finally, do reach out for help if you need it!  There are many people, including two of your friends, who deal with ESRP all of the time.  We're always happy to commiserate, provide assistance, and swap crazy stories about insane proposed penalty amounts and circumstances!