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What you need to do with an IRS penalty letter

Over the past few years, many employers have received a specific letter (form Letter 226J) from the IRS assessing a proposed Employer Shared Responsibility Payment (ESRP). This 226J letter is used by the IRS to notify an applicable large employer of a proposed employer mandate penalty. The letter gives a brief explanation of the employer mandate regulations, a payment summary table listing out the assessed penalty amount under penalty A or B by month, a list of the employees who were given a premium tax credit for at least one month, and the ESRP Response Form 14764 to be completed by the employer and returned to the IRS. Whenever an employer receives a 226J letter, the appropriate person should immediately look over the letter and pay special attention to the response due date listed on page 1, and determine what follow up is necessary. Sometimes the correct person doesn’t receive the letter for several weeks, leaving only a few weeks or days to respond by the IRS’s 30-day due date. As a result, some employers might need to request an extension if they need more time, which should be requested before the original response date. The IRS is much less likely to grant extension requests received after the response date listed on the first page of the Letter 226J. If the employer believes that the penalties are assessed in error, the responsible person should review records and reports that support a challenge to the IRS’s proposed penalty amounts. For example, the employer can include documents showing that an employee was offered coverage but declined, or documents showing that the coverage offered was affordable (under one of the 3 safe harbors) and met minimum value. The employer should also review 1094/1095-C forms from the corresponding year to find any discrepancies between the IRS’s letter and the information reported, and determine whether any information reported on those forms was inaccurate or incomplete. If the employer wants to challenge the proposed penalty, the employer should complete and send the attached 14764 and 14765 response forms. Here are some practical steps to take, depending on which penalty is assessed:

  • Attach a signed statement explaining why the employer disagrees with part or all of the proposed penalty. They could include supporting documents, such as enrollment information showing that an offer of coverage was made and an SBC showing that the coverage offered was MEC that met minimum value.

  • Describe any changes that the employer wants to make to the information reported on the 1094-C (this is the main form the IRS uses to calculate penalty A). At this point, the employer shouldn’t file a corrected Form 1094-C with the IRS but instead should use Form 14764 to report any changes to the Form 1094-C for the applicable tax year.

  • Explain any changes that the employer wants to make to the information reported on Form 1095-C (this main form that the IRS uses to calculate penalty B). This may include using Form 14765 to change indicator codes previously reported to the IRS on lines 14 and 16 of Form 1095-C. The employer shouldn’t file corrected 1095-Cs to report any changes to the IRS, but should instead use Form 14765.

  • Contest the method of penalty calculation. For example, the penalty A formula includes a “minus 30” component, so that the ALE member’s full-time employee count is reduced by 30 when the penalty is calculated. Transition relief for the 2015 plan year allowed this reduction to be “minus 80” instead of “minus 30”, temporarily reducing the penalty for one year. Many employers who received Letter 226J for 2015 have reported errors in the IRS’s application of the “minus 80” reduction (such as using “minus 30” instead of “minus 80”). Thus, employers should carefully review column c of the ESRP Summary Table since errors in this column directly impact the amount of penalty A.

Once the employer completes and mails the response forms and provides sufficient documentation, the IRS will acknowledge the response with a series 227 letter, which provide any additional actions to take. If, after receipt of Letter 227, the employer still disagrees with the IRS’s penalty, they can request a pre-assessment conference with the IRS Office of Appeals. If the employer fails to respond to either Letter 226J or Letter 227, the IRS will assess the proposed penalty and issue a notice and demand for payment.

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