Affordable Care Act Mistakes Can Result in Costly IRS Penalties to Employers

Published: Mar 12, 2024
By: Kristen De Noia; Miri Forster
Topics: Tax

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The Affordable Care Act (“ACA”) was enacted in 2010 and requires certain employers to offer affordable minimum essential health coverage, that provides minimum value, to at least 95% of their full-time employees and their dependents. An employer can be subject to a significant shared employer responsibility payment (“ESRP”) under IRC Sec. 4980H(a) if it fails to offer sufficient health coverage causing a full-time employee to qualify for a premium tax credit (“PTC”).

Under IRC Sec. 36B, eligible individuals who enroll themselves or a family member in coverage through a Health Insurance Marketplace may claim the PTC. If the employee’s required contribution to the insurance plan’s premiums is not affordable, the employer may be subject to a lesser, but still significant, ESRP under IRC Sec. 4980H(b).

Employers are also required to timely report information on health coverage on Form 1094-C, Transmittal of Employer-Provided Health Insurance Offer and Coverage Returns, and Form 1095-C, Employer-Provided Health Insurance Offer and Coverage, under IRC Sec. 6056. Failure to comply with the timely furnishing and filing rules contained in IRC Sec. 6056 may also result in IRS penalties.

Currently, the IRS is issuing ESRP and information reporting penalty notices to employers that relate back to the 2020 and 2021 tax years.

Who Is Required to Provide Health Coverage:

The ACA mandate applies to applicable large employers (“ALE”). An ALE is an employer that employed at least 50 full-time employees (including full-time equivalent employees) on average during the preceding calendar year. There are exceptions for employers who:

exceeded more than 50 full-time employees for 120 or fewer days during the prior calendar year, or
had an excess of 50 full-time employees as seasonal workers.

Therefore, a startup company that kept its employee count low during the majority of the year, but later increased to over 50 full-time employees during the last three months, would not be considered an ALE for that year. Likewise, a summer sleepaway camp that has a limited number of year-round full-time employees, but hires 100 college students as full-time counselors in the summers, would not be considered an ALE.

Consequences for Failure to Provide Sufficient Health Coverage:

An ALE’s failure to offer sufficient health coverage that causes a full-time employee to receive a PTC can subject an employer to a substantial ESRP under IRC Sec. 4980H(a). If the employee’s required contribution to the insurance plan’s premiums is not affordable, the employer may be subject to a lesser, but still significant, ESRP under IRC Sec. 4980H(b). Where ESRPs apply under both provisions, only the larger ESRP under IRC Sec. 4980H(a) will be assessed.

A. ESRP Under IRC Sec. 4980H(a)

An ALE must make an offer of minimum essential health coverage providing minimum value to at least 95% of its employees and their dependents as defined below.

Offer

An ALE’s employees must be given an effective opportunity to elect to enroll in coverage at least once in respect to the plan year. Whether an employee has an effective opportunity to enroll is determined based on all the relevant facts and circumstances, including:

adequacy of the notice of the availability of the offer of coverage,
period of time during which acceptance of the offer of coverage may be made, and
any other conditions on the offer.

Minimum Essential Health Coverage

The majority of commercially available group health insurance plans would meet the minimum essential coverage requirement. Examples of plans that would not fulfill this criterion include:

offers of only dental and/or vision plans,
coverage available solely under workers compensation, and
plans that only offer discounts on medical services.

Providing Minimum Value

A plan provides minimum value if it covers at least 60% of the total allowed cost of benefits that are expected to be incurred under the plan and provides substantial coverage of inpatient hospitalization services and physician services.

ESRP Calculation

ALEs that do not comply with the above requirements will be subject to a hefty ESRP under IRC Sec. 4980H(a). The ESRP is calculated on a month-by-month basis. An ESRP under IRC Sec. 4980H(a) is calculated by multiplying the total number of full-time employees for that month (less 30) by a factor called the applicable payment amount. The applicable payment amount is indexed annually for inflation. For 2024, it is 1/12 of $2,970.

To illustrate, if an ALE had 130 employees for every month of the year, and did not offer coverage at all during the year, the ESRP under IRC Sec. 4980H(a) would be $297,000.

B. ESRP Under Sec. 4980H(b)

Assuming an ALE offers sufficient health coverage to its full-time employees and their dependents, the offer must be affordable to each employee. If the coverage is not affordable, that may trigger an ESRP under IRC Sec. 4980H(b). The ESRP is only assessed under IRC Sec. 4980H(b) where the employer does not also have an ESRP under IRC Sec. 4980H(a).

Coverage is considered affordable when an employee’s required contributions to the least expensive self-only coverage policy offered are less than the affordability percentage of their household income. The affordability percentage is indexed annually for inflation. For plans beginning in 2023, this percentage is 9.12% (8.39% for plans beginning in 2024). Because employers often do not know the household income of their employees, they can rely on one of three safe harbor methods for determining affordability.

W-2 Safe Harbor

Coverage will be affordable if an employee’s required contribution does not exceed 9.12% of wages paid to the employee, as reported in box 1 of the employee’s Form W-2 (8.39% for 2024).

For example, assume an employee receives $30,000 in wages, as reported in box 1 of his 2023 Form W-2. Their contribution cannot exceed $2,736 for the year ($2,517 for 2024), or $228 per month ($209.75 for 2024).

Rate of Pay Safe Harbor

Coverage will be affordable if an employee’s required contribution does not exceed 9.12% (8.39% for 2024) of their monthly rate of pay, assuming 130 monthly hours worked.

For example, assume an employee receives a wage of $15/hr in a given month. Their contribution cannot exceed $177.84 per month in 2023 ($15/hr x 130 hours x 9.12%) or $163.61 per month in 2024 ($15/hr x 130 hours x 8.39%).

Federal Poverty Level Safe Harbor

Coverage will be affordable if the employee required contribution does not exceed 9.12% of the federal poverty line for a single individual (8.39% for 2024). The 2023 federal poverty guideline for a single individual is $14,580 ($15,060 for 2024). Therefore, coverage will be affordable under this safe harbor if the employee’s contribution does not exceed $1,329.69 for the year ($1,264 for 2024) or $110.81 per month ($105.29 for 2024).

ESRP Calculation

The ESRP under IRC Sec. 4980H(b) is calculated by multiplying the number of full-time employees that received a PTC on their individual income tax returns by the applicable payment amount (1/12 of $4,320 for 2023 and $4,460 for 2024).

Therefore, if an employer had four employees receiving a PTC for every month of 2023, the ESRP under IRC Sec. 4980H(b) would be $17,280 ($17,840 for 2024).

Consequences for Not Timely Satisfying ACA Information Reporting Requirements:

As a general rule, ALEs are required to furnish and file Form 1094-C and Form 1095-C to report information about offers of health coverage under IRC Sec. 6056. The IRS uses the information reported on Forms 1094-C and 1095-C to determine whether an ALE is subject to one of the above described ESRPs under IRC Sec. 4980H(a) or (b). Form 1095-C is also used by the IRS to determine the eligibility of an employee (and his family) to the premium tax credit under IRC Sec. 36B.

The IRS may impose penalties for failure to timely file Forms 1094-C and 1095-C with the IRS and for failure to timely furnish these forms to employees under IRC Secs. 6721(a) and 6722(a). For 2023, penalties are up to $310 per failure or $630 if the failure is due to intentional disregard. No penalty is imposed if the failure was due to reasonable cause and not willful neglect, per IRC Sec. 6724. These same penalties apply to late or incomplete Form W-2, Form 1099, or Form 1042-S filings.

For the 2023 tax year, ALEs were required to furnish and file Forms 1094-C and 1095-C by the following due dates:

Forms 1095-C furnished to employees by March 2, 2024.
Paper filed Forms 1094-C/1095-C filed with the IRS by Feb 28, 2024.
Electronically filed Forms 1094-C/1095-C with the IRS by March 31, 2024.

Penalties may also be imposed for failure to electronically file when certain thresholds are met.

The requirements the Affordable Care Act imposes on employers are incredibly complex, and one failure to comply could result in significant penalties. Taxpayers who are impacted by the employer shared responsibility payment should engage an experienced tax advisor to help them navigate the complexities.