5 Steps to Reduce Risk of IRS 226-J Assessments

Organizations across myriad industries have struggled to maintain compliance with the Affordable Care Act’s (ACA) Employer Shared Responsibility Payment requirements for many reasons – from the challenge of tracking variable hour staff to employee populations spread out among multiple commonly owned companies.

And yet, regardless of the fact that the COVID-19 pandemic is complicating compliance issues even further, the Internal Revenue Service (IRS) is under increasing pressure from the Treasury Inspector General for Tax Administration to assess potential ACA employer penalties for previous reporting years,[1] and those fines can total in the millions of dollars for a single employer.

The good news is that, even with the increasing complexity of ACA requirements brought on by the administration’s economic response to the pandemic, there are concrete steps employers can take to reduce their risk of receiving a Letter 226-J, the IRS notification of potential assessments.

1. Correctly Determine Each Employee’s Eligibility for Health Insurance Coverage

The ACA requires applicable large employers (ALEs) to offer 95 percent of their full-time employees health care coverage that meets minimum essential coverage requirements, provides minimum value (at least 60 percent actuarial value) and qualifies as affordable. While it’s never been simple to measure the eligibility of employees who work variable or seasonal schedules, COVID-19 has sparked more complexity due to furloughs, reduced hours and pay, leaves, layoffs and more.

For example, employees who have been kept on the company payroll but who also have not been working throughout all or a portion of the current national health crisis must still be measured for eligibility. Furthermore, employees who have been laid off or terminated and then rehired within 13 weeks (26 weeks for educational institutions) must be treated as ongoing employees — not new hires — which factors how measurement occurs.

Certain employers (mostly those with fewer than 500 employees) also must understand how the expanded Family and Medical Leave Act (FMLA) provision under the Families First Coronavirus Response Act (FFCRA) affects eligibility in order to mitigate the risk of accruing costly ACA employer responsibility penalties. Of particular note, FMLA leaves of absence are typically treated as a protected unpaid leave period, which is either:

• Excluded from the measurement period when averaging hours to determine if the employee meets the standard of 30 hours/week or 130 hours/month to be considered full-time, or
• Credited to the employee with their average number of hours during the leave of absence and then calculated to see if the employee meets the full-time standard for the measurement period.

Under the FFCRA, employers need to measure the sick, vacation or other PTO hours the employee uses for the first 10 days of a protected leave. For the remaining leave time, employers must credit hours to the employee at their typical hours of service each week so that the employee is not negatively impacted during the measurement period.

While the FFCRA provided some relief to struggling families, nothing in it protects employers from incorrectly calculating and reporting employees’ worked hours to determine eligibility for coverage, which could result in costly fines from the IRS (known as Penalty A). The financial impact of a Penalty A violation is $2,570 per full-time employee. If you are not an expert on these specific eligibility nuances, it’s important to be working with one to minimize your penalty risk exposure.

2. Validate Data and Correct Anomalies

Human Resource Information Systems (HRIS) are a wonderful advancement for HR management. However, the data they generate is only as good as the information entered. As the pandemic has caused changes in the status of employment for millions of workers, their employers need to update these changes in their HRIS platforms. The challenge is that, oftentimes, updating information for ACA reporting purposes falls off the priority list for many HR teams, resulting in data that’s fragmented, missing and/or confusing.

For example, if an employer were to code an individual as a terminated employee, even though that person has actually been furloughed and is still on the payroll, the resulting ACA report will reflect inaccurate data and may ultimately result in IRS penalties. If an employer really does need to take data shortcuts, it also then needs to ensure that all personnel involved in ACA reporting communicate with one another so that everyone is on the same page when it comes to understanding how data is entered, pulled and interpreted.

Finally, in addition to correctly classifying employees and/or ensuring strong cross-departmental communication practices, employers should take other standard data validation actions before their ACA reports are submitted, such as double- or triple-checking that worked hours are counted accurately.

3. Review Your Company’s Approach to ACA Affordability Requirements

The ACA requires applicable large employers (ALEs) to offer affordable coverage to their full-time employees. For plan years beginning in 2020, employer-sponsored coverage is considered affordable if an employee’s required contribution for self-coverage (for the least expensive plan option):

• meets ACA requirements, and
• does not exceed 9.78 percent of the employee’s household income for the year. For 2021, the affordability threshold increases to 9.83 percent.

Since most employers don’t know their employees’ household incomes, the ACA created safe harbors in which any of the following can be used in lieu of household income: federal poverty level (FPL), rate of pay or the employee’s W-2 Box 1 wages, provided the safe harbors are used for a class of employees, based on reasonable business distinctions.

Many employers start off using the FPL as their safe harbor, as it’s the calculation with the least variables. This can become challenging if there’s a sub-population of employees that is paying premiums above the affordability rate when using the FPL. A scenario like this can set the employer up for significant IRS penalties.

Another approach to safe harbors – one that would most likely be in an employer’s best interest – is segmenting the workforce population and applying different safe harbors to different employee categories that effectively demonstrate affordability for each.

However, we frequently see employers making a common mistake: Applying an affordability safe harbor method by each individual worker that seems like the best fit for that specific person. This goes against ACA reporting instructions. Each individual worker must be matched with a safe harbor method within a designated employee population. The IRS has indicated that selection and usage of affordability safe harbors must be applied for different employees by reasonable business categories (managers versus non-managers, for instance). If you’re discovering that what works best for a certain population doesn’t work for specific individuals within that population, consider increasing the number of reasonable employee categories to get a better fit for their safe harbors.

Reviewing the safe harbors assigned to employees during this year’s workforce upheaval is more important than ever. If some of your workers have been furloughed, their health coverage may no longer be considered affordable, which could result in your organization facing Penalty B under ACA compliance parameters. The financial hit under Penalty B is $3,860 per full-time employee who received a premium tax credit.

4. Validate the Total Number of Your Employees, Full-Time Status Measurement Methods and Form 1095-C Code Determinations

To avoid potential IRS penalties, an employer must correctly calculate its number of full-time employees to determine whether or not they are meeting the 95 percent offer threshold. This means also looking at the number of part-time staffers and combining those two groups to determine whether or not the organization qualifies as an ALE. (You read that right: To correctly count the number of your full-time employees, an employer should take into account that, when combined, an employee who works 10 hours and an employee who works 20 hours equates to one full-time employee at 30 hours.)

Employers also need to take care that they are populating 1095 forms to accurately reflect types of insurance coverage offers and to whom the offers were made according to hierarchy rules laid out in ACA reporting instructions. Data needs to show:

• whether or not an offer was of minimum value;
• whether or not it was made to the employee only, the employee and spouse, but not dependents; the employee and dependents; or the employee, spouse and dependents; and
• whether the person was determined full-time at the time the offer was made.

Remember that for ACA purposes, full-time status means an average of 30 hours per week (or 130 hours per month) worked during the applicable measurement period, not the traditional 40-hour work week.

Furthermore, an employee may have worked full-time in the past, but perhaps in 2020 doesn’t. There are two methods to measure employees for the ACA full-time determinations: monthly measurement and look-back measurement. Monthly measurement is exactly what it sounds like: measuring the hours worked on a monthly basis.

The look-back method is different in that it’s an approach for determining full-time status by tracking employee hours over a set period of time, then calculating the average number of hours worked over that period. This method is popular from an administration perspective, as determinations are made at the end of a measurement period and apply for a period of time (known as the stability period), meaning employers aren’t required to make monthly measurement determinations.

But employers need to be careful to apply the rules correctly, especially when an employee has a change in circumstance or status (such as stepping up from a part-time to full-time position, stepping down from a full-time to part-time position or experiencing another status change). Employers may fail to continue an offer of coverage or fail to make a timely offer of coverage in these situations without understanding the penalty risk.

5. Accurately Manage Acquisitions and Mergers

While COVID-19 is curbing much merger and acquisition activity, deals are still happening; the Nasdaq reports that there were 253 M&A deals in the first half of 2020.[2] If your organization is planning or has recently gone through a merger or acquisition, you’ll want to read the following.

When new companies are acquired or merged, it’s easy to forget that the ACA compliance concerns of these new entities are acquired as well. Failure to recognize the ACA requirements of new employee populations can expose even the most diligent and proactive companies to newfound ACA compliance issues.

For example, sometimes when one company acquires and merges with another, it will treat the acquired employees as if they were new hires (e.g., make them wait for insurance offers). This can set up the acquiring company for ACA penalties if the employees were taken on as a whole population and not hired individually, especially if the acquisition was a stock purchase. It’s also critical to know how the acquired company classified the status of its nonworking employees and to determine if, in fact, those workers are part of the merger or acquisition.

The acquiring organization also needs to have historical information to accurately and effectively measure employees to determine if they averaged 30+ hours per week or 130 hours per month during their measurements period to qualify as full-time employees under the ACA. In other words, you need to ensure both that you’re making the necessary offers of coverage to avoid Penalty A and that you can accurately calculate affordability safe harbors to avoid Penalty B. The best practice is to align the employees to their new measurement periods by using the acquired company’s data and coordinating the measurement periods of both organizations, carefully following the IRS guidance. If historical data isn’t available, the acquiring company should at least get the ACA eligibility determinations and negotiate with the prior employer, deciding which organization is going to continue the offer of coverage and for how long.

Conclusion

ACA employer responsibilities have taken on a new level of complexity in 2020, and the IRS will most likely be holding employers to a higher degree of liability, despite recent workforce upheavals and uncertainty. On top of this, California and Rhode Island are adding to the list of states (Massachusetts, New Jersey and Washington, D.C.) that are requiring state individual mandate reporting for 2020. If you’re puzzling over how to avoid inadvertent noncompliance and associated financial penalties, be sure to turn to a trusted health reform partner that monitors the changing landscape and provides expertise on how to manage it.

[1] https://www.treasury.gov/tigta/auditreports/2020reports/202043028fr.pdf

[2] https://www.nasdaq.com/articles/4-of-the-hottest-mergers-and-acquisitions-right-now-2020-07-24