Letter 226-J: ESRP Penalties

What to Do If Your Business Receives Letter 226-J

If you're an Applicable Large Employer (ALE) and you don't comply with the Affordable Care Act (ACA), the IRS may send you Letter 226-J. This notice explains the issue and outlines the penalties proposed against you. Keep reading to learn why your business received this IRS notice, how to respond to it, and how to protect yourself in the future. 

This post also outlines the basics of ACA compliance for ALES.

What Is Letter 226-J?

IRS Letter 226-J goes to Applicable Large Employers who are not compliant with the Affordable Care Act's mandate. Employers receive this notice when they don't meet the rules for offering affordable health insurance to their employees. The letter explains the penalties and outlines how the business can respond. 

Why Did I Receive Letter 226-J?

The IRS sends this letter to applicable large employers who are facing a penalty for one of the following:

1. Your business didn't offer health insurance to at least 95% of its full-time employees, and one or more of its employees claimed the Premium Tax Credit which covers the monthly cost of healthcare premiums.
2. 2)Your business did offer health insurance to at least 95% of your full-time employees, but some/all of them claimed the Premium Tax Credit.

In the first scenario, the ERSP is $2,000 per employee, but it's not assessed on your first 30 employees. Note this number is indexed to inflation, and as of 2024, it's $2,970 per year. However, the penalty is actually calculated monthly and is 247.50 per employee.

In the second scenario, the penalty is $3,000, but it only applies per employee who claims the Premium Tax Credit. Also indexed for inflation, this number is $4,460 annually and $371.67 monthly per employee in 2024. 

What Is an Applicable Large Employer?

An Applicable Large Employer is any business that had 50 or more full-time equivalent employees last year. If you meet this threshold, you must offer health insurance to your employees and file Forms 1094-C/1095-C. 

To determine the number of full-time and full-time equivalent employees during any month of business, first, count up all of the employees who work 30 or more hours per week or 120 or more hours per month. They are all full-time. Then, add up the hours of all of your part-time employees for the month, but don't count more than 120 hours per month for any individual. Then, divide the sum by 120 and add the result to your number of full-time employees. 

For example, say that you have 42 full-time employees and 15 employees who work 80 hours per month each. The 15 part-time employees work 1200 per month, and when you divide this number by 120, you get 10. When you add 10 to 42 (the number of full-time employees), you get 52, and thus, you are an Applicable Larger Employer.

ACA Rules for Applicable Large Employers

Applicable Large Employers must offer their full-time employees and their dependents affordable insurance or pay a "shared responsibility" penalty to the IRS. ALEs include businesses, non-profits, and government entities. If you qualify as an ALE, you must also file Forms 1094/1095-C.

ALE Reporting Requirements

ALEs must give each of their full-time employees Form 1095-C, showing which months they were offered minimum essential health coverage. Employers must also file this form with the IRS along with Form 1094-C which summarizes the details from the 1095-C forms. If you don't file these forms, the IRS will send you Letter 5699, assess penalties against you, and potentially file these forms on your behalf.

How to Find Out About Shared Responsibility Payments

The IRS has a tool called the Employer Shared Responsibility Provisions Estimator which can help you figure out if you're an ALE and calculate the penalty you will face if you don't meet the insurance coverage offerings.

Why Does the IRS Assess the Employer Shared Responsibility Penalty? 

The Premium Tax Credit is an income-based credit to offset the cost of health insurance premiums. Theoretically, the IRS assesses these penalties because large employers are legally mandated to provide their employees with affordable healthcare coverage, and if their employees are claiming the premium tax credit, the coverage is not affordable. 

How Does the IRS Determine When to Send Out Letter 226-J

The IRS uses information from the 1095-C forms and 1094-C form that your business filed along with individual tax returns filed by your employees. The agency may also use payroll and unemployment tax returns to learn more about your number of employees. If these returns indicate that you may be liable for a shared responsibility penalty, the IRS will send out Letter 226-J.

How to Respond to Letter 226-J With Forms 14764/14765

Note the deadline and make sure you contact the IRS before that date. Generally, if you open a line of communication, they'll give you an extension if you need more time to respond than offered by the original deadline. Review the details of the letter carefully and decide if you agree or disagree with the proposed penalty. Then proceed as outlined below.

If you agree

If you agree with the penalties noted on Letter 226-J, sign and date Form 14764 (ERSP Response). Then, make a payment through the EFTPS system or by mailing it with the form. Return the form and make the payment by the due date if you want to avoid any additional penalties. 

If you disagree

If you disagree, complete Form 14764 (ESRP Response) which should be included with Letter 226-J. This form allows you to note why you disagree and it helps you determine which supporting documents you should include. For example, you may need to include employee waiver formers, payroll records, benefit administration records, etc. If you make errors on Forms 1095-C or 1094-C, you can also note that on the form. 

Then, if applicable, you should note which changes need to be made to the penalty calculations on Form 14765. The IRS details penalty calculations on this form - it shows all of the full-time employees who received the Premium Tax Credit each month. If you disagree with the calculations, note the desired changes on their form. For example, you may argue that an employee wasn't full-time that month or that you were eligible for safe harbor considerations or other relief from the penalty.

After the IRS receives your response, they will review the information that you sent. If they agree with you, they should remove or adjust the penalties on your account. If they still want to assess the penalties against you, you have the right to appeal. 

If the IRS denies your appeal, they will calculate your final penalty amount and send you Notice CP220J which is a demand for payment. At that point, you must pay the penalty or request a payment plan. 

What If You Ignore Letter 226-J

When businesses don't respond to Letter 226-J, the IRS will move forward with formally assessing the penalties against them. Then, the agent will send a Notice and Demand for Payment. If the business continues to ignore the tax liability, the IRS may issue a federal tax lien or move forward with a tax levy. 

Staying Compliant: How to Avoid Letter 226-J in the Future

To avoid receiving this letter in the future, make sure you understand the ACA mandates. Keep close track of your number of employees, and keep records that substantiate your claims such as payroll records and timesheets. Carefully document all offers of health insurance coverage and if employees turn down coverage, get signed waivers. Consider getting professional tax help for completing Forms 1094-C and 1095-C. 

FAQs About 226-J

Most people have a lot of questions when they receive IRS notices. Although the IRS has announced plans to make the letters more readable, they're often still confusing. To help you out, here is a look at some FAQs. 

Is 266-J a tax bill?

No, Letter 226-J is not a tax bill. It is a proposed assessment of tax penalties. If you don't respond to the letter, the penalties will become a tax assessment, and the IRS will send you a bill.

Why does the IRS send Letter 226-J to employers?

The IRS compared info on the 1094-C/1095-C forms that you filed with information from your employees' individual income tax returns. Based on those details, the IRS has decided to assess an Employer Shared Responsibility Payment on your business. 

What should you do as soon as you receive Letter 226-J?

Note the deadline, and if you need more time, contact the IRS. Review the details on Form 14765 to see if you agree with how the IRS calculated the penalty. If you agree with the info, start to make plans on how to pay the penalty. If you disagree, draft your response or contact a tax professional to help dispute the letter. 

How do you request an extension to respond to Letter 226-J?

Call the IRS soon after receiving the letter and ask for an extension. You can also contact a tax attorney or other tax professional, give them a power of attorney, and have them request an extension for you.

What should you do if you disagree with the details in the letter?

Note your disagreements on Form 14875. Recalculate your penalty based on the information you provided. Then, indicate your disagreement on Form 14764 (ERSP Response). Send all of the documents to the IRS by the deadline on the Letter 226-J.

What if I can't afford the penalties in Letter 226-J?

You may be able to apply for a payment plan if you cannot afford to pay the penalties in full. In some cases, the IRS may even approve a settlement (offer in compromise), but this can be hard for businesses to obtain. 

Get Help With Letter 226-J

Has your business received Letter 226-J? Whether you agree or disagree with the penalties, you should reach out to a tax professional. TaxCure allows you to search for local tax professionals who have experience with business tax problems including ERSP penalties, correcting 1094-C/1095-C returns, and other issues. Don't wait, use TaxCure to search for experienced guidance today.