Letter 226J: Employer Shared Responsibility Payment (ESRP)

Understanding IRS Letter 226J: The Employer Shared Responsibility Payment Explained

The IRS isn’t exactly known for sending out friendly greetings cards. When you, as an employer, receive a letter from them, it’s usually important to pay attention. One such letter that can cause a bit of head-scratching is Letter 226J. This letter is directly connected to the Affordable Care Act (ACA), and it signals that you might owe something called an Employer Shared Responsibility Payment, or ESRP. Let’s break down what that really means.

What’s the Buzz About the Employer Shared Responsibility Payment (ESRP)?

To understand Letter 226J, we have to first understand the ESRP. The Affordable Care Act (ACA), often called Obamacare, has a set of rules for large employers. The basic idea is that if a company with a certain number of employees doesn’t offer adequate and affordable health insurance, they might have to pay a penalty. This penalty is the ESRP. It’s basically the government saying, “If you don’t provide health coverage, you’re contributing to the burden on the public healthcare system, and you might need to help offset the cost.”

Think of it like this: the government wants employers who are large enough to offer health insurance to do so, which benefits both employees and helps the overall healthcare system. The ESRP is designed to ensure that employers do that.

How Does the IRS Determine if You Owe an ESRP?

The IRS doesn’t just randomly pick names from a hat. It determines ESRP liability based on information you and your employees report. Here’s the process:

• Employer Reporting (Forms 1094-C and 1095-C): Each year, applicable large employers (ALEs) must file these forms with the IRS. The 1094-C provides a summary of your coverage offerings, and the 1095-C details the offers of coverage to individual employees.

• Employee Tax Returns: Simultaneously, some employees will indicate on their tax returns that they received subsidized health insurance through a state marketplace because their employer didn’t offer affordable coverage.

• Matching and Calculation: The IRS then matches the employer information with the information provided on employees’ tax returns. If there are discrepancies showing that employees received subsidized coverage through the marketplace because they weren’t offered affordable and adequate coverage from you, the IRS may determine that you owe an ESRP.

The Arrival of Letter 226J

If the IRS’s calculations show that you might owe an ESRP, you’ll receive Letter 226J. Here’s what you can generally expect:

• Notification of Potential Liability: The letter will inform you that the IRS believes you owe an ESRP for a specific tax year.

• Explanation of the Potential Penalty: The letter provides a calculation of the amount you may owe, explaining how they came to that number. It usually highlights specific employees and months that contributed to the payment.

• Response Instructions: Crucially, the letter will outline how to respond. You’ll have a limited time to either agree with the assessment or contest it.

• Forms and Documentation: There will typically be forms included in the letter to help you respond, and you’ll be told what documentation to provide.

Why is it Important to Respond Promptly to Letter 226J?

Responding to Letter 226J is critical. Here’s why:

• Avoid Penalties: If you disagree with the IRS’s assessment, you have a right to explain why. Ignoring the letter won’t make the problem go away. It will just make it more expensive.

• Correct Errors: The IRS may have made a mistake. Perhaps your 1094-C or 1095-C forms contained errors. The IRS may have misinterpreted some information. Responding allows you to fix those errors.

• Protect Your Business: Failing to respond can result in additional penalties, interest, and even liens against your company.

What Should You Do if You Receive Letter 226J?

If you’re staring at a Letter 226J, don’t panic. Here’s what you should do:

• Read It Carefully: Understand what the IRS is claiming. Review each employee they mention and the months they flagged.

• Gather Your Documents: Have your filed 1094-C and 1095-C forms readily available, along with records of health insurance offers you made to employees.

• Verify the Calculations: Ensure the IRS has calculated your potential ESRP correctly, according to the details on your filed forms.

• Consult with a Tax Professional: If you’re confused or unsure about what to do, seeking expert advice is highly recommended. They can help you analyze the letter, verify the calculations, and formulate a response strategy.

• Respond Within the Deadline: The letter will specify a due date, which may not be a lot of time. It’s imperative to respond to the IRS before this deadline, even if you’re still gathering information.

Common Scenarios and Examples

Let’s make this a little clearer with a couple of scenarios:

• Scenario 1: Coverage Not Offered: ABC Company, with 60 full-time employees, forgot to offer health insurance coverage to some of its eligible employees. Some employees went to the state marketplace and received tax subsidies to obtain health coverage. ABC company received Letter 226J for not offering coverage.
• Scenario 2: Coverage Offered But Not Affordable: XYZ Company offered health insurance, but it was deemed not affordable based on the employee’s income. Some employees chose to obtain subsidized coverage through the marketplace, triggering a Letter 226J. XYZ Company can look at the calculations and see where the affordability threshold was not met, and perhaps make a correction.
• Scenario 3: Incorrect Data: DEF Company offered adequate and affordable insurance, but there was an error on the 1095-C form, which triggered the letter. After reviewing its records, DEF Company responded to the IRS with the corrected information.

Key Takeaways for Employers

• Compliance is Key: Make sure you’re offering compliant health insurance coverage as required by the ACA.

• Accurate Reporting: Pay attention to detail when filling out forms 1094-C and 1095-C. Errors here can lead to penalties and unnecessary correspondence from the IRS.

• Affordability Matters: Ensure that the insurance you are offering is considered affordable based on your employees’ income.

• Seek Help: Don’t be afraid to get professional advice. Tax rules can be complex, and getting expert help can save you time and money.

Related Terms and Concepts

• Affordable Care Act (ACA): The law that mandates the ESRP and has many provisions relating to health insurance.
• Applicable Large Employer (ALE): The term for a company that must offer healthcare coverage.
• Form 1094-C: Employer transmittal form summarizing healthcare coverage offered.
• Form 1095-C: Provides details of health coverage offered to specific employees.
• Employer Mandate: The requirement for large employers to offer health insurance.

Common Mistakes and Misconceptions

• Ignoring the Letter: Many business owners believe that ignoring a letter from the IRS will make the issue go away, but this is far from the truth. Unanswered letters can increase fines and penalties.
• Assuming It’s an Error: Even if you believe the IRS has made a mistake, ignoring the letter will not resolve the issue. Always respond to an IRS letter.
• Thinking the ACA is Gone: Although there have been some changes, the ACA is still in effect, and the ESRP remains a rule for applicable large employers.

Letter 226J might seem intimidating at first, but with a little knowledge and the right approach, you can effectively navigate the process. Remember, understanding the rules, filing accurate forms, and addressing the letter promptly is crucial to staying compliant and avoiding penalties. If you’re unsure, always get help from a qualified tax professional.