The IRS’s Approach to Enforcing Affordable Care Act Filing Requirements and How to Mount a Defense
By Leo Unzeitig, CPA-San Antonio
August 25, 2023
The Affordable Care Act (ACA) was signed into law in 2010. It included I.R.C. § 4980H, which created an excise tax for certain employers who failed to provide appropriate health care coverage. While there are nuanced provisions within the ACA that many practitioners should be aware of, this article focuses on how the IRS “encourages” employers to file the forms necessary for the IRS to enforce the ACA provisions.
What forms are required and who must file them?
The IRS created a handy form that purports to collect all the information necessary to enforce the ACA provisions. This is Form 1095-C and like other information returns, the IRS mandates the filing of a Form 1094-C transmittal that summarizes key information from the entire collection of Forms 1095-C.
The tricky part is determining which employers are required to file these forms. That’s done with a look-back test. Employers “look back” to the previous year and if they had 50 or more full-time employees and/or “full-time equivalent” employees, then they are an Applicable Large Employer and must file the Forms.
For employers with large full-time staff, we see pretty good compliance because it’s fairly obvious that the taxpayer meets the threshold. Employers with large full-time staff also have a workforce that demands health care coverage and the employer thus has contacts with sophisticated employee benefits firms that assist with compliance and reminders when requirements are not being met.
The problems arise when employers have few full-time employees but significant part-time employees. This is because Applicable Large Employers are defined as employers who have 50 or more full time or “full-time equivalent” employees. Figuring out full-time equivalent employees is complicated in that it requires some math, but suffice it to say that a workforce with many part-time employees often bumps unsuspecting taxpayers into the ACA regime.
How does the IRS find out if I didn’t file them?
The IRM states that Appliciable Large Employers failing to file forms will be identified as follows:
Information Return Case Selection (ICRS) will use a list of identified non-filers to establish selection criteria and prioritize the information return non-filer cases in anticipation of work requests. Selected cases will be controlled on the Examination Returns Control System (ERCS), data will be provided by the assigned group and letters will be mailed by the National Distribution Center (NDC).
I.R.M. § 18.104.22.168.1(1)
I don’t really know what that means. But anecdotally, I have seen that the IRS tends to inquire as to non-filing when particular taxpayers have filed a significant number of Forms W-2 (like over 200), but there are no Forms 1095 in the system. And that makes sense. If a business has a large number of employees, they stand a good chance of being an Applicable Large Employer. The IRS computer system thus finds businesses with a significant number of Forms W-2 but no Forms 1095 and “inquires.”
And unlike some other divisions within IRS enforcement, the IRS is relatively nice about it. They start by sending a Letter 5699. It says something like “we think you may be an Applicable Large Employer. If so, please confirm and tell us when you filed your returns.” The notice also contains a phone number for the “4980H Response Unit,” one of the most effective and efficient service divisions within the IRS. Seriously, with all the discussion about the $60 billion Congress showered on the IRS and calls for improvements to taxpayer service, Congress and the IRS should look to the ESRP Unit as a model. The wait time is often non-existent and the staff members are refreshingly pleasant and knowledgeable. They genuinely seek to help taxpayers comply with the law and offer handy tips for doing so.
But getting back to that first Letter 5669, the “inquiry notice,” If the taxpayer realizes that they are an ALE but have not filed the returns yet, the letter gives them the option to either file the forms with the response or indicate when they will be filing them in the near future. There is no deadline, but the letter presumably gives the taxpayer some breathing room for getting into compliance.
If the taxpayer is not an ALE (because the business’ staff is mostly part-time or has some other excuse), the letter gives the taxpayer the option to explain why it is not an Applicable Large Employer.
My experience indicates that taxpayers who timely respond to this letter, either by stating that they are not an Applicable Large Employer or filing the delinquent forms late, invariably have their case closed without filing penalties. The IRS issues a Letter 5840, which it calls an “information return closing letter,” stating that the information resolved its inquiry and nothing further needs to be done.1
Where we have seen taxpayers run into trouble is when they ignore the inquiry letter. Reasons range from “I have an insurance broker. They told me they take care of this.” to “I’m not an applicable large employer. I only have a handful of full-time employees.” to “I have no idea what this letter is talking about.” We also occasionally get the “I never received the letter” defense.2
The consequences for not responding, though, are often severe. The IRS takes the number of Forms W-2 filed and issues section 6721 (failure-to-file) and section 6722 (failure-to-furnish) penalties for each employee. That’s $280 per failure (or a combined $560 per employee) for 2022. And the problem is that the number of Forms W-2 is often higher than the number of Forms 1095 that are required to be filed. This is because taxpayers that are Applicable Large Employers (which is determined by figuring full time and full-time equivalent employees) need only file Forms 1095-C for full-time employees. They do not need to file the forms for full-time equivalent workers. But with no Forms 1095 in the system, the only data in the IRS’ possession is the Forms W-2 on file. For employers with significant part-time employees (think home health care, restaurants, event staffing, etc.), they may have thousands of Forms W-2 but fewer than 50 full-time employees. With penalties of $580 per employee, we thus routinely see information return penalties in hundreds of thousands to well into the millions of dollars for returns that have no tax due and are computed on an incorrect basis.
Given the enormity of the penalties, revenue officers are often quickly assigned and notices of federal tax liens are duly filed.
And because this is a relatively new issue and the size of the penalties are so big, revenue officers are hesitant to recommend abatement. Instead, they prefer for Appeals to make the call.3
Appeals is a mixed bag as well. Some Appeals Officers are starting to see the frequency of these penalties and they apply the correct law to the facts in analyzing whether the penalties should be abated. Others take a pragmatic approach recognizing that the size of the penalty is laughable and would have no likelihood of ever being repaid given the size of the business. They thus settle on a “proportionality” basis recognizing the relative harm caused to the government and the level of sting that will correct the taxpayer’s behavior. And still a disturbingly large number of Appeals officers use the wrong reasonable cause analysis and ignore the fact that the giant size of the penalties have no bearing on the relative harm caused to the government and are in all likelihood uncollectible.
How do I abate the penalties?
So how do you mount a defense after the penalties have been assessed? You take a multi-prong approach.
Depending on when you discover the assessment, move quickly. If it’s unclear whether a revenue officer has been assigned, call the practitioner priority line. The helpful folks at the ESRP Unit lose jurisdiction over the case once the penalties have been assessed as the case is immediately moved to collections. I usually call the practitioner line and ask if it’s been assigned to a revenue officer. If it hasn’t, I ask the agent to leave a note in the file to let the eventual revenue officer know that the taxpayer is represented and to call me because I believe the case merits penalty abatement and lien deferral (this works about 15% of the time--really only in cases where I’ve had a history with the revenue officer who exercises professional courtesy). If a revenue officer has been assigned, I get the name and number and reach out to them to hopefully prevent a harmful lien filing pending an abatement request.
So how do you argue for abatement? You forget what you know about writing typical reasonable cause letters and you look to the specific provisions for information returns. Those are in section 6724 and the related regulations. The section 6724 regulations look to whether the taxpayer “acted in a responsible manner” and whether there are “significant mitigating factors with respect to the failure.” The regulations provide a number of factors, but the most commonly invoked is likely that the taxpayer has never incurred that particular penalty in prior years and if it has, the taxpayer has taken steps to prevent it from happening again.
Assuming you’ve been proactive in responding to the IRS, filing all delinquent returns and crafting a penalty abatement letter that cites the correct law, you stand a good chance of abating the penalties in full. The numbers get large in this area and practitioners often feel overwhelmed by ACA compliance matters on top of all other tax matters, but you really don’t need to have a thorough understanding of the ACA rules to craft the penalty abatement letter for non-filing. And the ESRP Unit usually gets it right. The problem is that once the case leaves their jurisdiction, you’re in the world of revenue officers and IRS campuses. While the correct resolution will likely arrive, it will only happen after expending significant time and treasure. In other words, you better hope your clients didn’t ignore the initial “inquiry notice.”