Received an ACA Penalty Letter? Understanding Letter 226J and What Happens Next

ACA 360 is seeing a significant increase in IRS Letter 226J activity, with letters reaching employers much faster than they have in prior enforcement cycles.

For an employer receiving one for the first time, the proposed penalty amount can make the letter feel like a final determination. It is not.

Letter 226J is the beginning of the IRS Employer Shared Responsibility Payment process. An employer has the opportunity to review the calculation, identify reporting or data issues, and respond by the date shown in the letter.

Understanding what the IRS calculated—and why—is the first step toward determining whether the proposed penalty is accurate.

What Is IRS Letter 226J?

Letter 226J is the initial letter the IRS sends to an Applicable Large Employer when the agency determines that the employer may owe an Employer Shared Responsibility Payment under Section 4980H of the Internal Revenue Code.

An Applicable Large Employer, or ALE, is generally an employer that averaged at least 50 full-time employees, including full-time-equivalent employees, during the preceding calendar year. Related entities may need to be combined when determining whether the group meets this threshold.

The IRS does not send Letter 226J simply because an employer filed Forms 1094-C and 1095-C. According to the IRS, the proposed assessment is generally based on two sources of information:

The coverage information reported by the employer on Forms 1094-C and 1095-C. Information showing that one or more full-time employees received a premium tax credit for Marketplace coverage.

The IRS compares this information to determine whether the employer may have failed to satisfy the ACA’s Employer Shared Responsibility requirements for one or more months.

A Proposed Penalty Is Not a Final Assessment

One of the most important details on Letter 226J is the word “proposed.”

The IRS has made a preliminary calculation based on the information available to it. The employer has not yet reached the end of the process, and the proposed amount has not automatically become a final liability.

The calculation may be accurate. It may also be affected by:

Incorrect or incomplete Forms 1094-C or 1095-C Employees reported under the wrong employer identification number Missing offer-of-coverage information Incorrect indicator codes Incorrect affordability information Full-time status determinations that were not reflected properly Coverage offers that were made but not reported accurately Safe harbors or other relief that were available but not properly coded Payroll, eligibility, or employment data that changed after the original filing

The employer’s response should be based on what actually occurred—not only on what appeared on the original forms.

Is It an A Penalty or a B Penalty?

Letter 226J may propose a penalty under Section 4980H(a), Section 4980H(b), or different penalties for different months. Although both fall under the Employer Shared Responsibility provisions, they are calculated differently.

The 4980H(a) Penalty

The 4980H(a) penalty may apply when an Applicable Large Employer fails to offer minimum essential coverage to at least 95% of its full-time employees and their dependents, and at least one full-time employee receives a premium tax credit through the Marketplace.

Because the penalty is generally calculated using the employer’s full-time employee population, the proposed amount can be substantial.

This is sometimes called the “A penalty.”

The 95% standard does not mean an employer may intentionally leave 5% of its full-time employees without an offer. It provides a limited margin for administrative errors. Employers are still expected to identify their full-time employees and make the required offers of coverage.

The 4980H(b) Penalty

The 4980H(b) penalty is calculated employee by employee and month by month.

It may apply when a full-time employee receives a premium tax credit and the employer:

Did not offer that employee coverage; Offered coverage that did not provide minimum value; or Offered coverage that was not affordable under the applicable ACA standards.

This is commonly called the “B penalty.”

An employer cannot owe both an A penalty and a B penalty for the same month. However, the type of penalty proposed may vary across the year depending on what the employer reported and what occurred during each month.

What Is Included With Letter 226J?

A Letter 226J package generally contains several documents that must be reviewed together.

The Proposed Penalty Calculation

The letter provides the IRS’s preliminary calculation of the Employer Shared Responsibility Payment. It may show the number of full-time employees used in the calculation, the months involved, and whether the proposed liability falls under Section 4980H(a) or 4980H(b).

Form 14764, ESRP Response

Form 14764 is used to indicate whether the employer agrees or disagrees with the proposed assessment.

Disagreeing with the calculation generally requires more than checking a box. The employer should provide a clear explanation and the documentation or corrected information supporting its position.

Form 14765, Employee Premium Tax Credit Listing

Form 14765 identifies the employees and months associated with the proposed assessment.

This listing is an important starting point, but it does not answer every question. Each employee and applicable month should be compared against the employer’s records, including:

Employment dates Hours of service Full-time or variable-hour classification Measurement and stability periods Offer-of-coverage records Enrollment or waiver information Employee contribution amounts Affordability calculations Payroll records Leave and termination history The codes originally reported on Form 1095-C

A name appearing on Form 14765 does not, by itself, establish that the proposed penalty is correct.

What Should an Employer Do After Receiving Letter 226J?

The response date printed on the letter should be identified immediately. The time allowed to respond has not changed simply because letters may be arriving more quickly, but the employer still needs enough time to gather and evaluate its records.

The initial review should include the following steps.

1. Confirm the Entity and Tax Year

Verify the legal entity, employer identification number, tax year, and mailing information shown on the letter.

This is especially important for organizations with multiple EINs or members of a controlled or aggregated group. Each ALE member generally has its own reporting and potential penalty responsibility, even when the entities are considered together for determining ALE status.

2. Review the Proposed Calculation

Determine whether the IRS is proposing an A penalty, a B penalty, or different penalties for different months.

The calculation should be reviewed month by month. A single reporting issue on Form 1094-C can affect how the IRS interprets the employer’s coverage offer across a much larger population.

3. Review Every Employee Listed on Form 14765

The employer should determine what occurred for each listed employee during each applicable month.

Relevant questions may include:

Was the employee full-time under the employer’s ACA measurement method? Was the employee in a permitted waiting period or initial measurement period? Was an offer of coverage made? When did the offer become effective? Did the offer provide minimum value? Was the employee contribution affordable under the employer’s applicable affordability safe harbor? Was the correct offer-of-coverage code reported? Was the correct safe-harbor or other applicable relief code reported? Did a correction to payroll, benefits, or employment data affect the original reporting?

The answer may be different for every employee and every month.

4. Compare the Letter With the Original ACA Filings

The employer should retrieve the Forms 1094-C and 1095-C submitted for the applicable year, including any corrected returns.

Those forms should then be compared with the underlying payroll, benefits, eligibility, and employment records. The goal is not simply to find a different code that produces a better result. The goal is to determine which code accurately reflects what occurred.

5. Gather Supporting Documentation

A response is stronger when it is supported by contemporaneous records.

Depending on the issue, documentation may include:

Coverage offer notices Enrollment and waiver records Benefit eligibility files Payroll deductions Rate sheets Affordability calculations Measurement-period reports Employee census records Hire and termination information Leave records Carrier or third-party administrator files Copies of the original and corrected ACA returns

The older the tax year, the more difficult this reconstruction may become. Personnel changes, system migrations, vendor changes, acquisitions, and changes in payroll platforms can all affect the availability of records.

Should the Employer Immediately Correct Its ACA Forms?

Not necessarily.

A difference between the employer’s records and the information shown in Letter 226J does not automatically mean that corrected forms should be filed before the entire issue is evaluated.

The employer first needs to determine:

What was originally reported; Whether that reporting was inaccurate; What actually happened during the applicable months; Whether the proposed penalty resulted from a reporting issue, an operational issue, or both; and How the discrepancy should be addressed in the response.

Making isolated corrections without understanding the full calculation can create additional inconsistencies. The response strategy and any necessary corrections should be considered together.

What Happens After the Employer Responds?

After reviewing the employer’s response, the IRS generally issues a Letter 227.

There are several versions of Letter 227, and the version received will indicate how the IRS handled the response. Depending on its determination, the IRS may:

Reduce the proposed penalty to zero; Revise the proposed amount; Request additional information; Confirm the proposed assessment; or Explain the employer’s next opportunity to challenge the determination.

Receiving a Letter 227 does not always mean the matter is finished. The employer should read the specific letter carefully and respond again if required.

Should an Employer Simply Pay the Proposed Amount?

A proposed penalty should be evaluated before the employer agrees to it.

Some assessments reflect an actual failure to offer compliant coverage. Others are driven by reporting errors, missing codes, incorrect employee classifications, incorrect application or reporting of an affordability safe harbor, entity-level reporting issues, or records that were not available to the IRS when it prepared the letter.

The size of the proposed assessment does not establish whether it is correct.

A proper review must connect the IRS calculation to the employer’s actual workforce and coverage history. That requires more than reading the letter or reviewing the Forms 1095-C in isolation.

The Letter Is Current. The Underlying Facts Are Not.

A Letter 226J received today may require an employer to reconstruct decisions made years earlier.

The response may depend on whether an employee averaged enough hours during a prior measurement period, when an offer was made, what the employee would have paid for coverage, which entity employed the individual, and how that information was coded at year-end.

That history becomes more difficult to reconstruct over time.

The strongest penalty responses begin with the underlying facts: who was employed, who was full-time, what coverage was offered, whether it was affordable, and what the employer can document.

Letter 226J may begin with a proposed number. Determining whether that number is correct requires understanding the operational history behind it.

ACA 360 assists employers with reviewing ACA penalty notices, reconstructing the applicable compliance history, validating the IRS calculation, and preparing supported responses.

Sources: Letter 226J Employer Shared Responsibility Understanding Letter 227J

This article provides general information and is not legal or tax advice. Employers should evaluate their specific circumstances and consult qualified advisers when appropriate.