To avoid penalties under section 4980H(a) of the Internal Revenue Code (“a” stands for “awful”), an applicable large employer must offer Minimum Essential Coverage (MEC) to 95% or more of its full-time employees and their dependents.[2] Recall that MEC is basically any level or type of health coverage; it doesn’t have to be affordable or meet MV.  We call it the awful penalty because if coverage is not offered to 95% of all full-time employees and dependents, and even a single full-time employee receives premium tax credits, the dollar amount of the penalty ($2,970 per year in 2024) is multiplied by the total number of full-time employees, including those who were offered coverage, minus thirty (30).  Very large employers receive very large penalties under 4980H(a).

Coverage does not have to “affordable” to avoid the awful penalty, and the penalty is not triggered if a dependent receives premium tax credits or cost sharing reductions.  This penalty is all about correctly identifying who your full-time employees are and making sure that at least 95% of them receive an offer of minimum essential coverage.

Many refer to the awful penalty as the “$2,000” penalty, because the statute says it is calculated by multiplying $2,000 by the number of full-time employees, minus 30. But the $2,000 penalty is indexed. In 2024, it’s $2,970, or $247.50 per month.  It’s typically calculated on a monthly basis because the number of full-time employees changes during the year.

Let’s begin with the worst-case scenario, just to get the blood pumping. You receive a letter from the IRS. You suspect it is not a wedding invitation or a thank you note for paying taxes. You open the letter and on the top right corner you see the phrase “Form 226J.”  It should strike terror into your heart. You read on, and soon learn that your employer, with only 300 full-time employees, may be liable for a penalty of $777,600. We’ll explore how that happens in the example below.

[2] The instructions to IRS Form 1095-C defines “dependent” as follows:

A dependent is an employee’s child, including a child who has been legally adopted or legally placed for adoption with the employee, who has not reached age 26. A child reaches age 26 on the 26th anniversary of the date the child was born and is treated as a dependent for the entire calendar month during which he or she reaches age 26. For this purpose, a dependent does not include stepchildren, foster children, or a child that does not reside in the United States (or a country contiguous to the United States) and who is not a United States citizen or national. For this purpose, a dependent does not include a spouse.

In 2023, Bear School District had 300 full-time employees. Jessie Johnson was the HR Director. She was responsible for ensuring that the District complies with the ACA, but she wasn’t given the proper training or tools. Jessie misclassified 8 of the district’s full-time employees as part-time employees because she failed to apply the look-back measurement method correctly (she used a measurement period of 3 months and a stability period of 12 months to exclude part-time employees – more on that later). She misclassified 3 of their maintenance workers as independent contractors when they should have been treated as full-time employees. She also failed to credit 5 part-time teachers with hours spent coaching that would have made them full-time employees. None of these employees receive an offer of coverage.  One of the 16 employees obtained individual coverage through MNsure and qualified for premium tax credits.

Although the coverage offered by Bear School District was Minimum Essential Coverage, met Minimum Value, and was affordable, the IRS concluded that the district failed to offer Minimum Essential Coverage to 95% of its full-time employees (95% of 300 FTEs is 285; the district only offered coverage to 284 FTEs). The IRS sent Bear School District a 226J letter notifying the district that it may be liable for a proposed Employer Shared Responsibility Payment.  “Shared responsibility” sounds nice, but read on.

In 2023, the “awful” penalty under 4980H(a) was $2,880 per year. The penalty in this case was $777,600. It was calculated by multiplying $2,880 x 270 (the 270 comes from 300 full-time employees – 30). The actual calculation may be a little more complex because it is based on months, to reflect people who come and go during the year. As it turns out, similar mistakes were made in 2021 and 2022. Similar penalties were assessed for those years.[3] The money was removed from the district and sent to the Pentagon, where it was used to pay federal employees to redact reports on unidentified aerial phenomena.

It became necessary for Bear School District to cut the football team, the marching band, the school musical, and the prom. On what would have been homecoming in 2024, the townspeople gathered in Jessie’s front yard. They had pitchforks and torches. Jessie fled out the back door. She spent the rest of her days alone in a cottage deep in the woods north of town. After her death, many years later, former students made a movie about her life called, The Bear Witch Project: Part 226J.

OK that got a little dramatic and dark, and we’ll admit that compliance companies often push the worst case scenario to improve sales. But it’s all plausible, except perhaps for the movie.

[4] At present, there is no statute of limitations for Employer Shared Responsibility penalties.  Reporting for the ACA started in 2015, and you could be liable for penalties dating back to then. See IRS Chief Counsel Memorandum 20200801F (Dec. 26, 2019), available here:  https://www.irs.gov/pub/irs-lafa/20200801f.pdf.

To avoid penalties under section 4980H(b) (“b” stands for “bad”), an applicable large employer must offer all of its full-time employees (and their dependents) the opportunity to enroll in minimum essential coverage (MEC).  The penalty is assessed for each full-time employee who is certified to the employer as having received premium tax credits through MNsure or another qualified state exchange.  Employees are not eligible for premium tax credits or cost reduction on MNsure if the coverage for the employee is (1) “affordable” and (2) meets Minimum Value (MV).  The dollar amount of the penalty is higher than under 4980H(a), but it only applies on a case-by-case basis and is not multiplied by the total number of full-time employees.

Some refer to the bad penalty as the “$3,000” penalty, because that’s how it appears in the statute. But the bad penalty is indexed for inflation. It’s $4,460 per year in 2024.

That’s a lot of ifs, ands, and ors.  But unlike the awful penalty, this penalty does not trigger a penalty based on all full-time employees. It only triggers a penalty based on the number of full-time employees who receive premium tax credits through MNsure because they weren’t offered affordable coverage that meets MV.

The penalty is applied monthly to reflect the fact that employees come and go, move from part-time to full-time and back again, may enroll mid-year in the health plan of a spouse’s employers, etc.  We’ll break down all these definitions and rules, but let’s start with an example just to illustrate how it works:

Example 2:  Tom and the Bad Penalty

Wolf Ridge School District is an applicable large employer. It offers a calendar year group health plan to its full-time employees that meets minimum value. To ensure that the plan is affordable, Wolf Ridge adopts the federal poverty line (FPL) safe harbor. (We’ll discuss that in more detail later).

Tom Wolfe, the business manager for Wolf Ridge, calculated the monthly FPL safe harbor for 2024. He multiplied the 2022[4] Mainland Federal Poverty Line for a household size of one ($13,590) by the ACA’s affordability percentage (originally 9.5% but indexed to 9.12% in 2023). He divided this amount by 12 to obtain the monthly safe harbor of $103.28. To meet the safe harbor in this case, each full-time employee’s share of the cost of premiums for the lowest cost self-only coverage in 2023 could not exceed $103.28 per month.

Tom Wolfe has never been diagnosed with dyslexia, but his wife has levied that charge from time to time. He transposed the 8 with the 3 in the affordability safe harbor, with the result that the amount employees must pay could not exceed $108.23 each month for self-only coverage rather than $103.28. Wolf Ridge was no longer within the affordability safe harbor.

During open enrollment, 15 full-time paraprofessionals decide that the plan costs too much (especially given the deductibles) and they declined coverage. Five obtained coverage through their spouse’s employer, and ten applied for individual insurance coverage through MNsure. All ten qualified for premium tax credits. They would not have qualified for premium tax credits if the plan was “affordable” under the monthly FPL Safe Harbor.

In late 2024, the IRS sent a 226J letter to Wolf Ridge advising it of penalties equal to $43,200. This represents $4,320, the “bad” penalty under 4980H(b) in 2023, multiplied by the ten paraprofessionals who obtained premium tax credits in 2023.

Tom checked the numbers again and found his mistake.  His wife may be right, he realized, but he wasn’t going to admit it.   Several months later, he woke up at 5 AM.  The recently disbanded high school marching band was in his front yard playing “Eye of the Tiger” at full volume.  It was time to come clean.

[4] Depending on when the plan year begins, they may have to use the 2023 Mainland Federal Poverty Line. More on that here. [/mepr-active]

We could end the example above by saying that Tom and his wife move to a small cottage in the woods outside of town, near Jessie, and that their neighborhood is growing fast. But given these facts, it makes more sense to challenge the IRS’ proposed assessment. Tom has made what the law calls a “scrivener’s error,” on par with leaving a word out of a document being copied by hand. (In ancient times, monks weren’t whipped for this type of error, at least not the first time). This doesn’t mean the IRS will let it slide, but employers cannot win arguments they do not make.[1] We hear anecdotally that the IRS is not imposing the 4080H penalties on cities, counties and school districts that respond to 226J letters even when their excuses would not typically justify waivers of penalties in other contexts (i.e., they are lame). But we also think that the era of lame excuses is coming to an end, especially given Congress’s new funding for the IRS under the Inflation Reduction Act with its direction to increase enforcement. The best strategy, of course, is to get it right the first time.

One of our attorneys handled a case involving a small school district just barely large enough to be an applicable large employer. The Superintendent made the employer’s offer of coverage verbally in a meeting with employees who were part of a collective bargaining group. One of the employees skipped the meeting. The employer’s offer of coverage was “affordable” as required by the ACA because the employer used the federal poverty line safe harbor to determine the employees’ premium. But employees don’t speak that lingo, and word circulated that the coverage was not “affordable” because the deductibles were too high. They had a point, but that’s not relevant to the determination of penalties.

The employee who missed the meeting declined coverage from the district and purchased an individual policy of insurance through MNsure. She indicated in the application that the coverage was not affordable, and she qualified for premium tax credits. Three years later, the IRS issued a 227J letter to the employer suggesting that it pay an Employer Shared Responsibility Payment (ESRP) of $24,600. The payment was triggered because the (1) the employee received premium tax credits through MNsure, and (2) the employer reported on its Form 1095-C that the employee was a full-time employee who declined an offer of coverage.

Even if you make an offer of coverage that is affordable and provides minimum value, nothing prevents an employee from saying “no thanks” and applying for coverage through MNsure. Depending on what they say on their application, and MNsure’s own processes, the employee may qualify for premium tax credits and cost sharing reductions. If the employee qualifies, MNsure will send an “Employer Shared Responsibility Notice” to the employer. MNsure sends this notice to all sized employers.  Large employers, at least, should push back if the employee received an offer of coverage that met minimum value and is affordable.

We threw a lot of defined terms out here in this section, and if you’re new to these rules we don’t expect you to fully understand how they all work together.  You will.  We also want to assure you that Minnesota insurers, third party administrators, and brokers in the public sector know what they’re doing.  We know a lot of health insurance professionals in this state, and they are smart and capable people. We are confident that every major medical group health plan administered by a reputable Minnesota insurer, third party administrator, or public employer pool (such as MHC) will only make coverage available that provides Minimum Essential Coverage (MEC) and meets Minimum Value (MV).