IRS Letter 226J and How to Respond

Figuring out U.S. tax laws and regulations is hard. One reason it’s so difficult for individuals and business to understand their tax obligations is because Congress often uses the IRS and its tax enforcement powers to promote certain policies, which makes the tax collection process more complex. A good example of this is the push to increase the number of people who have access to affordable health insurance.

While people might disagree as to the political merits of this approach, it doesn’t change the fact that certain businesses that fail to provide health insurance to their employees can face tax consequences. IRS Letter 226J is a perfect example of this. 

What Is IRS Letter 226-J? 

Sometimes referred to as Letter 226J, this is a document the IRS sends to certain employers explaining that they may be liable for an Employer Shared Responsibility Payment (ESRP). To better understand what this means, let’s provide a background.

Affordable Care Act Requirements for Large Employers 

In 2010, Congress passed the Affordable Care Act (ACA), a landmark piece of legislation that made it easier for individuals to obtain health insurance coverage. One way this new law worked was by requiring certain employers to offer their full-time employees health insurance coverage. If the employers failed to comply with this mandate, they would have to make Employer Shared Responsibility Payments (ESRPs).

This requirement applies to Applicable Large Employers (ALEs), which are employers that have 50 or more full-time equivalent employees. Under the ACA, ALEs must offer at least 95% of their full-time employees with health insurance that meets basic cost and coverage requirements. If an ALE doesn’t meet this requirement, then it’s liable for the ESRP.

Employer Share Responsibility Payments 

There are two types of ESRPs, although the ALE will only be responsible for paying one. The exact penalty paid depends on how the ALE failed to comply with the health insurance mandate. As of 2024, if the ALE fails to offer minimum essential coverage to at least 95% of its full-time employees (and their dependents), then the ALE must pay a tax penalty of $2,970.00 per year ($247.50 per month) for each of the ALE’s full-time employees, with the first 30 employees excluded from the calculation. This ESRP is sometimes referred to as the 4980H(a) penalty.

If the ALE does offer minimum essential coverage to at least 95% of its full-time employees (and their dependents), the ALE could still have to pay a tax penalty if at least one full-time employee received the health insurance premium tax credit because the coverage offered is lacking in a specific way, such as not being affordable. 

In this situation, the ALE must pay a tax penalty of $4,460.00 per year ($371.67 per month), but this penalty only applies to each full-time employee who obtains their health insurance from the marketplace and receives a premium tax credit. This ESRP is sometimes referred to as the 4980H(b) penalty. Note this is the current penalty as of 2024, but it changes with inflation.

When Does the IRS Send Letter 226-J?

IRS Letter 226-J is the first letter the IRS sends an employer about its potential ESRP liability. The IRS learns about the employer’s possible failure to offer necessary health insurance to its employees by examining information from the employer’s IRS Forms 1094-C and 1095-C. The IRS also sees the individual tax returns of the ALE’s employees when they obtain subsidized health insurance coverage through the marketplace or exchange and receive a health insurance premium tax credit.

One thing to keep in mind about Letter 226-J is that it’s not a tax bill. Rather, it’s the IRS’ initial proposal for the ESRP. As a result, if your business receives this letter, you have the opportunity to dispute the IRS’ conclusion that you owe an ESRP. 

What’s Included in Letter 226J? 

The exact contents and information of Letter 226J depend on your unique business and payroll situation. That being said, you can usually expect the following information to be included with IRS Letter 226-J:

• A table of information summarizing the required ESRPs and identifying which type of penalty applies for each month.
• IRS Form 14764, ESRP Response. This is where you have the opportunity to dispute the IRS’ conclusions or indicate your agreement with the IRS.
• IRS Form 14765, Employee Premium Tax Credit (PTC) Listing. You only need to complete this if you disagree with the IRS.
• An outline of the next steps the IRS will take if you don’t properly respond to Letter 226J. 

Responding to Letter 226J 

Assuming you disagree with the IRS concerning ESRPs, you need to submit your response within 30 days from the date of Letter 226J. If you need more time, you can reach out to the IRS using the contact information included in Letter 226J to ask for more time. The IRS will usually grant an extension as long as you have a good reason for it and request it before the deadline. It’s important to timely respond to Letter 226J because if you don’t, the IRS may send you a CP220J Notice, where the IRS formally asks you to send your ESRP.

Your primary response will be contained on Forms 14765 and 14764 and most likely revolve around the premise that the IRS has incomplete or incorrect information. Therefore, you’ll need to provide documentation to show the IRS what information it’s missing or got wrong. In addition to filling out these two forms, you should expect to provide copies of any waiver forms, payroll documents, and HR records to show proper coverage was available to eligible employees.

You also want to review your prior 1094-C and 1095-C forms to make sure they’re correct. If you find a mistake or that some of the information has changed, you can indicate that in your Letter 226J response, specifically on Form 14765. In most cases, you won’t need to file corrected 1095-C and 1094-C forms, although you should do so if asked by the IRS.

You can handle your ESRP response yourself, but it might be a good idea to hire a tax professional to help. If you have a lawyer, Certified Public Accountant (CPA), or enrolled agent (EA) that you’d like to handle your case and respond to the IRS, you’ll also need to send IRS Form 2848, Power of Attorney and Declaration of Representative. 

Where to Send Your Response to the 226J Letter 

IRS Letter 226-J will provide the contact information for the IRS representative handling your case. There should also be information about the person you should direct any questions you have as well as where to send your Letter 226-J response, including Forms 14765 and 14764. If you hired a tax pro to help you with this tax issue, they’ll most likely be communicating with this person at the IRS. 

What Happens After Sending Forms 14765 and 14764 

After the IRS receives your response, the IRS will send you an acknowledgment letter. This letter will have information explaining your right to appeal. This usually entails scheduling a conference with the IRS Independent Office of Appeals.

Get Help Avoiding ESRPs and Future 226J Letters from the IRS 

Like many other problems in life, prevention is the best way to avoid future problems with the IRS concerning ESRPs. If you don’t already have a plan in place, establish regular reviews of your ACA reporting compliance practices. If necessary, hire the appropriate professionals to conduct these reviews to make sure you’re satisfying your health insurance mandates. 

Whether you’re trying to prevent an IRS letter 226-J or you just received one, the tax professionals from the W Tax Group are here for you. We offer free consultations which you can schedule with our online contact form.