Article

Owning ACA reporting nonfiling penalties

2023 year-end tax letter

Oct. 30, 2023 · Authored by Eric Pochas, Michelle Hobbs

The process of buying and selling businesses is complicated and stressful. An organization’s past actions and history form the basis for diligence needing to be done — and done well — in order to assess a deal’s worthiness. Prudent strategists will add Affordable Care Act (ACA) compliance to the list of risk considerations worth contemplating to avoid costly implications after a deal is done.

Background

The ACA’s Employer Shared Responsibility (“pay or play”) mandate still requires Applicable Large Employers (ALEs) to offer health insurance to full-time employees. The Internal Revenue Service (the Service) continues to actively propose penalties whenever it suspects that an ALE may not have complied with this coverage mandate. Most noteworthy for this article is how the Service polices this mandate. It does so by way of reviewing the ALE’s submission of Forms 1094/1095 on an annual basis. For this reason, it also stands ready to introduce other penalties when it cannot find evidence of these forms.

For the 2023 tax year, the 1094/1095 forms must be issued to employees by March 4, 2024 (for Form 1095-C). The IRS requires these forms to be submitted to it on or before April 1, 2024 if electronically filed (required for 250 or more forms) or Feb. 28, 2024 if paper forms are filed. The paper filing threshold will decrease dramatically effective Jan. 1, 2024. As of that date, employers will only be able to paper file forms if they are preparing fewer than 10 forms.

The notification lag

The IRS has operated on a two-to-three-year lag since the IRS began imposing penalty propositions. By way of recent example, the Service is now releasing notices tied to Tax Year 2020 reporting-related activity. It is doing this even though employers completed their Tax Year 2022 reporting obligations during the first quarter of 2023. Most of these same employers are now setting up to ensure their Tax Year 2023 requirements are met in early 2024.

IRS Notices 5698 and 5699 provide the initial indication of a suspected nonfiling. To get to this place, the IRS evaluates Form W-2 submission counts at a Federal Employer Identification Number (FEIN) level against Form 1094 submissions for that same year. Whenever the W-2 count is sufficient enough for the IRS to deduce the employer might be an ALE yet cannot find evidence of a Form 1094 being on file for that same employer, it issues one of these notices. If no explanations are formally offered, noncompliance penalties are calculated and presented to the employer. For 2023, the penalty for an assumed intentional disregard is $580 per form. Since the Service has no Forms 1094 or 1095 on file to use in the calculation, it calculates the penalty using that FEIN’s Form W-2 count. In many instances, this count is significantly higher than the count of Forms 1095 the employer would have submitted on behalf of the full-time employees to which it is required to offer coverage.

This lag creates a variety of potential problems for employers who receive penalty propositions and wish to argue in favor of an abatement:

• Notices fall into an organizational “black hole”, never making it to the person or area best positioned to treat them with the seriousness they deserve. If not acted upon quickly, the IRS will drive the penalties to the point of lien and will garnish other anticipated funding. Most recently, employers have seen their granted pandemic-related relief curtailed because of this issue.
• People change, and with them goes the institutional knowledge. Most frequently, an organization’s reporting task sits within either the company’s human resources, employee benefits or payroll ranks. The reporting’s heavy lean in the realm of benefits eligibility and offers of health insurance coverage makes this positioning logical. However, not having documented processes and procedures available can mean the understanding of how and when the reporting makes its way to completion is lost.
• Systems and service providers change, and with them go…the forms! Employers make valid business decisions to replace payroll and HRIS systems and even ACA reporting support vendors. In doing so, however, they tend to not preserve the vital records that prove past actions as they relate to the forms issuance and filing processes. Those records include electronic copies of the forms, any proof of forms mailing, and the Receipt ID generated by the IRS AIR system. This ID provides tangible evidence that can be used by the IRS to trace and confirm an electronic filing.
• More significantly impactful when a payroll or HRIS system is replaced is that fact that in many instances, the conversion process does not factor in historic (past) employee and benefits data. This reality can be problematic if a filing is determined to be missed and the employer entertains recreating the forms as a resolution tactic.

These challenges are complicated and time-consuming for continuously operating organizations to overcome. They become even more vexing for companies that are bought and sold within these multiyear periods of time over which the Service makes its determinations. The penalty propositions can be stark. A recent example is an entity with less than 40 full-time employees (among over 1,400 total employees in the overall organizational structure, thus making it an ALE) who received a nonfiling penalty notice totaling over $900,000 for the 2020 tax year alone. This same organization had just fought a 2018 assessment. Upon investigating, it discovered the exposure extended from tax year 2018 through 2021. Efforts to work with the parties involved before the sale have been futile.

Action steps

It is incumbent upon business owners contemplating a buy or sell to include ACA compliance in their overall due diligence exercises and valuation processes. There are a variety of perspectives a business can take to fully mitigate related risks. Strictly from a form filing perspective, at any point from 2015 through to the current time, it is important to:

• Determine if the entity was considered an ALE to which the employer mandate and reporting obligations apply.
• If the entity was an ALE, determine if Forms 1094 and 1095 were prepared for each tax year. Seek physical evidence, such as filed hard copies of forms or PDF electronic form files.
• Determine if the forms were issued (mailed) to individuals. Seek recorded evidence of a mail date, the party who handled the mailing and the mailing method (e.g., USPS First Class Mail).
• Determine if the forms were paper filed with the IRS. If the answer is yes, seek recorded evidence of a mail date, mail method used and the address to which the forms were mailed. Many times, upon inquiry, an employer has mailed the hard copy forms to the incorrect IRS location. Whenever possible, the employer should save a full set of the hard copy forms. This helps to investigate any issues the IRS may report with the form formatting.
• Determine if the forms were electronically filed with the IRS. If the answer is yes, seek out evidence of the transmittal date, the issuing party and the Receipt ID. Whenever possible, if a vendor is being used to manage the transmittal process, request that the actual IRS XML files transmitted by the vendor be provided to you as one of your requirements.
• Establish a permanent location within your internal systems environment whereby all of this information can be held and easily retrieved several years past any particular tax year.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.