With the deadlines approaching for applicable large employers (ALEs) to complete their ACA filings for 2019, Chief Counsel for the IRS released a memorandum on February 21, 2020, concluding that there is no time limit under section 4980H of the Internal Revenue Code of 1986, as amended (IRC) for the IRS to assess employer shared responsibility payments (ESRPs) in response to such filings. This means that ALEs can no longer assume that a three-year statute of limitations has (or soon will) expire for an ESRP assessment with respect to their 2015 and 2016 ACA filings (the first two years for which such filings were required). Instead, the IRS will (at least in its view) have an indefinite period to assess ESRPs based upon information reported by ALEs for those, and all other, tax years. Although it remains to be seen if or how aggressively the IRS will attempt to pursue ESRPs for returns filed more than three years ago, ALEs should not assume that they are, at any time, “in the clear” for such years but should instead be prepared to pay or challenge an ESRP with respect to any calendar year beginning with 2015.
ALEs that fail to offer affordable minimum value health coverage to all full-time employees are subject to an ESRP under IRC 4980H if one or more of those employees obtains a premium tax credit (PTC) or cost-sharing reduction (CSR) for health coverage purchased on an Exchange. Unlike other excise taxes, ALEs do not file an IRS return to self-assess an ESRP. Instead, an ESRP is due on notice and demand from the IRS.
In order for the IRS to determine whether an ESRP is assessable against an ALE, IRC 6056 requires ALEs to file Forms 1094-C and 1095-C each calendar year to report, amongst other things, whether the ALE offered affordable minimum value health coverage to its full-time employees for that year. The IRS then uses that information (in conjunction with information obtained from other sources regarding whether any of the ALE’s full-time employees obtained a PTC or CSR for health coverage purchased on an Exchange) to determine if the ALE owes an ESRP. If the IRS believes an ESRP is due, it will initiate the assessment process by issuing Letter 226J to inform the ALE of the proposed ESRP.
Under IRC 6501, the IRS generally has three years from the date a return is filed to assess any tax in connection with that return. However, because an ESRP is not reported on a self-assessing return like most excise taxes and is triggered by a combination of events not all of which are reported on Forms 1094-C and 1095-C, it is not clear whether filing those forms is sufficient to trigger the three-year statute of limitations under IRC 6501. In spite of requests for clarification, the IRS has not historically addressed this question, explicitly reserving a section for “administration and procedure” in the IRC 4980H regulations issued in 2014. Nevertheless, in the absence of any indication that the IRS would treat Forms 1094-C and 1095-C differently from other returns to which IRC 6501 applies (e.g., returns required for income, employment, excise taxes, etc.), it was generally presumed that the three-year statute of limitations for the assessment of an ESRP would be triggered by the filing of those forms. In fact, IRS instructions regarding the completion of Forms 1094-C and 1095-C advised ALEs to keep copies of the returns, along with the data used to complete them, for at least three years – thereby suggesting that filing Forms 1094-C/1095-C would trigger the generally applicable three-year statute of limitations under IRC 6501 for the assessment of any ESRP associated with those returns.
Under this rationale, if an ALE did not receive Letter 226J within three years of filing Forms 1094-C and 1095-C, no ESRP could thereafter be assessed – so that the three-year statute of limitations for Forms 1094-C and 1095-C filed in 2016 (to report information with respect to the 2015 calendar year) would have expired in 2019 and the three-year statute of limitations with respect to Forms 1094-C and 1095-C filed in 2017 (to report information with respect to the 2016 calendar year) would expire this year.
IRS Chief Counsel Memorandum 20200801F, however, concludes otherwise – that filing Forms 1094-C/1095-C does not trigger the three-year statute of limitations for the assessment of an ESRP, thus creating open-ended exposure to potential IRC 4980H liabilities for ALEs.
In its memorandum, Chief Counsel for the IRS explains that the three-year statute of limitations under IRC 6501 is limited to taxes for which a “return” is required and that Forms 1094-C and 1095-C do not constitute “returns” for this purpose – because they do not contain the necessary data to calculate the amount of an ESRP that could be owed by an ALE as required under applicable Supreme Court precedent. In particular, an ESRP cannot be determined until it is known whether any of the reporting ALE’s full-time employees received a PTC or CSR for health coverage purchased on an Exchange and neither the Form 1094-C nor the Form 1095-C includes this information. Therefore, since the IRS can only calculate an ESRP by cross-referencing information reported on Forms 1094-C and 1095-C with information obtained from other sources (such as Forms 1040 filed by an ALE’s full-time employees), there is no single document that can be treated as a “return” that triggers the three-year statute of limitations for the ESRP.
According to IRS Chief Counsel Memorandum 20200801F, a delay by the IRS in responding to information reported by ALEs on Forms 1094-C and 1095-C is irrelevant with respect to the assessment of an ESRP – as there is no time limit for such assessments. This means that the IRS could potentially initiate an ESRP assessment based upon information reported on Forms 1094-C/1095-C several years after those forms have been filed – although it remains to be seen if that will occur. As ALEs wait to see how the IRS proceeds in light of this memorandum, there are a few considerations to keep in mind.
According to IRS Chief Counsel Memorandum 20200801F, the possibility of an ESRP assessment (for any year beginning with 2015) is left open for an indefinite period, thus creating uncertainty regarding an ALE’s ESRP liability. ALEs will, therefore, need to determine if/how to quantify and address this increased tax exposure under IRC 4980H. This could be particularly relevant (and troublesome) in a merger or acquisition transaction, thus reinforcing the need for targeted due diligence and robust representations and/or indemnifications with respect to a seller’s IRC 4980H compliance. In that regard, it will be important for a company involved in the acquisition of an ALE to ensure that it properly diligences the potential increased IRC 4980H risk exposure and includes ACA-specific representations and warranties in addition to the typical employee benefits provisions in the transaction agreement. We believe that a general compliance with law provision in a transaction agreement may not be sufficient for protection to the buyer because potential ESRP liability may not be treated as a violation of the ACA.
As long as an ALE offers affordable minimum value health coverage to all full-time employees (as those terms are defined in IRC 4980H), it will not be subject to an ESRP regardless of whether one or more of its full-time employees obtain a PTC or CSR for coverage purchased through an Exchange. However, if an ALE receives Letter 226J in this circumstance, it will need to document compliance with IRC 4980H to avoid paying the proposed ESRP – which means retaining records such as employee hours, health coverage offered, premiums charged for that coverage, enrollment procedures, etc. In light of IRS Chief Counsel Memorandum 20200801F, there is no limitation on the retention period for this type of data that will need to be preserved in order to dispute a proposed ESRP. The preservation of this data would also be relevant in the event of an ALE’s merger or acquisition as a buyer would likewise need it to dispute a proposed ESRP – and if an ALE were unable to supply this information (dating back to 2015), the ALE may very well need to provide some type of concession in order to mitigate the buyer’s IRC 4980H liability exposure in connection with the transaction. ALEs will, therefore, need to consider the extent to which its record retention policies may need to be revised.
Chief Counsel memorandums cannot be cited as precedent and are not binding on the courts. It is therefore quite possible that the conclusion reached in IRS Chief Counsel Memorandum 20200801F could be judicially challenged.
IRS Chief Counsel Memorandum 20200801F has no impact on reporting penalties under IRC 6721 and 6722 for failure to file (or furnish individuals) with correct ACA forms. Unlike ESRPs, reporting penalties under IRC 6721 and 6722 can be calculated based upon the data included in Forms 1094-C and 1095-C. Accordingly, the three-year statute of limitations under IRC 6501 should be triggered by the filing of those forms for purposes of failure to file penalties. In any event, the IRS has thus far extended good-faith reporting relief from these penalties (for calendar years 2015 through 2019) – so that the statute of limitations has not yet been particularly relevant to them.
The status of the ACA (including ESRPs) remains unclear in light of a recent decision by a Fifth Circuit district court invalidating the statute on the basis that its individual mandate – which was previously upheld by the Supreme Court as a valid exercise of Congress’ taxing powers – became unconstitutional when the mandate’s penalty tax was eliminated. The Fifth Circuit court of appeals vacated the portion of the district court’s decision concluding that the entire ACA must fall without the individual mandate – remanding it back to the district court to determine whether any portion is severable from the individual mandate and can thus remain in force and effect. In response, several state Attorneys General and the House of Representatives petitioned the Supreme Court to decide this issue – which it agreed to do on March 2, 2020.