Liable for a free-rider penalty? Well, not so fast

The IRS is just now getting around to sending out penalty notices to applicable large employers that didn’t offer 70% of their full-time employees affordable group health insurance that provided minimum value during 2015. (Beginning in 2016, that percentage went up to 95%.)

The three-year delay isn’t remarkable; the usual period for penalty assessments is three years after a return was due or filed. Payroll will be key in fighting these free-rider penalties.

Time to get to work. The IRS’ penalty notice is officially called Letter 226J. The letter shows the proposed penalty, as determined from Part III of your Form 1094-C. It will be accompanied by Form 14765, which lists your assessable full-time employees by name, truncated Social Security number and the months during which they received a premium tax credit in 2015. That information will be gleaned from the indicator codes you entered on their Forms 1095-C. Your response, on Form 14764, is due to the IRS within 30 days.

The key to liability for a free-rider penalty is whether a full-time employee bought individual insurance on the exchange and qualified for a premium tax credit. This can happen in one of two ways:

  • You didn’t offer affordable group coverage that provided minimum value at all
  • Your offer of group coverage wasn’t affordable or didn’t provide minimum value.

In order to dispute the IRS’ determination, you will need to check the box on Form 14764 and take the following actions:

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  • Examine the coding on Form 14765. Is it the same as your coding on Forms 1095-C? Did you enter the proper codes on Lines 14 and 16 of Form 1095-C? Pay special attention to Line 16 coding for your affordability safe harbor—the W-2, Box 1 safe harbor; the rate-of-pay safe harbor; or the federal poverty line safe harbor. For 2015, benefits were affordable if they didn’t exceed 9.56% of your chosen safe harbor.
  • Identify the employees listed in the notice. Did they work part-time during 2015? Did they turn down an offer of affordable coverage? Were they actually enrolled in your plan? Could they have enrolled, either through a regular open enrollment period or a special enrollment period, but didn’t enroll? You’re not liable for a free-rider penalty for those employees, even if they received a premium tax credit.
  • Determine whether other relief from a free-rider penalty applies. Are only certain months on Form 14765 highlighted? For months that aren’t highlighted, determine whether these employees were fulfilling a 90-day probationary period. You’re not liable for a free-rider penalty for them, even if they received a premium tax credit during that time.

A step-by-step payroll compliance guide to each pay period, month and calendar quarter of the year is now available. Download it free here.