IRS Issues Employer Mandate Penalties/Is an ESOP Right for Your Company?


IRS Issues Employer Mandate Penalties

On November 2, the IRS issued Letter 226J to applicable large employers (ALEs) (generally, an ALE is any employer with 50 or more full-time employees and full-time equivalents) that the IRS believes are subject to the penalties related to the employer ‘Pay or Play’ mandate for the 2015 tax year (the “Employer Shared Responsibility Payment (ESRP) Penalty”). It is reported that ESRP Penalties for some employers will include seven figure assessments! ALEs in receipt of Letter 226J will generally have 30 days from the date of the letter to respond.

What Information is Included in Letter 226J?

Letter 226J includes information on the individual employees who, during 2015 and for at least one month in the year, were full-time employees, were allowed a premium tax credit, and for whom the ALE did not qualify for an affordability safe harbor or other relief. The letter contains a summary table itemizing the proposed payment by month and indicating for each month if the liability is either:

  • A penalty for failure to offer minimum essential coverage to “substantially all” of your full-time employees (and their dependents) and at least one of your full-time employees was certified as being eligible for the premium tax credit (Code Section 4980H(a) or “Sledgehammer Penalty”); or
  • A penalty for offering minimum essential coverage to “substantially all” of your full-time employees (and their dependents) but at least one of your full-time employees was certified as being allowed the premium tax credit because the coverage was unaffordable, did not provide minimum value, or the full-time employee was not offered coverage).

The IRS notes that it will be useful to have available, for reference, Form(s) 1094-C and 1095-C (the “Forms”) that the ALE filed with the IRS for the 2015 tax year. Letter 226J states that if an ALE believes there is an error on the Forms, it may make changes to the Employee Premium Tax Credit Listing using the applicable indicator codes described in in the Instructions for the Forms, and it provides instructions for inclusion of the new, accurate codes. The IRS states that ALEs should not file a corrected Form 1094-C. Instead, the ALE should include the updated codes as instructed in Letter 226J along with a statement summarizing these changes in its ESRP Penalty disagreement response (described in more detail below).

How Should an ALE Proceed if it Agrees with the Penalty Assessment in Letter 226J?

If an ALE agrees with the Letter 226J Penalty, it should complete the enclosed Form 14764, ESRP Response, and return it to the IRS by the response date listed in Letter 226J. Failure to respond to Letter 226J within the requisite 30-day time period may result in a significant IRS penalty assessment and possibly an IRS audit. For a copy of IRS Form 14764, click here.

How Should an ALE Proceed if it Disagrees with the Penalty Assessment in Letter 226J?

  • Contact ERISA counsel to discuss how you should proceed and develop a process for substantiating any disagreement with the IRS’s ESRP Penalty.
  • Respond to Letter 226J in writing either agreeing with the IRS’s employer mandate penalty assessment or disagreeing with part or all of such assessment. The response should include supporting documentation to justify your disagreement. Review payroll, time and attendance, and HR data that is required for IRS ACA filings to ensure there are no inaccuracy issues. If you discover errors, correct them and identify a process to ensure the inaccuracies are caught in the future.
  • Implement a process to maintain documentation for the 2016 and 2017 tax years. You should make certain that all documentation that may be required to respond to a future IRS inquiry or audit is readily available when needed.
  • If you disagree with the proposed or revised employer mandate penalty assessment, request a pre-assessment conference with the IRS. Following this conference with the IRS, if you still disagree with the assessment, you may also ask the IRS Office of Appeals to review the case.

The IRS will acknowledge an employer response to Letter 226J with a Letter 227. For a copy of Letter 226J, please click here.
DOL Delays Implementation of Updated Claims Procedures Regulations

On November 24, the Department of Labor announced a 90-day delay of the applicability of a final rule amending the claims procedure requirements applicable to ERISA-covered employee benefit plans that provide disability benefits (the “Final Disability Rule”). The Final Disability Rule was originally effective on January 18, 2017, and it was scheduled to become applicable on January 1, 2018. According to the DOL, the delay announced in this document is necessary to enable it to carefully consider comments and data as part of its effort, pursuant to Executive Order 13777 (Presidential Executive Order on Enforcing the Regulatory Reform Agenda), to examine regulatory alternatives that meet its objectives of ensuring the full and fair review of disability benefit claims while not imposing unnecessary costs and adverse consequences. This guidance is scheduled to be published in the Federal Register on November


Is an ESOP Right for Your Company?

Determining whether an ESOP is right for your company requires examination from a variety of perspectives. If you are an individual with a significant portion of your net worth tied up in your business, an ESOP is one way to transfer ownership to employees, serving as an attraction and retention tool. The ESOP acquires some or all of the company’s stock and provides employees tax benefits, through a qualified retirement plan, that are unavailable in a traditional buy-sell transaction. Additionally, companies may reap significant federal income tax breaks through an ESOP.

Meeting Corporate Objectives

Many corporate objectives can be met with an ESOP, such as:

Solving ownership succession issues

Refinancing existing debt

Borrowing at reduced after-tax cost

Eliminating federal income tax at both corporate and shareholder levels

Estate planning

Facilitating an acquisition or divestiture

Providing employees with incentives for productivity

ESOP Company Characteristics

ESOPs work well in companies that have the following characteristics:

Strong, consistent cash flow

Little to no permanent debt

Adequate capitalization in place to sustain future growth

Good management team to carry on after the owner has left

Relatively large payroll base

Alignment of shareholder and employees’ interests


Before deciding to establish an ESOP, there are numerous considerations to ensure an ESOP is the most beneficial retirement plan tool. Consider the following questions:

What is the owner’s succession plan for the company?

What are the real goals and objections as far as company ownership and timing?

Will an ESOP best help achieve those goals, or will a profit sharing plan or stock bonus plan be a better fit?

Are there pre-existing retirement plans that must be taken into consideration in designing an ESOP?

Will an ESOP fit into your corporate culture, and are you willing to commit to communicating with the new employee-owners in the ESOP?

What is the company’s forecast of the future with the ESOP in place?

Will the ESOP have to obtain a loan to purchase the stock from the owner?

Business Succession

Do you worry about who will run your company when you leave or retire? ESOPs are often used as a tool in business succession planning as a way for an owner to sell his or her shares of stock to a retirement plan in a tax advantaged way and then allocate the purchased shares to plan participants. In an ESOP, even though the plan beneficiaries have some limited voting rights, the board of directors will still exist to run the company, and the officers and managers will continue to manage the company.


Because they can be used to refinance existing corporate debt to be repaid with pre-tax dollars, ESOPs can be used to lower the borrowing costs for corporate debts. This is achieved when the sponsoring company refinances its existing debt by issuing new shares of stock to the ESOP equal in value to the amount of debt assumed by the ESOP. Also, the company can make tax deductible contributions to repay the loan principal, up to 25% of the total plan participants’ payroll.

Tax Advantages

If your company is extremely profitable, there are numerous tax advantages and incentives that are unique to ESOPs. ESOPs do not pay federal income tax. Furthermore, employees do not pay taxes on the stock in their ESOP accounts until they take a distribution at retirement (or other, limited events), and even then those amounts can be rolled over to an IRA or other qualified plan to continue the tax deferral.


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Hall Benefits Law, LLC

HBL offers employers comprehensive legal guidance on benefits in mergers and acquisitions, Employee Stock Ownership Plans (ESOPs), executive compensation, health and welfare benefits, healthcare reform, and retirement plans. We counsel a wide spectrum of clients including small, mid-sized, and large companies, 401(k) investment advisors, health insurance brokers, accountants, attorneys, and HR consultants, just to name a few. HBL is passionate about advising clients, and we are dedicated to our mission: to provide comprehensive, personalized, and practical ERISA and benefits legal solutions that exceed client expectations.

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