Summary: In a recent Northern District of Texas court ruling titled “Faulk Company, Inc. v. Xavier Becerra et al,” the plaintiff, a Texas-based janitorial services company, prevailed in their challenge against the U.S. Department of Health and Human Services (HHS) and the Internal Revenue Service (IRS) in connection with an Affordable Care Act (ACA) employer mandate penalty. The district court ordered the IRS to refund the ACA-related penalty to the plaintiff and ruled that a related HHS regulation is void and unenforceable.
Read on for more information regarding the ruling and considerations for employers facing ACA employer mandate penalties.
ACA Employer Mandate Background
The ACA’s employer shared responsibility payment (ESRP) rules (also known as the “employer mandate” rules) require applicable large employers (ALEs) to offer affordable, minimum value health coverage to their full-time employees or potentially pay a penalty (detailed in the table below).
An ALE may be subject to a penalty only if one or more full-time employees obtain a premium tax credit to buy a qualified health plan through the Health Insurance Marketplace, also known as the Exchange, either because the ALE does not offer health coverage or offers coverage that is unaffordable or does not provide minimum value.
Applicable Large Employer (ALE) Definition Refresher
An ALE is an employer with at least 50 full-time employees, including full-time equivalent employees, on average during the prior calendar year. ALEs include all employers within the same controlled group.
Letter 226-J Background
Letter 226-J is the initial letter issued by the IRS to ALEs to notify them that they may be liable for an ESRP assessment, and also describes the general procedures the IRS uses to propose and collect ESRP assessments. The IRS will issue Letter 226-J to an ALE if it determines that, for at least one month in the year, one or more of the ALE’s full-time employees was enrolled in an Exchange plan for which a premium tax credit was allowed (and the ALE did not qualify for an affordability safe harbor or other relief for the employee). For historical reference, the IRS began issuing Letter 226-J notices to assess ESRP penalties for the 2015 tax year in late 2017.
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ACA ESRP/Employer Mandate Penalties
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2025
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Notes
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“A” Penalties §4980H(a)
“sledgehammer” penalty
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$2,900
($241.67/month)
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Penalty for failing to offer group health plan coverage to at least 95% of full-time employees (and their children up to age 26) for any month during the year and at least one employee enrolls in Exchange coverage with a premium tax credit.
- Based on the total number of full-time employees employed that month minus the first 30.
- Calculated on a group level, which means this penalty applies to each full-time employee, even if they did not receive a premium tax credit to enroll in Exchange coverage.
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“B” Penalties
§4980H(b)
“tack hammer” penalty
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$4,350
($362.50/month)
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Penalty for failing to offer affordable, minimum value group health plan coverage to a full-time employee who enrolls in Exchange coverage with a premium tax credit.
- Calculated on an employee level, based on which employees receive premium tax credits.
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Recent Letter 226-J/ESRP Assessment Updates:
Federal legislation signed into law in late 2024 provides additional time of 90 days (from the prior 30 days) to respond to IRS Letter 226-J, and also established a six-year statute of limitations for the IRS to collect ESRP assessments. Click here for a Risk Strategies article with more details on these ESRP-related updates.
Legal Case Background
The plaintiff, a Texas-based janitorial services company and an ALE, stopped offering health insurance coverage to its employees in 2019, resulting in the IRS issuing a Letter 226-J and assessing ESRP penalties for the 2019 tax year in the amount of $205,621.71. Plaintiff paid the penalty assessment “under protest” and subsequently filed a refund claim with the IRS for the 2019 ESRP, but never received a response. In June 2024, plaintiff filed this matter in the Northern District of Texas.
Plaintiff argued that the IRS and HHS violated its statutory due process rights by deeming the Letter 226-J as a "certification" before assessing the ESRP penalty. Plaintiff argued that HHS, rather than the IRS, should have provided the certification first to the plaintiff, and that the certification lacked proper notice of potential liability and the right to appeal. Plaintiff based its argument on relevant statutory language (under ACA Section 1411), asserting that HHS is first required to certify to an employer that one or more full-time employees were enrolled in an Exchange before the IRS can propose penalties.
The court agreed with plaintiff’s argument, holding that “once HHS provides certification to an employer, consisting of the notice of potential liability and notice of the right to appeal, only then may the IRS assess an ESRP.” On a practical level, many, if not most, employers facing a proposed ESRP assessment do not receive the requisite HHS certification; rather, they typically receive only the IRS Letter 226-J (as the court concedes is the “established practice by the IRS to issue certifications”).
Plaintiff also challenged a related HHS “Certification Regulation” (45 CFR 155.310(i)), delegating the certification obligation to the IRS. The court agreed with plaintiff’s challenge, ruling that “HHS did not have authority to add any certification program to be administered by the IRS because ACA § 1411 does not allow HHS to delegate to the IRS.” As a result, the court concluded that the HHS Certification Regulation “should be set aside as void and unenforceable.[1]”
The ruling also ordered the IRS to refund plaintiff $205,621.71 for the ESRP assessed for the 2019 tax year.
Notable Case Takeaways
This case and ruling underscore the legal and procedural complexities surrounding the enforcement of the ACA employer mandate, particularly around the intersection and overlap (or lack thereof) of HHS and IRS procedures and practices in connection with assessing and collecting ESRP penalties.
Notably, the district court acknowledges that “its ruling is not the only possible interpretation of the statutes in question,” but states “it is the best interpretation” given the “plain meaning and language of the statute.”
The court continues on to recognize that “the downstream effect of ruling that the HHS Certification Regulation is void and unenforceable may inhibit the IRS's ability to assess the ESRP excise tax until HHS determines the proper way to issue such certification through the Exchange as ACA § 1411 requires.” All to say, the court admits this ruling is likely to have a profound impact on the current IRS ESRP assessment and collection landscape.
Employer Considerations
Employers currently facing proposed IRS ESRP assessments are advised to contact their legal counsel and/or tax advisors since this ruling could create a new pathway for them to challenge the assessments. Similarly, employers who paid an ESRP assessment to the IRS in the past are advised to speak to their legal counsel and/or tax advisers to determine an appropriate course of action in terms of seeking potential refunds in light of this ruling.
On a broad level, this ruling could imperil the ACA employer mandate rules and possibly remove the deterrence element that compels employers to offer ACA-compliant health plan coverage to their full-time employees in the first place.
Risk Strategies is closely monitoring any developments related to this recent ruling, including a potential appeal by the current HHS administration, HHS beginning to issue the requisite Section 1411 certification notices, or even the more unlikely possibility of Congressional action revising the ACA statutory language under Section 1411.
Contact your Risk Strategies account team with any questions or contact us directly here.
[1] Pursuant to the Administrative Procedure Act, which the court wrote "empowers courts to 'hold unlawful and set aside agency action, findings, and conclusions found to be ... arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with the law.'"
