Notice & Comment

The IRS Rewrites the ACA Shared Responsibility Tax

In my prior posts and in a prior article, I’ve explained several circumstances where the IRS has rewritten Section 36B of the tax code, which offers tax credits to persons who purchase health coverage on an exchange established by a state. In this post, I want to discuss how the IRS has, out of thin air, created exceptions to Section 4980H(b). That statute unequivocally imposes or increases taxes on large employers whenever their employees properly obtain tax credits under Section 36B.

Specifically, under Section 4980H(b), a large employer potentially faces a tax even though it offers minimum essential health coverage to its employees. By enacting this provision, Congress not only wanted employers to provide health care coverage, but also wanted that coverage to provide minimum value and be affordable. The provision reflects a concern that if an employer’s offered health coverage does not satisfy value or affordability standards, employees may find themselves turning away from employer-provided coverage and may enroll on an exchange established by a state. Consequently, the employer will have shifted the responsibility of providing quality, affordable health coverage from itself to the rest of taxpayers, who may bear some of the costs associated with the state-established exchanges.

Nonetheless, to make sure that the employer contributes to the cost of coverage (or “shares in the responsibility”), Section 4980H(b) imposes a tax on large employers, equal to $3,000 per year, for each employee who receives a tax credit under Section 36B. The statute uses unqualified language, offers no exceptions, and is perfectly clear on this point: A tax is “hereby imposed” when the employee properly receives a credit under Section 36B. See also, e.g., Dep’t of Treasury, Shared Responsibility for Employers Regarding Health Coverage, 78 F.R. 218, 220 (Jan. 2, 2013) (explaining relationship between Sections 4980H(b) and section 36B).

However, the statutory scheme creates alleged difficulties for large employers. An employee’s eligibility for a premium tax credit is unknowable at the time she obtains coverage because her eligibility generally depends on her annual household income for a future year. For example, credits for coverage purchased in October 2015 for the 2016 taxable year will depend on household income for that future year. This correspondingly makes it impossible for an employer to know if it will face the Section 4980H(b) shared responsibility tax, because it can’t predict whether an employee will properly get a credit, and it can’t predict whether employer-provided coverage is affordable to a given employee. See Section 36B(c)(2)(C)(ii) (generally speaking, affordability test operates on employee-by-employee basis, based on the employee’s household income for the future year).

Of course, the employer will know the employee’s projected wages for the future year, but again, the credit depends on actual household income, not projected wages. Household income could be greater or lower than projected wages, on account of non-wage income items or any allowable items of deduction. See Sections 36B(d)(2) and 62. And it would be very uncommon for an employer to receive information on all these items. I’m not aware of any employer who, for example, routinely asks its employees to reveal the amount of deductible alimony they pay to their ex-husbands or ex-wives. See Sections 62(a)(10) and 215. Consequently, absent unusual measures, employers cannot fully avoid shared responsibility obligations under Section 4980H(b).

But, as seems to frequently be the case, when something seems troublesome or inadministrable in an ACA provision, the IRS sweeps in and saves the day with a regulation that contradicts the statute. Although Section 4980H(b) admits of no exceptions when a credit is properly allowed, Treas. Reg. 54.4980H-5(e) essentially allows large employers to avoid their shared responsibility obligations when they take reasonable efforts to offer affordable health coverage. (Note that the regulation does not actually refer to “reasonable efforts.” That’s my umbrella characterization for the various technical regulatory safe harbors which have no statutory basis. See also IRS Notice 2011-73 (stating that forthcoming regulations would provide a “more workable and practical method” rather than the statutory method).)

The IRS is not coy on this point. The regulation candidly states that relief “applies even if the applicable large employer member’s offer of coverage . . . is not affordable for a particular employee under section 36B(c)(2)(C)(i) and an applicable premium tax credit or cost-sharing reduction is allowed.” Treas. Reg. 54.4980H-5(e)(2). Employers can of course challenge the Section 4980H(b) tax when employee credits are improperly allowed, see Section 4980H(d)(3) and ACA Section 1411(f)(2)(A) (authorizing establishment of appeal procedures), but the IRS regulation eliminates the employer tax even though the statutory criteria are squarely satisfied and the employee is unambiguously entitled to a credit.

My prior writings on the flawed Section 36B regulations were made with some hesitation. It’s not exactly heartwarming to point out problems with regulations that extend benefits to some of our society’s most vulnerable members. But I think the IRS’s giveaway under Section 4980H(b) to large employers is troublesome for multiple reasons.

First, even if we incorrectly assume that the IRS can rewrite the law whenever that it thinks that doing so serves some unexpressed legislative purpose, the flawed Section 4980H(b) regulations adopt a policy inconsistent with the ACA. Congress has decided that when an employee resorts to the exchanges to obtain health coverage, the employer should share in the collective responsibility associated with providing coverage.

I do not see why it matters that the employer “tried really hard” and satisfied the safe harbors invented in the regulations. At the end of the day, the employee did not obtain employer provided coverage and she actually purchased a policy on an exchange. The employer thus avoided costs related to coverage of the employee, such as contributions towards the employee’s monthly premium. Its shared responsibility obligation should be triggered.

Second, the IRS should not wantonly shift tax burdens without statutory authority. When an employer avoids obligations via the Section 4980H(b) regulations, the premium tax credit for the employee does not simply disappear. The money must come from somewhere. The IRS regulations effectively shift the burden (up to the $3000 annual amount) from the statutory specified class of persons (i.e., large employers) and on to the rest of us. Maybe, as a policy matter, Section 4980H should be scrapped and tax credits should be funded via a broadly applicable tax increase. But that’s not the policy choice that the legislature made.

Third, the IRS regulations confuse Section 4980H(b) with the many actual penalties imposed by the tax code. Generally, when Congress imposes a penalty on a taxpayer, it allows her to defeat the penalty by showing that she acted with “reasonable cause and in good faith,” or something along those lines. See, e.g. Sections 6664(c)(1), 6664(d)(1), 6717(c). When the statute offers a penalty defense of this type, IRS regulations can appropriately offer safe harbors or other rules that flatly block the imposition of the penalty.

But Section 4980H does not impose a penalty, at least not technically speaking. Many of us, including me, will sometimes colloquially refer to the statute as the “employer penalty,” but the statute is designed as a tax, not a penalty. See Sections 4980H(b)(2) and (c)(7) (referring to “tax imposed”). The Code’s actual penalty provisions, mostly codified in Chapter 68, Sections 6651-6725, usually allow for reasonable cause defenses, because they are designed to punish culpable conduct.

Section 4980H(b), by contrast, is designed as a shared responsibility tax. Congress borrowed some principles from the penalty regime regarding assessment and collection matters, see Section 4980H(d)(1), but nothing in the statute allows an employer to escape its obligations for “reasonable cause” or anything along those lines. Congress knows how to provide a good faith defense and it did not do so under Section 4980H(b). Even if Section 4980H(b) were branded a penalty, cf. 4980H(c)(2)(D), it would be a strict liability one.

Fourth, the IRS misunderstands the role that safe harbors play in regulatory law. Safe harbors are properly used when a statute permits or forbids a range of conduct, and the administering agency draws a line within that range which, if not crossed, will avoid adverse consequences.

For example, consider Section 162(a) of the tax code, which generally prohibits deductions for unreasonably high salaries. If the IRS promulgated some safe harbors regarding this nebulous standard — say, a regulation providing that a salary would be automatically reasonable as long as it did not exceed 3% of a company’s net profits — the agency would be acting well within its statutory authority. When a statute’s ambiguous language potentially reaches a wide range of conduct, it’s perfectly appropriate for an agency to draw a line where the public can feel safe. See, e.g., Mayo Found. for Med. Educ. & Research v. United States, 562 U.S. 44, 59 (2011) (“Regulation, like legislation, often requires drawing lines.”).

Yet for Section 4980H(b), Congress itself drew the line. An employer that fails to offer affordable health coverage to an employee must share the financial responsibility when an employee properly receives a tax credit under Section 36B. The Section 4980H regulations do not reflect an attempt to draw a regulatory line within the space that the legislature provided. Rather, the IRS has re-drawn the line prescribed the statute. This is something that the IRS cannot lawfully do.

Fifth and finally, this reflects another instance of the IRS re-writing the ACA to implement the law that it believes will be politically palatable, rather than the law that was actually enacted. I’ve repeatedly expressed concerns along these lines, so I will say no more except to emphasize that the flat rewriting of the statute should raise questions about whether the IRS has made serious attempts to respect its statutory authority in implementing the tax provisions of the ACA, including those at issue in King v. Burwell.

Given the difficulties associated with taxpayer standing, see Flast v. Cohen, 392 U.S. 83 (1968), it seems doubtful that anyone will have standing to challenge the IRS’s rewrite of Section 4980H(b). Nonetheless, the invalid regulation should inform public debate over IRS rulemaking under the ACA.

Also, the legislature should carefully re-consider the flawed design of the ACA tax provisions. Sections 36B and 4980H establish a regime where taxpayers sign up for health coverage with a mere prediction of their allowable tax credits and employers cannot predict their shared responsibilities. In a future post, I will detail some reasons to shift away from this framework, but I want to immediately identify this as an area for legislative improvement, which ACA supporters may wish to consider.

By Andy Grewal