IRS Letter 226J is the official notification of a proposed Employer Shared Responsibility Payment (ESRP). While technically a penalty for failing to offer health coverage, it is triggered by data reporting inconsistencies in Forms 1094-C and 1095-C that misrepresent an employer’s actual compliance status.
Preventing this liability requires shifting from a reactive filing mindset to a proactive strategy of data validation, risk assessment, and forensic auditing prior to submission.
Pre-Filing Data Validation
The IRS utilizes the ACA Compliance Validation (ACV) system to cross-reference employer filings against individual tax returns. If the data submitted on your forms contradicts itself or fails to match IRS logic, the system automatically flags the file for a penalty assessment.
Navigating ACA Deadlines: Pre-Filing vs. Post-Penalty Relief
A critical part of avoiding and resolving ACA penalties is understanding which deadlines can be extended and when. There are two entirely separate timelines employers must manage: one before filing, and one after a penalty is assessed.
Pre-Filing Relief: The 30-Day Reporting Extension (Form 8809)
Many employers may focus on meeting the initial March 31 electronic filing deadline over data accuracy to avoid late-filing penalties. However, rushing to file inaccurate data just to hit this deadline often results in significantly higher financial exposure via Letter 226J.
Recommendation: If your data quality is in question as the filing deadline approaches, do not rush. Instead, file Form 8809 to request an automatic 30-day extension for your initial ACA reporting.
Important Distinction: Form 8809 is strictly a pre-filing extension. It gives you 30 extra days to audit codes and verify employee counts before transmitting data to the IRS. It cannot be used to extend your time to respond to a Letter 226J after a penalty has been assessed (which is covered by a separate 90-day response window).
Post-Penalty Relief: The 90-Day Defense Window (Letter 226J)
If data has already been filed and the IRS automated system flags it for a proposed penalty, the agency will issue Letter 226J. Historically, employers only had 30 days to respond to this massive financial threat. That has changed.
- The Strategy: Under the Employer Reporting Improvement Act, employers now have 90 days to respond to a Letter 226J assessment. Do not treat this like a standard filing extension. Use this newly expanded 90-day window to conduct a full forensic audit of the penalized year, re-calculate employee eligibility, and correct historical coding errors to definitively eliminate the assessment.
Important Note: This 90-day extension applies exclusively to Letter 226J. It does not cover IRS Letter 5699 for non-filers, which still strictly requires a 30-day response.
Conducting an ACA Penalty Risk Assessment
A Penalty Risk Assessment is a review of ACA data designed to mimic the IRS audit process. This assessment allows employers to identify exposure and file corrections before a penalty notice is issued.
1. Calculation of Risk Exposure
Employers must analyze data using the specific penalty formulas applied by the IRS for the applicable tax year.
- Verify Full-Time Counts: The “A Penalty” (IRC 4980H(a)) is calculated based on the full-time employee count reported on Form 1094-C. Overstating this number artificially inflates the penalty multiplier. For the 2025 tax year, the “A Penalty” is $2,900 per full-time employee (annualized).
- Audit Code Combinations: Review Forms 1095-C for logical inconsistencies that trigger IRC Section 4980H risk.
2. Identification of incompatible 1095-C codes
The IRS uses automated cross-referencing to find conflicting stories in your data. While a single coding error may not always trigger a full audit, specific mismatches are immediate red flags for IRC Section 4980H(b) penalties.
- The 1E / Blank Error: If Line 14 shows Code 1E (Qualifying Offer) but Line 16 is left Blank, you are telling the IRS that you offered coverage but have no legal reason (Safe Harbor) for the employee not being enrolled.
- The Trigger: If that specific employee goes to a state or federal exchange and receives a Premium Tax Credit (PTC), the IRS system will automatically flag the Blank Line 16 as an admission of unaffordability.
- The Consequence: This triggers an automated 4980H(b) penalty assessment. Even if the coverage was actually affordable, the Blank code makes the penalty legally defensible from the IRS’s perspective until you prove otherwise during the 90-day defense window.
3. Identification of Latent Errors
Review submitted data for errors that may pass initial transmission schemas but fail substantive audits.
- Headcount Discrepancies: Mismatches between the total number of Forms 1095-C filed and the full-time count listed on Form 1094-C.
- Indicator Errors: Incorrect Minimum Essential Coverage (MEC) indicators or misapplication of 4980H Transition Relief codes.
4. Proactive Correction
If errors are identified in previous years’ filings, employers should submit corrected Forms 1094-C and 1095-C immediately. A voluntary correction demonstrates good faith and corrects the record before the IRS ACV system generates a proposed assessment.
Common Data Errors That Trigger Letter 226J
The following data entry errors are the most frequent causes of automated penalty assessments.
Failure to Check the “All 12 Months” Box
On Form 1094-C, Part III, Column (a), employers must attest to offering Minimum Essential Coverage (MEC) to at least 95% of full-time employees.
- The Error: Failing to check “Yes” or the “All 12 Months” box when coverage was actually offered.
The Impact: This omission is treated by the IRS as an admission of non-compliance, inviting an automatic “A Penalty” assessment.
Overstatement of Full-Time Employee Counts
The “A Penalty” is calculated using the count reported in Form 1094-C, Part III, Column (b).
- The Error: Reporting total headcount (including part-time and variable hour staff) instead of the specific full-time ACA count defined by the monthly or look-back measurement method.
- The Impact: This error inflates the penalty liability calculation, potentially resulting in a multi-million dollar assessment for a compliant organization.
Conflicting Indicator Codes
The codes on Form 1095-C (Lines 14 and 16) must tell a coherent compliance story. If the narrative is inconsistent, you are essentially inviting the IRS to look closer at your entire filing.
- Line 14 (The Offer): Indicates the nature of the coverage offer.
- Line 16 (The Safe Harbor): Justifies why no penalty should be assessed.
- The Risk: Codes that conflict — such as claiming an affordability safe harbor for a month where the employee was not employed — are technically inaccurate. However, it is important to note that an audit or Letter 226J is generally only triggered if that specific employee receives a Premium Tax Credit (PTC).
- The Strategy: Without a PTC, a coding error may simply sit in the system. But because employers cannot predict which former or part-time employees will seek a PTC, every line must be audited for Substantive Accuracy prior to filing to ensure no latent triggers exist in your data.
Establishing a Compliance Process
ACA compliance requires continuous data monitoring rather than a single annual filing event. To reduce risk, organizations should implement the following protocols:
- Monthly Data Monitoring: Track offers of coverage and affordability thresholds on a monthly basis. Note that the affordability threshold for the 2025 tax year is 9.02%.
- Variable Hour Tracking: Implement the Look-Back Measurement Method to accurately classify variable-hour employees and defend full-time status determinations.
- Strict 6-Year Record Retention: The Employer Reporting Improvement Act officially established a six-year statute of limitations for ACA penalties. Employers must retain all records of offers, waivers, and Summary of Benefits and Coverage (SBC) documents for a minimum of 6 years following the filing date to satisfy potential IRS inquiries.
Preventing these automated assessments requires a forensic approach to data validation that mirrors the rigor of the IRS’s own audit process. Trusaic has leveraged this proactive methodology to save our clients over $1 billion in proposed penalties — with many achieving reductions of 90% or more — ensuring your compliance strategy relies on verified accuracy rather than chance.