Last week the Treasury Inspector General for Tax Administration (TIGTA) released its findings from an extensive audit it conducted to assess the ability of IRS to enforce the Affordable Care Act’s (ACA) employer shared responsibility (pay-or-play) mandate and thus assess excise taxes/penalties against employers. TIGTA discovered major, systemic problems with the technology IRS uses. The technological woes of IRS are undoubtedly at the heart of why it has not yet assessed any ACA pay-or-play penalties against a single employer. The audit findings also provide insight into IRS penalty procedures.
IRS Can't Scan Documents Efficiently
The first major issue the audit report discussed is the inability of IRS systems to timely and accurately convert paper Forms 1094-C and 1095-C to the electronic formats that are processed by its ACA Information Returns system (AIR system). As of July 22, 2016, only 2% of Forms 1094-C and 1% of Forms 1095-C submitted on paper had been successfully scanned and uploaded to the AIR system. The report cites several reasons for the low conversion rate including:- hardware time being prioritized for individual tax returns (Forms 1040),
- errors in the scanned output itself, and
- programming errors that led to inaccurate identification of an employer as an "applicable large employer," or ALE.
IRS Software Full of Bugs (to Say the Least)
More problematically, the AIR system was unable to accurately generate error codes when an error condition existed. The AIR system also generated error codes when no error condition existed. (That's tech speak for, "It didn't work.")To its credit, the IRS software did include more than 155 conditions in its validation process and 141 possible error codes that could be output. Some of those error codes worked as expected and caused Forms 1094-C and 1095-C to be rejected in cases where, for example, there was a missing EIN or business name. However, other error codes, such as might result from a missing employee TIN or mailing address, did not cause the system to reject a Form 1094-C or 1095-C when it should have.
TIGTA also discovered a problem with line 14 of the Form 1095-C. Recall that Line 14 of the Form 1095-C contains the offer of coverage codes (1A, 1E, 1H, etc.). Line 14 must be completed for all 12 months on each Form 1095-C submitted to the IRS. During the audit, TIGTA reviewed an internal IRS management report from April 12, 2016, in which IRS said it had rejected 6.2 million Forms 1095-C because of a missing code in line 14. However, upon digging a bit deeper TIGTA found that this error condition actually only occurred 828 times within the 6.2 million forms that IRS rejected. IRS has since investigated and found that the problem was incorrect programming and labeling. Stop and think about that for a minute. IRS rejected 6.2 million forms for a particular reason, but upon investigation, it should have only rejected 828 forms, and the reason was because it mislabeled fields in the software. Are you serious?!
TIN Validation Process Was Less than Stellar
The report specifically mentions the incorrect TIN issue—experienced by nearly every employer—as a recurring problem. As we have written about extensively, an employer is not given sufficient information to determine which individual was causing the TIN error message because the IRS' software did not specify which individual on the form was causing the error message. The report states the IRS was aware of this issue and stated it would be corrected for future tax years. For 2016 forms IRS did update its software such that an employer could tell whether it was the employee or one of the dependents that caused the error, but employers were still left guessing which dependent caused the error if there was more than one."Room for Improvement" Is an Understatement
The report suggested—and IRS agreed—that all error codes should be properly functioning for future filing seasons. It also recommended that each error code should provide sufficient information to allow the employer to correct errors, and IRS agreed with that recommendation as well, though it remains to be seen what, if anything, IRS will actually do and when. The audit report did state the IRS planned on implementing new automation tools to enforce the employer mandate in March 2017. It's not clear whether IRS met its planned implementation date.What is absolutely baffling to me is that IRS did not already have functional, efficient systems in place to process Forms 1094 and 1095 or enforce the employer pay-or-play penalties. The IRS’s struggles to create the necessary software tools also explains why, to date, no employer has been assessed a penalty.
What Does This Mean for Employers?
We should not assume that the ACA employer pay-or-play regime is dead unless and until Congress repeals it, but the utter ineptitude of IRS to implement proper systems does beg some interesting questions. Does IRS have the capability to enforce employer pay-or-play? Will IRS try to save face and not issue penalty letters to employers until it has overhauled its systems? Or will IRS forge ahead potentially sending millions of erroneous penalty assessment letters to employers that will have to defend themselves against bad data from IRS?An employer's obligation to prepare Forms 1094 and 1095, file them with IRS and send them to employees hasn't changed, and this is certainly no signal that IRS is doing away with employer reporting or employer pay-or-play penalties. It does, however, change the risk calculus and may influence how much effort employers put into perfecting their own systems and processes. Depending on how much an employer has invested thus far in ACA pay-or-pay and employer reporting compliance, and depending on an employer's risk tolerance, it could take a wait-and-see approach, or it could view it as necessitating an assessment of whether the employer has sufficient data and reporting to defend completely inaccurate penalty assessments from IRS. At the very least, it looks like it's something to discuss with your advisors at Wortham.