Federal District Courts Split Over IRS Authority to Certify ACA Employer Mandate Penalties

By: HUB’s EB Compliance Team

A federal district court in Florida has upheld the Internal Revenue Service's (“IRS”) authority to certify Employer Shared Responsibility Payments (“ESRPs”) under the Affordable Care Act (“ACA”), reaching the opposite conclusion of an earlier Texas federal court decision on the same question. In Supreme Linen Services, Inc. v. U.S., the court held that the IRS may issue the certification needed to assess an ESRP without an express statutory delegation from the U.S. Department of Health and Human Services (“HHS”). This decision creates a split between federal district courts and leaves plan sponsors facing genuine uncertainty about the validity of ESRP assessments issued through IRS Letter 226-J.

Regulatory Background

As a reminder, the employer mandate applies to Applicable Large Employers (“ALEs”) as defined under the ACA. An ALE generally employs an average of 50 or more full-time or full-time equivalent (“FTE”) employees during the prior calendar year. This definition also applies to controlled groups, and in those instances, a controlled group member company with fewer than 50 employees may still be considered an ALE. Only employers who are ALEs are subject to the ACA employer mandate.

Before the IRS may assess an ESRP, the regulations require that the employer be “certified” to that a full-time employee has enrolled in exchange coverage with a premium tax credit or cost-sharing reduction. In 2013, HHS issued a regulation, 45 C.F.R. § 155.310(i), stating that the IRS will “adopt methods to certify to an employer that one or more employees has enrolled for one or more months during a year in a QHP for which a premium tax credit or cost-sharing reduction is allowed or paid.” In practice, the IRS has relied on Letter 226-J — the notice proposing an ESRP — to serve as both the certification and the penalty assessment.

In Faulk Company, Inc. v. Becerra, a Texas court rejected this approach. The court held that the ACA gives HHS exclusive authority to issue the certification, and that HHS has no statutory basis to delegate that function to the IRS. Because the employer in that case had never received a certification from HHS or an exchange, the court ordered the IRS to refund the ESRP the employer had paid under protest.

The Supreme Linen Decision

The recent case from Supreme Linen Services presented the same underlying question to the court. After the IRS assessed an ESRP against the company, Supreme Linen sought a refund, arguing — as the employer in Faulk had — that the assessment was invalid because neither HHS nor an exchange had certified that a full-time employee received a premium tax credit. The IRS denied the refund claim, maintaining that Letter 226-J itself satisfied the certification requirement.

The U.S. District Court for the Southern District of Florida sided with the IRS. The court reasoned that the IRS has inherent authority to administer the Internal Revenue Code, including § 4980H as it applies to ESRPs, and that this authority does not depend on an express delegation from HHS. Because the Code itself contains no language delegating the certification function elsewhere, the court concluded that the IRS may issue the certification on its own authority. The court entered judgment for the government and denied the refund to Supreme Linen Services.

The new decision creates a direct conflict between the decisions of the Northern District of Texas and the Southern District of Florida on whether IRS-issued certifications under Letter 226-J are legally sufficient. Absent an intervening appellate ruling, employers in different jurisdictions may currently face different legal standards governing the same ESRP assessment process.

Implications for Plan Sponsors

The new split decision between courts has limited practical significance for any applicable large employer that has received, is disputing, or may in the future receive a Letter 226-J. Employers should not assume that Faulk protects them from an ESRP simply because the employer’s argument succeeded in that case. Any subsequent employer challenge to a penalty assessment similar to the cases noted above will now depend heavily on the circuit and district in which the refund action is filed.

Because Faulk and Supreme Linen are both district court decisions, neither is binding outside its own district, and both are subject to review by their respective courts of appeals (the Fifth and Eleventh Circuits). Employers should expect continued litigation on this issue and the possibility of a definitive appellate ruling — or an eventual circuit split requiring U.S. Supreme Court review — in the coming months.

Conclusion

The decision in the Supreme Linen Services case confirms that the legal landscape governing ESRP certifications remains unsettled. Employers cannot yet rely on a single, nationwide rule for challenging IRS Letter 226-J assessments, and the answer may depend on where an employer is located and where any refund action is filed. Plan sponsors should continue to track this litigation closely, as an appellate decision, and eventual Supreme Court decision addressing the certification question, could reshape ESRP enforcement in the future. Employers should also work with experienced counsel on any challenges related to ESRP enforcement.

If you have any questions, please contact your HUB advisor. View more compliance articles in our Compliance Directory.

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Neither Hub International Limited nor any of its affiliated companies is a law or accounting firm, and therefore they cannot provide legal or tax advice. The information herein is provided for general information only and is not intended to constitute legal or tax advice as to an organization’s or individual's specific circumstances. It is based on Hub International's understanding of the law as it exists on the date of this publication. Subsequent developments may result in this information becoming outdated or incorrect and Hub International does not have an obligation to update this information. You should consult an attorney, accountant, or other legal or tax professional regarding the application of the general information provided here to your organization’s specific situation in light of your or your organization’s particular needs.