Court Orders Refund of Employer’s ACA Penalty, Upends IRS Assessment Process

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Last month, in Faulk Company, Inc. v. Xavier Becerra, et al. 4:24-CV-00609-P (April 10, 2025), the U.S. District Court for the Northern District of Texas granted an employer’s challenge to employer shared responsibility penalties assessed by the Internal Revenue Service (“IRS”) and ordered IRS to refund $205,621.71 that Faulk Company, Inc. (“Faulk”), the lone plaintiff in the case, paid in 2019 penalties.  As part of the court’s order, it struck down the employer shared responsibility regulations at 45 C.F.R. § 155.310(i).

IRS Assesses Faulk an ESRP Penalty.  Prior to 2019, Faulk, a Texas-based provider of janitorial services for schools, provided its full-time employees with minimum essential health insurance coverage as required under the Affordable Care Act (“ACA”).  Beginning in 2019, Faulk discontinued providing such coverage.  In December 2021, Faulk received from the IRS a Letter 226-J, assessing an employer shared responsibility (“ESRP”) excise tax in the amount of $205,621.71 due to Faulk’s failure to offer its full-time employees minimum health insurance coverage under the ACA for 2019.  Faulk paid the penalty to IRS but filed along with it a letter explaining that Faulk made such payment under protest.  Faulk received no response, so it filed a refund claim with the IRS in 2022 and then promptly filed suit in the Northern District of Texas.

Faulk’s Lawsuit.  In Faulk’s lawsuit, it alleged that the IRS had violated the company’s due process rights by issuing the Letter 226-J and assessing a penalty before the Department of Health and Human Services (“HHS”) had first issued Faulk a “certification” as to Faulk’s potential liability and provided Faulk a notice of right to appeal, a process Faulk asserted is rooted in the requirements of the ACA statute.

The ACA’s Employer Mandate.  Under ACA § 1411, applicable large employers (those employing at least 50 full time equivalent employees) must provide their employees minimum health insurance coverage, generally known as the “employer mandate.”  In the statute, Congress gave to HHS the exclusive authority to make that employer mandate effective.  Employers who fail to satisfy the employer mandate may be statutorily liable for an ESRP penalty.  However, Congress guaranteed due process rights to employers subject to the employer mandate and directed HHS to make the determination whether an employer has failed to satisfy it.  Under the statute, if HHS determines an employer did not fulfill the employer mandate, HHS must notify the health insurance marketplace (the “Exchange”) and then the Exchange must give the employer two notices.  The first notice advises “that the employer may be liable” for an ESRP, and the second notifies the employer of its right to appeal.  Once it has been determined that an ESRP penalty is owed, the ACA requires HHS to “certify” that finding to the employer.  Nothing in the ACA authorizes HHS or the Exchange to delegate any part of this process to the IRS.  Consistent with the ACA, once HHS has certified that an employer owes an ESRP payment, IRS has the obligation to assess and collect the ESRP penalty. 

HHS Attempts to Delegate Duties to IRS.  Three years after passage of the ACA, HHS promulgated regulations detailing the certification of an ESRP penalty under 45 C.F.R. § 155.310(i), in which HHS attempted to streamline that process, delegating to the IRS the duty to certify to an employer that an ESRP penalty is owed. 

The Court’s Ruling.  Upon review of Faulk’s challenge to the ESRP penalty assessment by IRS, the court ruled that nothing in the ACA authorized HHS to delegate to the IRS its duty to certify to an employer that an ESRP penalty is owed.  In this respect, the court struck down the regulation at § 155.310(i), declaring it “void and unenforceable,” as inconsistent with the plain language of the ACA.  The court went on to reason that because IRS relied on improperly delegated authority from HHS when it issued the ESRP penalty to Faulk, the penalty itself could not stand, and the IRS must refund the full penalty amount to Faulk.

Practical Implications for Employers.  In what has become a somewhat rare occurrence of federal district courts exercising judicial restraint, the court’s ruling in Faulk Company, Inc. resulted in no nationwide injunction against HHS, IRS, or the ESRP assessment process.  Rather, the court’s ruling provided limited relief to Faulk, alone.  Still, the well-reasoned analysis of the court provides all employers in receipt of Letter 226-J a potential roadmap for challenging the authority of IRS to assess an ESRP penalty without HHS having first provided the employer with the required certification, intended to ensure the employer’s access to due process of law.

While employers experienced of flurry of Letter 226-Js during the Biden Administration, ESRP penalties were virtually unheard of during the first Trump Administration, and it remains to be seen how the second Trump Administration will handle IRS enforcement of ESRP penalties, if at all.  The court’s ruling in Faulk Company, Inc., may at least give the administration pause to re-evaluate the roles of HHS, the Exchange, and IRS in ensuring employer access to due process, consistent with the plain language of the ACA, itself.  In the meantime, employers who find themselves challenging existing assessments of ESRP penalties have newfound legal support for attacking the shortcomings of the IRS process.