Employer Payment Letters Sent to Churches Are Routine Requests

UILC: 7611.00-00
Release Date: 6/18/2021

Date: June 08, 2021

CC:EEE:EOET:EO3 - POSTN-112245-21

to:
Mark Hulse
Division Counsel
Tax Exempt and Government Entities Division Counsel (CC:TEGEDC)

from:
Rachel Levy
Associate Chief Counsel
Employee Benefits, Exempt Organizations, and Employment Taxes (CC:EEE)

subject:
Application of Section 7611 to Letter 226-J.¹

This memorandum should not be used or cited as precedent.

Issue

Does the routine request exception in Treas. Reg. § 301.7611-1, Q&A-4 apply when the IRS sends Letter 226-J to a church applicable large employer?

Conclusion

Yes. When sent to a church applicable large employer, Letter 226-J is a routine request within the meaning of Treas. Reg. § 301.7611-1, Q&A-4.

Background and Applicable Law

Section 4980H and Related Process Generally

Enacted as part of the Affordable Care Act, section 4980H generally provides that an applicable large employer (ALE) is subject to an assessable payment if either (1) the ALE fails to offer its full-time employees (and their dependents) the opportunity to enroll in minimum essential coverage under an eligible employer-sponsored plan for any month and at least one full-time employee is certified as having enrolled for such month in a qualified health plan for which a premium tax credit is allowed; or (2) the ALE offers its full-time employees (and their dependents) the opportunity to enroll in minimum essential coverage and one or more full-time employee is certified as having enrolled for such month in a qualified health plan for which a premium tax credit is allowed for that employee because the offered coverage did not provide minimum value or was not affordable, or the particular employee was not offered coverage. The assessable payment under section 4980H is commonly referred to as the employer shared responsibility payment (ESRP).

For purposes of section 4980H, ALEs generally are employers that employed on average 50 full-time employees, including full-time equivalent employees, on business days during the preceding calendar year. ALEs use Forms 1094-C, Transmittal of Employer-Provided Health Insurance Offer and Coverage Information Returns, and 1095-C, Employer-Provided Health Insurance Offer and Coverage, to report information required under sections 6055 and 6056 about offers of health coverage to, and enrollment in health coverage by, their employees. The IRS uses the information contained in the Forms 1094-C and 1095-C, along with information in IRS records from the individual income tax returns filed by the ALE's full-time employees regarding whether any of the ALE's full-time employees is allowed a premium tax credit for enrolling in a qualified health plan, in preliminarily determining whether an ALE may owe an ESRP under section 4980H and calculating its amount. This is the only information used by the IRS in making this preliminary determination and calculation.

ALEs cannot proactively determine, calculate, or pay any amounts payable under section 4980H because they do not know whether their offer of coverage to their full-time employees is affordable based on the household income for their full-time employees.² The IRS, however, has information about the ALE's offer of coverage from the ALE's information return and information about the ALE's full-time employee's household income from that full-time employees' individual income tax returns. Therefore, for every ALE, the IRS generates a preliminary calculation of the ESRP based solely on the information contained in the ALE's Forms 1094-C and 1095-C and the ALE's full-time employees' tax returns. The IRS then informs each ALE of this preliminary calculation via Letter 226-J. ALEs must receive the preliminary calculation in the Letter 226-J and a notice and demand for payment from the IRS before they can pay any amounts.

The Letter 226-J also affords ALEs an opportunity to provide information to clarify or correct the information from its Forms 1094-C and 1095-C that is contained in the letter and used to determine and calculate the ALE's ESRP, if any. Such clarification or correction may or may not reduce or eliminate the preliminary amount provided in the Letter 226-J. The IRS does not request books, records, or similar documents of any nature, including corporate and financial records regularly kept by an ALE, in connection with the Letter 226-J.

There are several ways that an ALE may respond to the issuance of the Letter 226-J:

If the IRS determines that an ALE still owes an ESRP after taking into account any response to Letter 226-J and the ALE disagrees with all or part of the ESRP amount listed, the ALE is afforded an opportunity to take the case to the IRS Independent Office of Appeals.

Section 7611 Procedural Requirements

In 1984, Congress enacted section 7611 to expand the requirements relating to IRS interactions with churches to protect churches from undue interference while allowing the IRS to retain the ability to pursue individuals who inappropriately use the church form as a tax-avoidance device. Section 7611(a) permits the IRS to begin a church tax inquiry only upon a written, reasonable belief determination by an appropriate high-level Treasury official. Delegation Order 7-3 (Rev. 2) requires the Commissioner, Tax Exempt & Government Entities (TE/GE) to make all reasonable belief determinations under section 7611(a). Section 7611(a) also contains an inquiry notice requirement that requires the IRS to provide taxpayers subject to section 7611 specific information before it can begin a church tax inquiry. Current IRS procedures provide that the specific information required by the inquiry notice requirement is provided to church taxpayers using Letter 5307, Notice of Church Tax Inquiry. See, IRM 4.75.39.7.4.

Section 7611(h)(2) defines a church tax inquiry as any inquiry to a church (other than an examination) to serve as a basis for determining whether a church is exempt from tax under section 501(a) by reason of its status as a church, or is carrying on an unrelated trade or business (within the meaning of section 513) or otherwise engaged in activities which may be subject to taxation under title 26. The legislative history for section 7611 provides that “[T]he procedures also are not intended to apply to routine IRS inquiries to a church, including inquiries with respect to income tax withholding for church employees, social security taxes, and similar matters.” S. Rpt. No. 169 Vol. 1, 98^th Cong. 2d Sess. (March 21, 1984). The Conference Agreement legislative history expands on the Senate amendment and provides that “The conferees further intend that routine IRS inquiries to a church will not be considered to commence a church tax inquiry and therefore will not trigger application of the church audit procedures. Routine questions for [the] purpose include (but are not limited to) questions regarding (1) the filing or failure to file any tax return or information return by the church, (2) compliance with income tax or FICA tax withholding responsibilities by the church, (3) any supplemental information needed to complete the mechanical processing of any incomplete or incorrect return filed by the church, (4) information necessary to process applications for exempt status, letter ruling requests, or employment tax exemption requests by the church, and information identifying a church that is used by the IRS to update its Cumulative List of Tax Exempt Organizations and other computer files, and (5) confirmation that a specific business is or is not owned and operated by a church. H.R. Rep. No. 861, 98^th Cong. 2d Sess. (June 23, 1984).

Treas. Reg § 301.7611-1, Q&A-2 reiterates the statutory definition of a church tax inquiry, and further provides that a church tax inquiry does not include a routine request described in Treas. Reg § 301.7611-1, Q&A-4. Treas. Reg § 301.7611-1, Q&A-2 also provides that a church tax inquiry is considered to commence when the IRS requests information or materials from a church of a type contained in church records.

Treas. Reg § 301.7611-1, Q&A-4, which essentially repackages the legislative history, provides that routine requests to a church will not be considered to commence a church tax inquiry and will not necessitate application of the procedures set forth in section 7611. Routine requests for this purpose include (but are not limited to) questions regarding (1) the filing or failure to file any tax return or information return by the church; (2) compliance with income tax or FICA (social security) tax withholding responsibilities by the church; (3) any supplemental information needed to complete the mechanical processing of any incomplete or incorrect return filed by the church; (4) information necessary to process applications for exempt status and letter ruling requests; (5) information necessary to process and update periodically a church's (i) registrations for tax-free transactions (excise tax), (ii) elections for exemption from windfall profit tax, or (iii) employment tax exemption requests; (6) information identifying a church that is used to update the Cumulative List of Tax Exempt Organizations (Publication No. 78) and other computer files; and (7) confirmation that a specific business is or is not owned or operated by a church.

Cases Involving Sections 7611 and 4980H

All ALEs, including churches or convention or association of churches, are subject to section 4980H. Section 7611 generally applies to all cases involving a church, unless an exception applies.⁴ In 2018, this office considered whether section 7611 applies to a section 4980H case that involves an ALE that is a church, taking into account the newness of the ESRP compliance program and its unique nature as compared to other compliance programs under which churches may ultimately owe a tax. After consideration of the law, the newness and distinctions of the compliance program, and the intent of section 7611 to provide additional procedural protections to churches, this office advised a cautious approach of applying section 7611 to the ESRP compliance program with respect to church taxpayers. Based on that advice, TE/GE has been applying section 7611 to communications issued to a church taxpayer under the ESRP compliance program, including Letter 226-J. Accordingly, each Letter 226-J has been reviewed by the Commissioner, TE/GE in accordance with section 7611(a) when the taxpayer is a church, and the Letter 226-J is sent as an attachment to the Notice of Church Tax Inquiry (designated as Letter 5307-A as opposed to Letter 5307 when issued with Letter 226-J attached).

After two years of administering the ESRP compliance program as applied to taxpayers that are churches, TE/GE's experience is that the vast majority of churches that receive Letter 226-J clarify or correct the information they previously reported to the IRS on Forms 1094-C and 1095-C, and that such clarification or correction usually results in elimination of the liability preliminarily calculated in the Letter 226-J.⁵ Those church ALEs for which a response does not eliminate the preliminarily calculated ESRP either pay the ESRP and resolve the matter or receive additional correspondence from the IRS.

Furthermore, treating Letter 226-J as a church inquiry subject to section 7611, and the associated necessity of obtaining approval of the high-level Treasury official, has resulted in substantial delays in providing Letters 226-J to church ALEs, as compared to ALEs that are not churches. This, in turn, delays resolution of a church ALE's reporting errors, potentially leading to repeated reporting errors in subsequent years. Thus, rather than providing extra protection for church taxpayers, as intended by section 7611, requiring approval of the high-level Treasury official and the associated delay result in less favorable treatment for church ALEs.

Further, Letter 226-J is a template letter generated solely based on the church ALE's own reporting and the tax returns of one or more of its full-time employees allowed a premium tax credit. It is a routine review of the same general fact pattern and identical legal issues involved.

Accordingly, our office reconsidered the 2018 advice in light of the information gained from operation of the ESRP program. In particular, the office further considered whether the Letter 226-J is best viewed as the beginning of a church tax inquiry subject to the reasonable belief and inquiry notice requirement in section 7611(a), or whether Letter 226-J, when sent to a church ALE, is better characterized as a routine request within the meaning of Treas. Reg § 301.7611-1, Q&A-2 and Treas. Reg § 301.7611-1, Q&A-4. As discussed below, we have determined that when sent to a church ALE, Letter 226-J is a routine request within the meaning of Treas. Reg. § 301.7611-1, Q&A-4.

Analysis

In order to provide procedural safeguards to churches, section 7611 limits the ability of the IRS to begin church tax inquiries and examinations. Under section 7611, a church tax inquiry is any inquiry to a church that will serve as a basis for determining whether the church is exempt from tax under section 501(a), is carrying on an unrelated trade or business, or is otherwise engaged in activities which may be subject to taxation under title 26. Neither section 7611 nor 4980H addresses whether the requirement that a church ALE provide minimum essential coverage or owe an ESRP is an “activity which may be subject to taxation under title 26.” Similarly, neither the legislative history nor the existing regulations under section 7611 address this issue.

Assuming section 7611 generally applies to the ESRP compliance program and that Letter 226-J would otherwise meet the definition of a church tax inquiry, we consider whether any exception applies.⁶ Relevant for this analysis are Treas. Reg § 301.7611-1, Q&A-2 and Treas. Reg § 301.7611-1, Q&A-4, which as noted, are drawn from the discussion of the scope of the statute in the legislative history. Q&A-2 reiterates the statutory definition of a church tax inquiry, and further provides that, among other things, a church tax inquiry does not include routine requests for information. Q&A-2 references Q&A-4 for the description of a routine request. Q&A-4 provides that routine requests to a church will not be considered to commence a church tax inquiry and will not necessitate application of the procedures set forth in section 7611. The regulation further states that, routine requests for this purpose include (but are not limited to) questions regarding (1) the filing or failure to file any tax return or information return by the church; (2) compliance with income tax or FICA (social security) tax withholding responsibilities by the church; (3) any supplemental information needed to complete the mechanical processing of any incomplete or incorrect return filed by the church; (4) information necessary to process applications for exempt status and letter ruling requests; (5) information necessary to process and update periodically a church's (i) registrations for tax-free transactions (excise tax), (ii) elections for exemption from windfall profit tax, or (iii) employment tax exemption requests; (6) information identifying a church that is used to update the Cumulative List of Tax Exempt Organizations (Publication No. 78) and other computer files; and (7) confirmation that a specific business is or is not owned or operated by a church. (Emphasis added).⁷ Although inquiries regarding compliance with section 4980H are not explicitly included in the seven examples provided in Treas. Reg. § 301.7611-1, Q&A-4 (and indeed could not have been since the regulations predate the passage of section 4980H), it is clear from the parenthetical in bold text above, that Q&A-4 sets forth a non-exhaustive list of what constitutes a routine request.

It is our view that Letter 226-J is rightfully characterized as a routine request for purposes of section 7611. Our view is based on the reasons described below.

Conclusion

After further consideration of Letter 226-J, the applicable regulations, and TE/GE's experience in the demonstrated routine nature of the initial letter and the employer's responses thereto, we have determined that Letter 226-J is appropriately characterized as a routine request within the meaning of Treas. Reg. § 301.7611-1, Q&A-4.¹⁰