Let’s be clear: Congress deserves much of the scorn heaped upon it for its gross mismanagement of the tax law. No greater example of its negligence need be given than the fact that sometime this week, 55 provisions of the law that expired on January 1, 2014 will be retroactively extended….through the end of 2014, a move that completely defeats the purpose of extending the provisions in the first place. Because the last time I checked, tax provisions can’t provide incentive for businesses and individual taxpayers if, you know…the provisions are only part of the law for two weeks out of the year.
Sometimes, however, Congress tries to do the right thing regarding the tax law, and still winds up the target of public vitriol. For example, in 2010 Congress voted to temporarily reduce an employee’s share of Social Security payroll taxes by 2%, a tax cut that resulted in up to $2,200 of extra cash making its way into the annual income of salaried workers. The reduction was always intended to be temporary, however, and when it finally expired on January 1, 2013, America collectively freaked out over what it termed to be a covert ”tax increase.”
Why is any of this news? Because I’ve got a strong feeling that in a few months, another well-intentioned tax benefit is going to backfire in spectacular fashion on the President and members of Congress: the Premium Tax Credit.
What is the Premium Tax Credit? As you may have read somewhere in the past four years – or if you happen to double as a Supreme Court Justice, as you may have come across as part of your day job– starting in 2014, individuals are required to pay a
penalty tax penalty? to the IRS if we don’t hold “minimum essential health insurance coverage.” This is the so-called “individual insurance mandate,” and it was the greatest source of controversy in the controversy-laden Affordable Care Act (ACA), eventually landing the Act in front of the nation’s highest court where it was ultimately blessed as constitutional.
But this isn’t about the penalty side of things. This is about the good news: if we do carry such coverage, however, and if we meet certain conditions, the government is going to help subsidize our insurance premiums in the form of a tax credit.
Section 36B provides that an individual is entitled to the “Premium Tax Credit” if you meet the following conditions:
- You must have purchased insurance through the Health Insurance Marketplace. (More on this later, but generally, under the ACA, each state was required to set up an exchange so that those residents who were neither offered employer-provided health insurance nor eligible for insurance through a government program could go out and get the minimum essential health insurance coverage necessary to avoid imposition of the individual insurance mandate directly from the state.)
- As mentioned above, you must not have been otherwise eligible for employer-provided insurance or coverage through a government program such as Medicaid, Medicare, CHIP, or TRICARE.
- You cannot be claimed as a dependent by another person.
- Except for very limited circumstances, you can’t file a tax return using the Married Filing Separately filing status.
- Your household income must be within 100% and 400% of the federal poverty line. Household income is defined as your adjusted gross income plus any tax-exempt interest income, plus nontaxable Social Security benefits, plus any foreign earned income excluded under Section 911. The federal poverty line for 2014 starts at $11,490 for a single taxpayer, $15,510 for a family of two, and $23,550 for a family of four, and 400% of the poverty line is reached at $45,690, $62,040, and $94,200, respectively.
So How Does the Credit Work?
The credit is only intended for lower or middle-income taxpayers or families, hence the requirement that household income be between 100% and 400% of the federal poverty line. From there, it’s helpful to conceptualize the premium tax credit in the following manner:
If we assume that EVERYONE your age were on the same insurance plan and paying the same premiums (called the second-lowest silver cost plan), let’s compute how much you should have to pay for that premium out of your own pocket based on your income. Once we’ve determined that amount, you should get a credit for the difference between the imaginary premiums for this standard-bearer of a plan, and the amount you should have to pay out of pocket for such premiums.
If you prefer a step-by-step approach, the Form 8962, which will be used to calculate the credit, works like so:
Step 1: Determine the household income for you and any other individual in your family you can treat as a dependent and who is required to file a federal tax return.
Step 2: Measure what percentage that household income is of the federal poverty line. Only if it is between 100% and 400% are you eligible for the credit.
Step 3: Based on the percentage determined in Step 2, go to the form instructions and find your “applicable percentage.”
Step 4: Multiply the applicable percentage from Step 3 by the household income in Step 1. This is the most you should have to pay out of pocket for the entire year, if you were on the second lowest silver cost plan. Because the credit is computed on a monthly basis in most cases, however, you must divide this number by 12 to determine your maximum monthly outlay.
Step 5: Determine what your actual premiums were for each month. This is where the insurance exchange you bought the insurance from comes into play: the exchange will be required to mail you a Form 1095-A by the end of January 2015. Included on the form will be your actual premiums for the year. Your actual premiums factor into the credit because remember, the credit is the difference between the cost of the second lowest cost silver plan and the maximum you should have to pay out of pocket as determined in Step 4 above. If your actual premiums exceed the cost of the second lowest cost silver plan, however, well…you’re footing that extra cost yourself. On the flip side, if your actual premiums are LESS than the cost of the second lowest cost silver plan, your credit will only be for the difference between your actual premiums and your maximum out-of-pocket costs as determined in Step 4.
Step 6: Determine the monthly premiums for the second lowest cost sliver plan. Once again, this is going to be provided by the exchange on Form 1095-A.
Step 7: Your credit (for the moment) for each month is the premium from Step 6 less your monthly out-of-pocket costs determined in Step 4. As mentioned in Step 5, however, if your actual premiums from Step 5 are less than the premiums from Step 6, your credit will be the difference between Step 5 and Step 4.
The Premium Tax Credit is refundable; as a result, even if you owe no tax liability for the year, the credit will increase your refund and wind up in your wallet in the form of cash.
So What’s the Problem?
Fundamentally, the credit works fine. I’ve got a strong suspicion, however, that many of the people who have read about the credit don’t realize that instead of getting extra cash with their return, the Premium Tax Credit will actually cause them to pay more over to Uncle Sam come tax time.
How can that be? What kind of credit increases your tax liability?
Here’s the thing: many taxpayers eligible for the credit have already gotten it.
That’s because the Premium Tax Credit is one of the rare credits that is generally paid in advance. When you purchased insurance from the exchange, thereby making you eligible for the credit, you had the option of receiving the credit in advance. If you chose that option, whether knowingly or unknowingly, your exchange than went about the task of estimating what your Premium Tax Credit would be. Once it determined that amount, the government paid those amounts directly to the exchange on your behalf, reducing the amount you were required to pay for your insurance premiums.
But there’s a catch… In order to calculate your anticipated credit, the exchange obviously needed certain financial income in order to compute, for example, your household income. You provided that income when you signed up for the exchange, but in many cases, that financial information was from 2012.
Can you guess what the problem with that is? As we discussed above, the credit is driven by your income as a percentage of the federal poverty line. As your income increases, your credit decreases. As a result, if the 2012 information you provided the exchange when you signed up reflected lower income than what you actually earned in 2014, the advance credit the exchange computed on your behalf was greater than what you are truly entitled to when you file your 2012 return. This means that the amount the exchange received from the government to subsidize your premiums was more than what you were entitled to. And this means that you’ve got a problem. Because if your advance premium tax credit exceeds what you are actually entitled to when you compute your credit using 2014 numbers, you have to pay the difference back to the IRS on your tax return.
To illustrate, assume you earned $20,000 in 2012, and this is the information you supplied the exchange when you purchased insurance. Using this information, the exchange estimated your Premium Tax Credit to be $1,500. The exchange then goes out and collects $1,5o0 throughout the year from the federal government, reducing your need to pay your premiums by this amount.
In 2014, however, you earn $28,000. When you get around to filing your return, you’re giddy about the prospect of this additional credit you’ve read about that’s going to pay for next Christmas. When you fill out Form 8962, however, you find that based on your 2014 income, your credit is only $1,100, as opposed to the $1,500 that you received in advance. As a result, on your tax return, you have to pay the difference, or $400, back to the government.
Now of course, this makes total sense. You received the benefit of $1,500 and were only entitled to $1,100. It’s not a problem of fairness, but rather one of communication. How many people who have heard about the credit understand that they’ve already received it, and are very likely — due to the ability to use old information when signing up for the exchange — to have to pay part of that advance credit back?
To help ease the pain, the amount you have to pay back is capped based on your filing status and income as a percentage of the federal poverty line; for example, in 2014, a single taxpayer with income of between 200% and 300% of the federal poverty line cannot be required to pay back more than $750 of advance credit. But it’s still going to hurt, particularly if you didn’t know it was coming, and had budgeted on receiving extra cash, not paying an additional liability over to the IRS. Of course, if your advance credit was LESS than what you are due on your 2014 return –which might happen, for example, if your income went down from 2012 to 2014 or you elected not to receive the credit in advance– you will get a credit for the excess amount you are owed.
If all of this news has you turned off at the credit, keep in mind, it could get a whole lot worse for a lot of you.
The Supreme Court is set to hear whether the Premium Tax Credit is even valid in 36 states. This is because, as mentioned above, to facilitate the availability of insurance to all Americans, each state was required to set up an exchange. Only 14 did, however. The other 36 did not, forcing the federal government to establish a marketplace in those states.
That’s a problem, because the statute at Section 36B provides that you are only eligible for the credit if you purchased coverage on a “state exchange.” Once the IRS recognized that only 14 states had set one up, however, the language in the regulations expanded the credit eligibility to anyone who acquired the insurance on a “state or federal exchange.”
And that started a flood of lawsuits arguing that the IRS can’t change an unambiguous statute, and thus only people in the 14 states that set up an exchange are eligible for the credit. Why would people sue to get rid of a tax credit, you might ask?
There are two reasons, actually. First, starting in 2016, employers with more than 50 employees will be required to pay a penalty to the IRS if they don’t provide health insurance coverage to their employees. The law, however, states that the employer is only subject to the penalty if “at least one of its employees is eligible for the Premium Tax Credit.” Thus, if there’s no credit in 36 states, there’s no employer penalty.
In addition, the penalty for not carrying insurance only applies if the “cost of the insurance” does not exceed 8% of your household income. The “cost of the insurance” is treated as the excess of your premiums “reduced by your Premium Tax Credit.” Thus, if there’s no credit in 36 states, there’s a greater likelihood that the cost of insurance for certain taxpayers in those states will exceed 8% of their household income, and the taxpayers will avoid the individual insurance mandate.
In November, the Supreme Court announced that it will decide whether the Premium Tax Credit stays or goes in 36 states. Until that time, however, be warned that this particular credit may have you writing checkscome tax time. And Congress, be warned that you might have (another) public perception problem on your hands.
Obamacare Individual Premium Tax Credit