Repaying The Health Care Subsidy

Twice in a couple of weeks I have heard:

“They should check on the Exchange.”

The Exchange refers to the health insurance marketplace.

In both cases we were discussing someone who is between jobs.         

The idea, of course, is to get the subsidy … as someone is unemployed and can use it.

There might also be a tax trap here.

When you apply for Obamacare, you provide an estimate of your income for the coverage year. The answer is intuitive if you are applying for 2020 (as we are not in 2020 yet), but it could also happen if you go in during the coverage year. Say you are laid-off in July. You know your income through July, and you are guessing what it might be for the rest of the year.

So what?

There is a big what.

Receive a subsidy and you have to pay it back – every penny of it – if your income exceeds 400% of the poverty line for your state.

Accountants refer to this as a “cliff.” Get to that last dollar of income and your marginal tax rate goes stratospheric.

Four times the poverty rate for a single person in Kentucky is approximately $50 grand.  Have your income come in at $50 grand and a dollar and you have to repay the entire subsidy.

It can hurt.

How much latitude does a tax preparer have?

Not much. I suppose if we are close we might talk about making a deductible IRA contribution, or selling stock at a loss, or ….

There may be more latitude if one is self-employed. Perhaps one could double-down on the depreciation, or recount the inventory, or ….

Massoud and Ziba Fanaieyan got themselves into this predicament.

The Fanaieyans lived in California. He was retired and owned several rental properties. She worked as a hairstylist.

They received over $15,000 in subsidies for their 2015 tax year.

Four times the California poverty line was $97,000.

They reported adjusted gross income of $100,767.

And there was (what I consider) a fatal preparation mistake. They failed to include Form 8962, which is the tax form that reconciles the subsidy received to the subsidy to which one was actually entitled based on income reported on the tax return.

The IRS sent a letter asking for the Form 8962.

The Fanaieyans realized their mistake.

Folks, for the most part tax planning is not a retroactive exercise. Their hands were tied.

Except ….

Mr. Fanaieyan remembered that book he was writing. All right, it was his sister’s book, but he was involved too. He had paid some expenses in 2012 and 2013. Oh, and he had advanced his sister $1,500 in 2015.

He had given up the dream of publishing in 2015. Surely, he could now write-off those expenses. No point carrying them any longer. The dream was gone.

They amended their 2015 tax return for a book publishing loss.

The IRS looked at them like they had three eyes each.

To Court they went.

There were technical issues that we will not dive into. For example, as a cash-basis taxpayer, didn’t they have to deduct those expenses back in 2012 and 2013? And was it really a business, or did they have a (dreaded) hobby loss? Was it even a loss, or were they making a gift to his sister?

The Court bounced the deduction. They had several grounds to do so, and so they did.

The Fanaieyans had income over four times the poverty level.

They had to repay the advance subsidies.

I cannot help but wonder how this would have turned out if they had claimed the same loss on their originally-filed return AND included a properly-completed Form 8962.  

Failing to include the 8962 meant that someone was going to look at the file.

Amending the return also meant that someone was going to look at the file.

Too many looks.

Getting Married And ObamaCare Subsidies

I am reading a case that reminds me of a return from last year’s filing season. I had an accountant who became upset, arguing that the result was unfair.

I agree, but this is tax.

I started practice in the eighties, and a significant portion of my tax education was at a law school.  Tax accounting classes tended to be staccato-like:  issue-driven, procedural and reliably arithmetic. Tax law classes were case and doctrine-focused: what is income, for example, and we would study the concept of income as it evolved over the decades.

It seemed to me that tax law early in my career followed – as a generalization - more of that law school feel: corporate liquidations and the General Utilities doctrine; the claim of right doctrine and North American Oil; business purpose and Helvering v Gregory. There were strong Ways and Means and Finance Committee chairs with some understanding of the issues (and precedent) their committees were addressing.  

But those were different politicians. Both they and taxes have gotten progressively weirder.

Congress went on to introduce something called uniform capitalization, arguing that accountants did not know how to absorb costs into inventory; tax items – personal exemptions or itemized deductions, for example – that would evaporate like a Thanos movie moment; an alternative minimum tax that would tax something that ultimately went down in value; the increasing refundability of tax credits, meaning that those at the low end of the income scale had as much if not more opportunity to game the system than any big-baddy McMoneybags did.

Let’s look at the Fisher case.

Christina Fisher began the year as a single mom. She married Timothy in November. Christina was struggling, and she received Obamacare subsidies.

You may recall that there are two relevant aspects to Obamacare that will come into play in this case:

(1)  If you are below a certain income level, you might be entitled to some – or even full – subsidy of your health insurance premiums.

(2)  You can use that subsidy to pay your premiums immediately rather than wait to the end of the year and receive the subsidy via a tax refund.

There was no question that Christina was entitled to a subsidy for more than 10 months. Her circumstances changed when she married; she no longer qualified.

Time to prepare her taxes.

One is supposed to attach a reconciliation of projected income when receiving the subsidy to actual income ultimately reported on the tax return. The Fishers did not.

The IRS did it for them. They also wanted approximately $4,500, saying she was not entitled to the subsidy.

A rational mind would expect that the tax law would go to a month-by-month calculation. There was no doubt that she qualified for 10 months. Let’s allow for some doubt in the month of marriage. Let’s also disqualify the last month of the year because of Timothy’s income.

At worst she would have to pay back 2 months, right?

Nah.

She has to use her household income for the year – including Timothy’s income.

Then she takes half of that amount for her monthly testing.

Not her OWN income, mind you, but one-half of combined income for the year.

Who came up with this?

Not the best and brightest exercising due deliberation, clearly.

Well, using even one-half of the combined household income, Christina failed all 10 months one would have expected her to pass. She owed almost $4,500 to the IRS.

And that is why my accountant lost his mind last year. He could not believe that what he was reading is really what was meant. It made no sense! Surely there is an alternative calculation? Does the tax Code allow a facts and circumstances …?

Ahh, he is still young. He will learn.

Difference Between An Advance And A Loan

Do you remember when the Washington Redskins and the Miami Dolphins went to the Super Bowl? It was 1983, and I was living in Florida at the time. I am pretty sure I was rooting for the Florida team. The Redskins had a hard-charging fullback named John Riggins. His nickname was “Diesel” and he scored a touchdown on a forty-something yard run. Blocking for him was (among others) George Starke, an offensive tackle. The Washington offensive linemen, the ones who block for the quarterback and running back, were known as The Hogs.

George Starke is second from the left.

George was very much on the backside of his career at that point. He shortly thereafter left football and opened a car dealership in Maryland. He couldn’t help but notice that the dealership had difficulty recruiting service technicians. He helped establish a technical school to educate and train technicians. He also hoped that - by providing a realistic hope for a better life – the school would also help with the poverty and violence in the area.

He eventually sold the dealership and cofounded the Excel Institute, a nonprofit program that provided a two-year reading, writing, arithmetic and technical skills curriculum. The program was free of charge, but one had to commit.

Starke received a salary and housing allowance, as well as a credit card. He would charge business and personal expenses on the card. The personal charges were segregated on the books and records. George discontinued any personal charges in 2006, and from 2007 onward the only activity relating to the credit card was a payroll deduction to repay the balance.

There was a change in the Board, and Starke did not like the new direction of things. He stopped fundraising. He left the Excel Institute altogether in 2010.

Excel put the remaining balance due from George of $83,698 on a Form 1099, sent a copy to George, a second to the IRS and figured that was that.

George did not include the $83 grand on his individual tax return, however.

The IRS noticed and insisted that George do so. George said no.

And off to Tax Court they went.

Before proceeding, tell me: do you think George has a prayer?

As you know, forgiveness of a loan triggers income. The tax issue is whether these monies were ever a loan.

Your first thought is: of course they were! Heck, he was paying it back, wasn’t he?

Let’s walk through this.

Just because someone gives you money does not mean that there exists a loan. A loan implies that both sides anticipate the monies will be repaid. It would also be swell if there were some attention to the basic formalities, like perhaps a loan agreement and repayment terms.

And – just to dream – maybe interest could be charged on the whole affair.

There was no loan agreement. Excel itself gave mixed messages to the Court on whether it thought the monies were a loan. George told the Court that he never had any intention of paying back the money, and that he thought the payroll deductions were for health insurance or something like that.

If not a loan, then what were the monies to George?

They were advances, akin to nonrecoverable draws.

Advances are more easily understood in a draw-against-commission environment. Draws are intended to provide some predictable cash flow to the salesperson. Say that a salesperson receives commissions, and against the commissions is a $5,000 monthly draw. There are two types of draws - recoverable and nonrecoverable. A nonrecoverable draw does not have to be paid back should a saleperson fail to meet quota. A recoverable draw does have to be paid back. Granted, a salesperson who fails on a continuous basis to meet quota would soon be unemployed, but that is a different conversation.  For our purposes, the key is that a nonrecoverable draw represents income upon receipt.

Back to our courtroom drama.

The IRS pulled his 2010 tax year.

George received no advances in the 2010 tax year.

George last received advances in 2006.

There was nothing to tax in 2010 because George received no monies in 2010.

The IRS should have pursued his 2006 tax year. They did not, nor could they under the statute of limitations.

The Court dismissed the case. George won. The IRS got embarrassed.

I am curious why the IRS even bothered. The only thing I can figure is that they were hoping for a miracle play. Maybe like John Riggins running that football for a touchdown in Super Bowl XVII with George Starke blocking for him.