The Obamacare Subsidy Cliff

 

I am looking at a case involving the premium tax credit.

We are talking about the Affordable Care Act, also known as Obamacare.

Obamacare uses mathematical tripwires in its definitions. That is not surprising, as one must define “affordable,” determine a “subsidy,” and - for our discussion – calculate a subsidy phase-out. Affordable is defined as cost remaining below a certain percentage of household income. Think of someone with extremely high income - Elon Musk, for example. I anticipate that just about everything is affordable to him.

COMMENT: Technically the subsidy is referred to as the “advance premium tax credit.” For brevity, we will call it the subsidy.

There is a particular calculation, however, that is brutal. It is referred to as the “cliff,” and you do not want to be anywhere near it.

One approaches the cliff by receiving the subsidy. Let’s say that your premium would be $1,400 monthly but based on expected income you qualify for a subsidy of $1,000. Based on those numbers your out-of-pocket cost would be $400 a month.

Notice that I used the word “expected.” When determining your 2022 subsidy, for example, you would use your 2022 income. That creates a problem, as you will not know your 2022 income until 2023, when you file your tax return. A rational alternative would be to use the prior year’s (that is, 2021’s) income, but that was a bridge too far for Congress. Instead, you are to estimate your 2022 income. What if you estimate too high or too low? There would be an accounting (that is, a “true up”) when you file your 2022 tax return.

I get it. If you guessed too high, you should have been entitled to a larger subsidy. That true-up would go on your return and increase your refund. Good times.

What if it went the other way, however? You guessed too low and should have received a smaller subsidy. Again, the true-up would go on your tax return. It would reduce your refund. You might even owe. Bad times.

Let’s introduce another concept.

ACA posited that health insurance was affordable if one made enough money. While a priori truth, that generalization was unworkable. “Enough money” was defined as 400% of the poverty level.

Below 400% one could receive a subsidy (of some amount). Above 400% one would receive no subsidy.

Let’s recap:

(1)  One could receive a subsidy if one’s income was below 400% of the poverty level.

(2)  One guessed one’s income when the subsidy amount was initially determined.

(3)  One would true-up the subsidy when filing one’s tax return.

Let’s set the trap:

(1)  You estimated your income too low and received a subsidy.

(2)  Your actual income was above 400% of the poverty level.

(3)  You therefore were not entitled to any subsidy.

Trap: you must repay the excess subsidy.

That 400% - as you can guess – is the cliff we mentioned earlier.

Let’s look at the Powell case.

Robert Powell and Svetlana Iakovenko (the Powells) received a subsidy for 2017.

They also claimed a long-term capital loss deduction of $123,822.

Taking that big loss into account, they thought they were entitled to an additional subsidy of $636.

Problem.

Capital losses do not work that way. Capital losses are allowed to offset capital losses dollar-for-dollar. Once that happens, capital losses can only offset another $3,000 of other income.

COMMENT: That $3,000 limit has been in the tax Code since before I started college. Considering that I am close to 40 years of practice, that number is laughably obsolete.

The IRS caught the error and sent the Powells a notice.

The IRS notice increased their income to over 400% and resulted in a subsidy overpayment of $17,652. The IRS wanted to know how the Powells preferred to repay that amount.

The Powells – understandably stunned – played one of the best gambits I have ever read. Let’s read the instructions to the tax form:

We then turn to the text of Schedule D, line 21, for the 2017 tax year, which states as follows:

         If line 16 is a loss, enter ... the smaller of:

·      The loss on line 16 or

·      $3,000

So?

The Powells pointed out that a loss of $123,822 is (technically) smaller than a loss of $3,000. Following the literal instructions, they were entitled to the $123,822 loss.

It is an incorrect reading, of course, and the Powells did not have a chance of winning. Still, the thinking is so outside-the-box that I give them kudos.

Yep, the Powells went over the cliff. It hurt.

Note that the Powell’s year was 2017.

Let’s go forward.

The American Rescue Plan eliminated any subsidy repayment for 2020.

COVID year. I understand.

The subsidy was reinstated for 2021 and 2022, but there was a twist. The cliff was replaced with a gradual slope; that is, the subsidy would decline as income increased. Yes, you would have to repay, but it would not be that in-your-face 100% repayment because you hit the cliff.

Makes sense.

What about 2023?

Let’s go to new tax law. The ironically named Inflation Reduction Act extended the slope-versus-cliff relief through 2025.

OK.

Congress of course just kicked the can down the road, as the cliff will return in 2026.

Our case this time was Robert Lester Powell and Svetlana Alekseevna Iakovenko v Commissioner, T.C. Summary Opinion 2002-19.

Yet Another Preparer Penalty Starting In 2018

We have spoken before of social-worker duties the tax Code expects of a professional preparing a return with an earned income credit, a refundable child credit or the American Opportunity (that is, the college) credit.

Take the earned income credit, for example. If you have two children, that credit can be $5,616; have three and the credit can reach $6,318. Remember that the credit is refundable – meaning the IRS will write you a check – and no wonder this provision is rife with fraud.  

If the IRS wanted to push-back on the fraud, it could require a preparer to review documentation that a child (or several) actually lives with the parent/taxpayer.

To be certain to get the preparer’s attention, the IRS could also impose a penalty if the preparer failed to do so.

Let’s have the IRS tighten this up a notch by also requiring a form or schedule with the return requiring the preparer to declare that he/she did all of this Sherlocking.

Which is why I will not prepare a return with these credits unless I have known (or, alternatively, my partner has known) the client for a while.

This rule is expanding in 2018 to include head of household filing status.

Oh boy.

Let’s go through a Tax Court case I was reviewing recently.

(1)  Joe and Cerice lived together and had a child in 2006.

(2)  The relationship went south either late 2014 or early 2015.

(3)  Cerise moved in with her mother.

(4)  Joe and Cerise started sharing custody, although Joe’s parents also took care of the child while he was working.

(5)  There was a custody proceeding in 2015, and the Court order gave each parent equal time. For some reason, the Court came back in 2016 and reduced Joe’s share of parental time.

(6)  The Court stated that Cerise could claim the child in 2015 and all odd-numbered years. Joe could claim the child in even-numbered years.

QUESTION: Who claims the child in 2014?

The technical detail here is that head-of-household status requires the child to spend more than one-half of the year with the claiming parent.

Let’s say that I have never met Joe or Cerise. I meet with either one, who asks me to prepare the 2014 return. Whoever I meet with wants to claim the child, of course, as it will power head of household status, an earned income credit and a child credit. I suspect either Joe or Cerise could present a formidable argument that the child was with him/her for more than one-half of the year.

What am I supposed to do?

I would of course look at the custody agreement, but that doesn’t start until the following year. No help there.

I could get assurance from the other parent that he/she is not claiming the child.

Let’s say that fails.

I could get a letter from the pediatrician, I suppose.

Or the school, if the child were old enough.

Or maybe the landlord where either Joe or Cerise lives.

Here I am social-working this situation. If I don’t, the IRS can penalize me $510. For each instance. Miss both the head of household and refundable child care credit and the penalty is $1,020.

Which might be more than I am charging to prepare the return.

How keen would you be to accept Joe or Cerise as a client?

That is my point.

Paying Back The ObamaCare Subsidy

I do not see many tax returns with the ObamaCare health exchange subsidy.

Our fees make it unlikely.

However, take an ongoing client with variable income or business losses and we do see some.

I saw one this busy season that gave me pause.

Let’s discuss the McGuire case to set up the issue.

Mr. McGuire was working and Mrs. McGuire was not. In 2013, they applied with the Covered California and qualified for a monthly subsidy of $591, or $7,092 per year. They enrolled in a plan that cost $1,182 monthly. After the subsidy, their cost was (coincidentally) $591 monthly.

Mrs. McGuire started a job that paid $600 per week. She contacted Covered California, as she realized that her paycheck would affect that subsidy.

This being a government agency, you can anticipate the importance they gave Mrs. McGuire.

That would be “none.”

Several months later they did send a letter stating that the McGuires did not qualify for a subsidy.

The letter did not talk about switching to a lower cost plan. Or dropping the plan altogether. Or – be still my heart - provide a phone number to speak with an actual government bureaucrat.

It did not matter.

The McGuires had moved. They tried to get Covered California to update their address, but it was the same story as getting Covered California to update their premium subsidy for her new job.

The McGuires never received the letter.

It goes without saying that they never received Form 1095-A in 2014 either. This is the tax form for reporting an Exchange subsidy.

There are two main individual penalties under the Affordable Care Act:

(1) There is a penalty for not having “qualified” insurance. This is not the same as being uninsured. Have insurance that the government disapproves of and you are treated as having no insurance at all. 

(2) Subsidies received have to be reconciled to your actual household income. Make less that you thought and you may get a few bucks back. Make more and you may have to repay your subsidy. While technically not a “penalty,” it certainly acts like one.

The McGuires indicated on their tax return that they had health insurance (thereby avoiding penalty (1), but they did not complete the subsidy reconciliation (which is penalty (2)).

The IRS did, however.

Sure enough, the McGuires did not qualify for a subsidy. The IRS wanted its money back. All of it.

The McGuires fired back:

We would never have committed to paying for medical coverage in excess of $14,000 per year.”

True that.

We cannot afford it and would have continued to shop in the private sector to purchase the minimal, least expensive coverage or gone without coverage completely and suffered the penalties.”

That is, they would have avoided penalty (2) by not accepting subsidies and instead paid penalty (1), which would have been cheaper.

If we are deemed responsible for paying back this deficiency, it would be devastating and completely unjust. ….  The whole purpose of the Affordable Care Act was to provide citizens with just that, affordable healthcare. This has been an absolute nightmare and we hope that you will rule fairly and justly today.”

Here is the Tax Court:

But we are not a court of equity, and we cannot ignore the law to achieve an equitable end.”

Equity means fairness, so the Court is saying that – if the law is otherwise bright-line – they cannot decide on the grounds of fairness. 

Although we are sympathetic to the McGuires’ situation, the statute is clear; excess advance premium tax credits are treated as an increase in the tax imposed. The McGuires received an advance of a credit to which they were ultimately not entitled.”

The McGuires had to pay back $7 grand, despite the incompetence of Covered California.

Ouch.

Let’s return to CTG Galactic Command. How did my client get into a subsidy-repayment situation?

Gambling.

The tax Code is odd about gambling. It forces you to take gambling winnings into income. The subsidy calculation keys-off that income number.

Wait, you say. What about gambling losses?

The tax Code requires you to take gambling losses as an itemized deduction.

The subsidy calculation pays no attention to itemized deductions.

Win $40 grand and the subsidy calculation includes it. Your household income just went up.

Say that you also lost $40 grand. You netted nothing in real life.

Tough. The subsidy calculation does not care about your losses.

Heads you lose. Tails you lose. 

That was my client’s story.

A Sad Grandma Story

 You know a tax case is going to irritate when you read this sentence early on:

The Commissioner does not defend the justice of this result, but says the law requires it.”

The story involves a grandmother, a son and daughter-in-law and two grandkids. Grandma appears to be the only one working and that as a nursing assistant in Texas. She also collected social security, which was just enough to keep the household afloat.

          []’s job is hard, and it does not pay much.”

It was 2012. He son did not work. Her daughter-n-law…

          … stayed home and took care of the babies.”

She filed her 2012 tax return and claimed the two grandchildren as dependents. That made sense, as she was the only person there with a job.

This allowed her to claim head of household and the dependent exemptions. Much more important than that, however, it allowed her to claim the child and earned income credits. She got a refund of almost $5,300, almost half of which was those credits.

Good for grandma.

The IRS sent her a notice. They wanted the money from the credits back.

Being the warm, fuzzy IRS we have come to know, she was also assessed a $1,000 penalty.

She figured ID theft. Somebody else must have claimed the kids.

She was right, partially. Somebody else did claim the kids.

Their parents.

That would be her son, the one who …

… did not work, and he was into dealing with drugs.”

Sigh.

We all know what a child is, but in the tax Code must rise to the level of a “qualifying child” before the tax goodies flow. There are requirements, of course – such as age and where they live – and grandma easily met those.

But only one person can claim each qualifying child, which is why one is required to include dependent social security numbers on the return. The IRS tracks those numbers. If you are the second person to use a dependent’s number, the IRS will bounce (or at least hold up) your return.

Grandma was the second to file, so she got bounced.

Now, there are families where more than one person can say that a child was his/her qualifying child. Congress anticipated this and included tie-breaker rules. For example, if two people contest and have equal claim, then the tie-breaker goes to the person with more income.

Or if the parents and someone else claim, then the parents win the tie-breaker.

However, this can be sidestepped if the parents DO NOT claim the child.

In grandma’s case, her son and daughter-in-law filed and claimed.

Can this situation be saved?

You bet.

How?

Amend the return. Have the parents “unclaim” the kids.

To their credit, the son and daughter did amend. They handed the amended return to the IRS attorney.

And here we have the technicality that makes you cringe.

Filing a return means sending it on to a service center or handing it to “any person assigned the responsibility to receive hand-carried returns in the local Internal Revenue Service office.”

Problem: the IRS attorney is not “assigned the responsibility” to receive or handle returns. Handing him/her a return is the equivalent of giving your return to a convenience store clerk or a Starbucks barista.

I suppose the attorney could bail you out by filing the return on your behalf upon returning to the office, but that did not happen here.

The return was never filed. Without an amended return, the son and daughter never revoked their dependency claim.

As the parents, they took priority over grandma, who only supported everyone that year.

And grandma could not claim the kids a second time.

Which cost her the child and earned income credits.

She had to repay the IRS.

The Court did not like this, not even a little bit.

We are sympathetic to []’s position. She provided all the financial support for …, had been told by her son that she should claim the children as her dependents, and is now stuck with a hefty tax bill. It is difficult for us to explain to a hardworking taxpayer like [] why this should be so, except to say that we are bound by the law.”

Sad.

At least the Court reversed those blasted penalties.

Spotting A (Tax) Dependent

Let’s talk about claiming someone as a dependent.

There are several tax “breaks” that require you to have a dependent, for example:

·        Head of household (HoH) filing status

·        A dependent exemption

·        Child credit

·        Child care credit

·        Education credit

·        Earned income credit

Some of these breaks go only so far. The head of household (HoH) filing status, for example, can get you to zero tax, but it cannot “create” a tax refund. You have to have tax withholdings before HoH can get you a refund; even then, you are getting your own money back. Not so with the child credit or the earned income credit, however.  Meet all the triggers and the EIC can refund you over $6,000, irrespective of whether you have any withholdings or not. It is a transfer payment from the government.

So what is required to claim someone as a tax dependent?

There are two overall categories of dependents. The first is your own child (or stepchild, adopted child, or descendants of the same) and is referred to as a “qualifying child.” This is the workhorse test: think a child at home with his/her parents.

There are five requirements for a “qualifying child”:

1. Are they related to you? 
2. Are they under age 19 or – if a full-time student – under age 24? 
3. Do they live with you for more than half the year?
4. Do you support them financially? 
5. Are you the only person claiming the child?

Any other type of dependent is a referred to as a “qualifying relative.” The requirements are as follows:

1. Do they live with you for more than half the year?
2. Do they make less than $3,950?
3. Do you support them financially?
4. Are you the only person claiming the child?

The term “qualifying relative” is misleading, by the way. The person does not need to be related to you at all. For example, a girlfriend could be my dependent – assuming that all the other requirements were met AND my wife allowed me to have a girlfriend.

Did you notice the age thing? A qualifying child ends at age 24 (unless we are talking permanent disability, which is a different rule). Past age 23 and the child is your dependent under the qualifying relative rules.

Which also means that an income test kicks-in. That after-age-23 child would not qualify as a dependent if he/she earned more than $3,950 for the year. This can be a cruel surprise at tax time for parents whose kids have moved back.

That answer, by the way, is the same for an over-18-under-24 child who does not go on to college.

Let’s take a little quiz on dependents. We will use the Tax Court case of James Edward Roberts v Commissioner. Here are selected facts:

1. In January, 2012 Roberts’ daughter became homeless. 
2. She had two young kids. 
3. She was pregnant with the third.

Roberts was a decent soul, and worked out a deal with a Ms. Moody, whereby he and the two children (very soon three) moved in with her. He agreed to pay 75% of the rent and utilities. He also agreed to pay 100% of the meals.

Then he did something unexpected. He wrote down the agreement, and both he and Ms. Moody signed and dated it.

Roberts and his (now three) grandchildren lived in the apartment from January until October, 2012. His daughter also lived there on-and-off. When she was not there, Ms. Moody helped take care of the kids.

When Roberts filed his 2012 tax return, he claimed the following:

(1)  Head of household

(2)  Dependent exemption for three grandchildren

(3)  Child credit

(4)  Earned income credit

The IRS bounced his return, and they wound up in Tax Court.

The IRS had an issue whether the kids were his dependents.

What do you think?

Let’s walk through it.

·        The kids are related (grandchildren) to Roberts. CHECK

·        The kids are young. CHECK

·        They lived with him from January through October, which is more than half the year. CHECK

·        He paid 75% of the rent and utilities and 100% of the food. Sounds to me like that would be over half the support for the kids. CHECK

·        The Court tells us that their mom did not claim them. CHECK

Seems that Roberts met all the requirements to claim the grandchildren as dependents for 2012. Why did the IRS press on this?

I don’t know, and the Court did not explain why. I can guess, though.

I see a person who…

·        moved

·        put three dependents on his return who were not there the prior year

·        was not living with the kids by the time the IRS contacted him

·        lived in an apartment with someone who (perhaps, who knows) might have been his girlfriend. This would raise the issue of who actually paid the expenses for rent, utilities and food – you know, the same expenses that Roberts needed to show that he supported the kids.

Roberts won his day in Court.

I suspect that written – and contemporaneously signed - agreement with Ms. Moody carried a lot of weight with the Court.

I allow that the IRS had cause to look at this return. After that, however, they should have left Mr. Roberts alone.  The IRS made a mistake on this one.

Talking About 2014 ObamaCare Employer Taxes

I have been reviewing two ObamaCare employer taxes that are scheduled to kick-in in 2014. It’s more than a year away, but let’s say you call me and we meet for coffee. It’s a business meeting. With cheesecake.

I’ll start the conversation off:

Me:                  If an employer has enough employees, then the employer is expected to provide health benefits.

You:                 What constitutes “enough employees?”

Me:                  More than 50 full-time employees. Full-time is defined as 30 hours per week, by the way.

You:                 So if I have less than 51 full-time employees, I escape the tax?

Me:                  Yes.

You:                 What if I have more than 50?

Me:                  Depends.

You:                 On what?

Me:                  On whether any employee receives a government subsidy.

You:                 And I am supposed to know this how?

Me:                  Trust me, you’ll find out.

You:                 What if I have more than 50 employees but no one gets a subsidy?

Me:                  How did you accomplish that, Houdini?

You:                 All my employees have their insurance covered by their spouse.

Me:                  Congratulations, Harry.

You:                 What if one divorces and gets a subsidy?

Me:                  You have a problem.

You:                 What problem?

Me:                  Your penalty will be either $2,000 or $3,000, depending.

You:                 Depending on what?

Me:                  Depending on whether you offer no insurance or offer unaffordable insurance.

You:                 So if I offer no insurance it will cost me $3,000 multiplied by some number?

Me:                  No.

You:                 You are getting on my nerves.

Me:                  The penalty for not offering health insurance is $2,000.

You:                 Per employee?

Me:                  No. You get to exclude the first 30 employees.

You:                 Huh?

Me:                  I didn’t write this stuff.

You:                 Say I have 55 full-time employees. What is it going to cost me?

Me:                  (55 minus 30) times $2,000 = $50,000.    

You:                 What if I fire 5 employees?

Me:                  Then you meet the 50-employee limit and have no tax.

You:                 Seriously?

Me:                  Yep.

You:                 Even if an employee gets government subsidy?

Me:                  Did you ever work at Bain Capital?

You:                 What is this “unaffordable” insurance thing?

Me:                  If the insurance exceeds a certain percentage of the employee’s family income, then the insurance is deemed “unaffordable.”

You:                 What is that percentage, oh beacon of despair?

Me:                  9.5% of household income.

You:                 Household income, what is that?

Me:                  An easy answer would be to add the husband and wife’s income.

You:                 How am I to know the spouse’s income?

Me:                  Trust me, you’ll find out.

You:                 How?

Me:                  When the government notifies you about the subsidy.

You:                 I am really starting to dislike you.

Me:                  Hey, I’ve got feelings here.

You:                 So if I see to it that all my employee’s spouses are doctors and engineers, then I can avoid the penalty?

Me:                  You have escaped yet again, Harry.

You:                 Say that I don’t escape. What is my tax?

Me:                  Well, you get to do two calculations. You pay the lower number.

You:                 Are you charging me for this aggravation?

Me:                  Yes.

Me:                  The first calculation is to multiply every employee receiving a subsidy for your unaffordable insurance by $3,000.

You:                 Then what?

Me:                  You do the same calculation as if you offered no insurance at all.  You know, the $2,000 calculation.

You:                 Huh, what’s the difference?

Me:                  The $2,000 calculation excludes the first 30 employees. Then it is just multiplication.

Me (cont’d):    The $3,000 calculation counts only those employees receiving a subsidy.

You:                 So if I offer unaffordable insurance, but no one gets the subsidy, my tax is zero?

Me:                  I am in awe, Harry.

You:                 What if I set up two companies, with neither having more than 50 employees?

Me:                  They already thought of that angle. No go if the companies are related. You owning both makes them related.

You:                 What if I increase my portion of the insurance to, you know, keep it “affordable?”

Me:                  That would work.

You:                 I would have to reduce the actual salaries or eliminate bonuses and raises to make the numbers work.

Me:                  Were you grades too high for community organizing?

You:                 What are other companies doing?

Me:                  Depends on the company. Some companies are too large for the 50 employees to mean anything. Still… Did you hear about Darden Restaurants?

You:                 Darden is who?

Me:                  Think Red Lobster and Olive Garden.

You:                 Are you charging me by the word?

Me:                  I’ll ignore that. Anyway, according to the Orlando Sentinel the company intends to reduce its maximum schedule to 28 hours per week per employee in “selected” restaurants. They told the newspaper that this is "just one of the many things we are evaluating to help us address the cost implications healthcare reform will have on our business."

You:                 Wow, that seems harsh.

Me:                  Where do you have that money tree planted, exactly?

You:                 How does an employee get a subsidy, exactly? Is that what sets this whole thing off?

Me:                  By “whole thing” you mean “unaffordable?”                      

You:                 I am going to hit you.

Me:                  There are two conditions. We already talked about the first one: the 9.5% of household income.

You:                 You mean 9.5% of a number that I have no hope of knowing or finding out?

Me:                  Yep, that one.

You:                 Do I want to know the second one?

Me:                  If you want your head to blow off.

You:                 What…? You have to tell me now.

Me:                  The second condition is that your employee’s household income ….

You:                 Which I do not know, right?

Me:                  Right. Now continuing where I was …. Your employee’s household income must be less than 400% of the federal poverty level.

You:                 You said 400%. I thought accountants were supposed to be good with numbers.

Me:                  I am. And it’s 400%.

You:                 Seriously?

Me:                  You are way too sharp to ever be hired by CNN.

You:                 So… what is 400% for a husband and wife?

Me:                  Close to $90 grand.

You:                 $90 grand! I didn’t make that last year! Or the year before!

Me:                  Maybe you can qualify for the subsidy.

You:                 I think I am going to fire you as my CPA.