It’s A Cliff, Not A Slope

It is one of my least favorite areas of individual tax practice.

We are talking about health insurance. More specifically, health insurance purchased through the exchanges, coupled with advance payment of the premiums.

Why?

Because there is a nasty tax trap in there, and I saw the trap again the other day. It caught a client who gets by, but who is hardly in a position to service heavy tax debt.

Let’s set it up.

You can purchase health insurance in the private market or from government-sponsored marketplaces – also called exchanges. The exchanges were created under the Affordable Care Act, more colloquially known as Obamacare.

If you purchase health insurance through the exchange and your income is below a certain level, you can receive government assistance in paying the insurance premiums. Make very little income, for example, and it is possible that the insurance will be free to you. Make a little more and you will be expected to contribute to your own upkeep. Make too much and you are eliminated from the discussion altogether.

The trap has to do with the dividing line of “too much.”

Let’s look at the Abrego case.

Mr and Mrs Abrego lived in California. For 2015 he was a driver for disabled individuals, and he also prepared a few tax returns (between 20 and 30) every year. Mrs Abrego was a housekeeper.

They enrolled in the California exchange. They also did the following:

(1)  They provided an estimate of their income for 2015. Remember, the final subsidy is ultimately based on their 2015 income, which will not be known until 2016. While it is possible that someone would purchase health insurance, pay for it out-of-pocket and eventually get reimbursed by the IRS when filing their 2015 tax return in 2016, it is far more likely that someone will estimate their 2015 income to then estimate their subsidy. One would use the estimated subsidy to offset the very real monthly premiums. Makes sense, as long as all those estimated numbers come in as expected.

(2)  They picked a policy. The monthly premiums were $1,029.

(3)  The exchange cranked their expected 2015 numbers and determined that they could personally pay $108 per month.

(4)  The difference - $ 1,029 minus $108 = $921– was their monthly subsidy.

The Abregos kept this up for 10 months. Their total 2015 subsidy was $9,210 ($921 times 12).

Since the Abregos received a subsidy, they had to file a tax return. One reason is to compare actual numbers to the estimated numbers. If they guessed low on income, they would have to pay back some of the subsidy. If they guessed high, the government would owe them for underestimating the subsidy.

The Abregos filed their 2015 return.

They reported $63,332 of household income.

How much subsidy should they have received?

There is the rub.

The subsidy changes as income climbs. The subsidy gets to zero when one hits 400% of the poverty line.

What was the poverty line in California for 2015?

$15,730 for a married couple.

Four times the poverty line was $62,920.

They reported $63,332.

Which is more than $62,920.

By $412.

They have to pay back the subsidy.

How much do they have to pay back?

All of it - $9,210.

Folks, the tax rate on that last $412 is astronomical.

It is frustrating to see this fact pattern play out. The odds of a heads-up from the client while someone can still do something are – by the way – zero. That leaves retroactive tax planning, whose success rate is also pretty close to zero.

Our client left no room to maneuver. Why did her income go up? Because she sold something. Why did she not call CTG galactic command before selling – you know: just in case? What would we have done? Probably advised her to NOT SELL in the same year she is receiving a government subsidy.

How did it turn out for the Abregos?

They should have been toast, except for one thing.

Remember that he prepared tax returns. He did that on the side, meaning that he had a gig going. He was self-employed.

He got to claim business deductions.

And he had forgotten one.

How much was it?

$662.

It got their income below the magic $69,920 level.

They were on the sliding scale to pay back some of that subsidy. Some - not all.

It was a rare victory in this area.

Our case for the homegamers was Abrego v Commissioner.

How Will You Report The ObamaCare Subsidy On Your Tax Return?

It is called the “premium assistance tax credit,” and it refers to the subsidy that people will receive under the ObamaCare individual mandate. It will begin in 2014, and it is supposed to make insurance more affordable for people under 400% of the federal poverty line (FPL). I am not really sure how the politicians came up with 400%, as many if not most of us would agree that 4 times the poverty line is nowhere near poverty. For example, if you are married and have a child, 400% of the FPL is $78,120. That picks up a lot, if not the majority, of people in the Cincinnati area. 

OBSERVATION: I did not realize that Washington views the average Cincinnatian as impoverished and in need of their help.  How did we ever survive this blight before?

Starting next year, you have to address your health insurance, either by receiving it through work, remaining on your parent’s policy, buying it in the private marketplace or on the public exchange. If you don’t, tax advisors are supposed to calculate a tax penalty when preparing your 2014 taxes in April 2015. If you do, then tax advisors may have to go through a separate calculation to determine whether the government paid too much or too little subsidy toward your health insurance. As a tax advisor, I say … whoopee. You would think the government could at least put me on its 401(k) plan for doing its yeoman work.

So how do you calculate whether the government paid too much or too little? That is our topic this week.

We will need two tables to do this. The first is the FPL table by household size.

The second table provides the phase-out of the subsidy as one’s income increases through the FPL table.

When you and I meet in April 2015, I will know your 2014 adjusted gross income (AGI), which starts off this exercise. A good definition of AGI is the amount of money you made before you deduct your house, taxes, contributions and kids. I will then have to make some adjustments to it, if you have certain items on your return:

·        I will add tax -exempt interest

·        I will add the untaxed portion of your social security

·        If you worked overseas I will add the exempted portion of your salary

You now have something called modified adjusted gross income (MAGI).

Let’s say that you are married, have a toddler and your MAGI is $55,000. You have a modest home, an older car and are living the dream. 

The table tells me that you are under 400% of the FPL (which is $78,120 for a family of 3), so we next talk about your health insurance. You tell me that you do not have insurance at work. Your wife is staying at home and being a mom. You went and bought a health policy on the public exchange. You purchased an Anthem bronze plan costing $715 per month. That $715 however was before the subsidy, to which we will return in a moment.

We now have your actual 2014 income, and we have to settle-up with the government. If you were under-subsidized, you will get a check. If you were over-subsidized, you have to return the money. 

NOTE: The subsidy is being paid directly to the insurer. You never see this check. It is very possible that you never even paid attention to the subsidy amount, as you were focusing only on your out-of-pocket.

At MAGI of $55,000, you are at 282% of the FPL ($55,000/$19,530). We now go to the next table. There is a sliding scale between 250% and 300% FPL, going from 8.05% to 9.5% of MAGI. You are somewhere in the middle, so we have to do some math:

            282 – 250 = 32

            32/50 = 64%

            9.5% - 8.05% = 1.45%

            1.45% * 64% = 0.93%

            8.05% + 0.93% = 8.98%

Your premiums are limited to 8.98% of your MAGI. As we said, your income was $55,000. That means your share of the premiums caps-out at $4,939.

How much was your subsidy? Total annual premiums were $8,580 ($715 * 12 months). Your cap is $4,939. The difference is $3,641, or $303 per month. If your subsidy was less than $303/month, I have good news for you. If it was more, then I have bad news, as you will be writing the government a check.  How do we know the subsidy? There will be a new tax form – Form 1095-A- that will be issued about the same time as your W-2. You will have to bring that form to me when preparing your taxes.

There are limits on how much you have to repay the government:

·        If you are below 200% of the FPL, the most you have to pay back is $600

·        Between 200% and 300% the maximum is $1,500

·        Between 300% and 400% the maximum is $2,500

The $600/$1,500/$2,500 limits are for a family. It is one-half that amount if you are single.

By the way …. IF your MAGI exceeds 400% FPL, then you have to repay ALL the subsidy with your tax return.

The above limits ($600/$1,500/$2,500) do not apply if the government owes you. This could happen if your income dropped significantly, such as your employer moving you to part-time.

You may have read that the White House delayed the employer reporting for one year. It will now start in 2015 (for 2014), rather than 2014 (for 2013). The White House believes that it has limited the potential for fraud because of the requirement to settle-up the individual mandate when filing the individual income tax return. You can see their point.

I am very uncomfortable with this action, however. Since when does a White House get to decide which laws it wants to enforce and which laws it does not? What if the next president decides to “suspend” the corporate tax for a year? This White House is creating precedence for that White House to do so.

What we have now are three categories of health consumers:

(1) Over 400%: you pay full boat. The exchanges and subsidies mean nothing to you.

(2) Between 133% and 400% of the FPL: you may be subject to the above, depending upon your insurance situation at work.

(3) Below 133%: you are likely enrolled in Medicaid and pay no premiums at all. This however will vary by state, as many states did not participate in the Medicaid expansion under ObamaCare.

You cannot deduct the portion of your health insurance that is being subsidized. However, since the medical deduction threshold is increasing to 10% (from 7.5%) of AGI, it is highly unlikely that you will ever deduct medical expenses again, unless you have exceptional circumstances. 

And there is how the government intends that people will settle up their ObamaCare if they qualify for a subsidy. Seems reasonable, as in I-haven’t-been-in-the-real-world-and-earned-a-real-paycheck-for-many-years-now and how-hard-can-it-be-to-build-a-website sort of way.

After all, what could possibly go wrong?