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.

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.

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.

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.

Is There Any Point To Middle Class Entitlements?

I was reading a Bloomberg article last week titled “Those Pointless Upper-Middle-Class Entitlements.” It is - to be fair - an opinion piece, so let’s take it with a grain of salt.

The article begins:

Let’s talk about upper-middle-class entitlements, the subsidies that flow almost entirely to those in the upper fifth or even tenth of the income distribution. You know, the home mortgage interest deduction and the tax subsidies for 401(k)s, IRAs and other retirement plans.

Then we have a spiffy graph: 

I am confused with what is considered a “tax break.”

The true “tax break” here is the earned income credit. We know that this began as encouragement to transition one from nonworking to working status, and we also know that it is the font of massive tax fraud every year. The government just sends you a check, kind of like the tooth fairy. An entire tax-storefront industry has existed for decades just to churn-out EIC returns. Too often, their owners and practitioners are not as … uhh, scrupulous … as we would want.

And this is a surprise how? Give away free money to every red-headed Zoroastrian Pacific Islander and wait to be surprised by how many red-headed Zoroastrian Pacific Islanders line up at your door. Even those who are not red-headed, Zoroastrian or Pacific Islander in any way. 

Here is more:

Of course, we wouldn’t want to take away all of those tax expenditures, would we? The earned income tax credit and the Social Security exclusion, for example, are targeted at people with pretty low incomes.

Doesn’t one need to have income before receiving an INCOME TAX expenditure?

Then we have these bright shiny categories:

·       Defined contribution retirement plans

·       Defined benefit retirement plans

·       Traditional IRAs

·       Roth IRAs

Interesting. One would think that saving for retirement would be a social good, if only to lessen the stress on social security.

We read:

Wealthy people who would save for retirement in any case respond to subsidies by shifting assets into tax-sheltered accounts; the less wealthy don’t respond much at all.

It makes some sense, but don’t you feel like you are being conned? Step right up, folks; make enough money to save for retirement and you do not need a tax break to save for retirement.

When did we all become wealthy? Did someone send out letters to inform us?

Did you know that the majority of income tax breaks are claimed by people with the majority of the income?  

Think about that one for a second, folks.

This following is a pet peeve of mine:

·       Deferral of active income of controlled foreign corporations

We have discussed this issue before. Years ago, when the U.S. was predominant, it decided that U.S. corporations would pay tax on all their earnings, whether earned in the U.S. or not.

There is a problem with that: the U.S. is almost a solo act in taxing companies on their worldwide income. Almost everyone else taxes only the profit earned in their country (the nerd term is “territoriality”).

Let’s be frank: if you were the CEO of an international company, what would you do in response to this tax policy?

You would move the company – at least the headquarters - out of the U.S., that’s what you would do. And companies have been moving: that is what "inversions" are.

So, the U.S. had no choice but to carve-out exceptions, which is how we get to “deferral of active income of controlled foreign corporations.” This is not a tax break. It is a fundamental flaw in U.S. international taxation and the reason Congress is currently considering a territorial system.

By the way, how did these tax breaks come to be, Dudley?

Why do these subsidies continue nonetheless? Mainly, it seems, because they’ve been granted to a sizable, influential population who, it is feared, will fight any effort to take them away. 

Politicians giving away money. Gasp.

But mainly it’s the millions of upper-middle-class Americans who, like me and my family, are beneficiaries of tax subsidies for home mortgages, retirement accounts and/or college savings.

To state another way: It is unfair that people with more money can do more things with money than people with less money.

Profound.

What offends about this bella siracha is:

You train for a career.

You set an alarm clock daily, dress, fight traffic and do your job.

You get paid money.

You take some of this money and save for nefarious causes such as your kids’ college and your eventual retirement.

Yet you keeping your own money is the equivalent of receiving a welfare check euphemistically described as an “earned income credit.”

No, no it is not.

And the false equivalence is offensive.

I get the issue. I really do. The theory begins with all income being taxable. When it is not, or when a deduction is allowed against income, there is – arguably - a “tax break.” The criticism I have is equating one-keeping-one’s-money (for example, a 401(k)) with flat-out welfare (the earned income credit). Another example would be equating a deeply-flawed statutory tax scheme (multinational corporations) with the state income tax deduction (where approximately 30% of this tax break goes to two states: California and New York). 

And somebody please tell me what “wealthy” means anymore. It has become one of the most abused words in the English language.

Bloomberg

TomatoCare And The Supreme Court

Let’s play make believe.

Late on a dark and stormy Saturday night, the Congressional Spartans - urged on by Poppa John's and the National Tomato Growers Association – passed a sweeping vegetable care bill by a vote of 220-215.

The bill went to the Senate, where its fate was sadly in doubt. The fearless majority leader Harry Leonidas negotiated agreements with several recalcitrant senators, including the slabjacking of New Orleans, an ongoing automatic bid for the Nebraska Cornhuskers to the college Bowl Championship Series and the relocation of Vermont to somewhere between North Carolina and Florida. After passage, the bill was signed by the president while on the back nine at Porcupine Creek in Rancho Mirage, California.

As a consequence of this visionary act, Americans now had access to affordable tomatoes, thanks to market reforms and consumer protections put into place by this law. The law had also begun to curb rising tomato prices across the system by cracking down on waste and fraud and creating powerful incentives for grocery chains to spend their resources more wisely. Americans were now protected from some of the worst industry abuses like out-of-season shortages that could cut off tomato supply when people needed them the most.

California, Vermont and Massachusetts established state exchanges to provide tomato subsidies to individuals whose household income levels were below the threshold triggering the maximum federal individual income tax rate (presently 39.6 percent). The remaining states had refused to establish their own exchanges, prompting the federal government to intervene. The Tax Exempt Organization Division at the IRS, recognized for their expertise in technology integration, data development and retention, was tasked to oversee the installation of federal exchanges in those backwater baronies. IRS Commissioner Koskinen stated that this would require a reallocation of existing budgetary funding and – as a consequence - the IRS would not be collecting taxes from anyone in the Central time zone during the forthcoming year.

The 54 states that did not establish their own exchanges filed a lawsuit (Bling v Ne’er-Do-Well) challenging a key part of the TomatoCare law, which read as follows:

The premium assistance amount determined under this subsection with respect to any vegetable coverage amount is the amount equal to the lesser of the greater…”

These benighted states pointed out that, botanically, a tomato was a fruit. A fruit was defined as a seed-bearing vessel developed from the ovary of a flowering plant. A vegetable, on the other hand, was any other part of the plant. By this standard, seedy growth such as bananas, apples and, yes, tomatoes, were all fruits.

There was great fear upon the land when the Supreme Court decided to hear the case.

Depending upon how the Supreme Court decided, there might be no tomato subsidies because tomatoes were not vegetables, a result clearly, unambiguously and irretrievably-beyond-dispute not the intent of Congress on that dark, hot, stormy, wintery Saturday night as they debated the merits of quitclaiming California to Mexico.

The case began under great susurration. The plaintiffs (the 54 moon landings) read into evidence definitions of the words “fruit” and “vegetables” from Webster’s Dictionary, Worcester’s Dictionary, the Imperial Dictionary and Snoop Dogg’s album “Paid tha Cost to Be da Bo$$.”

The Court acknowledged that the words “fruit” and “vegetable” were indeed words in the English language. As such, the Court was bound to take judicial notice, as it did in regard to all words in its own tongue, especially “oocephalus” and “bumfuzzle.” The Court agreed that a dictionary could be admitted in Court only as an aid to the memory and understanding of the Court and not as evidence of the meaning of words.

The Court went on:

Botanically speaking, tomatoes are the fruit of the vine. But in the common language of the 202 area code, all these are vegetables which are grown in kitchen gardens and, whether eaten cooked, steamed, boiled, roasted or raw, are like potatoes, carrots, turnips and cauliflower, usually served at dinner with, or after, the soup, fish, fowl or beef which constitutes the principal part of the repast.”

The Court decided:

            But it is not served, like fruits generally, as a dessert.”

With that, the Court decided that tomatoes were vegetables and not fruit. The challenge to TomatoCare was courageously halted, and the liberal wing of the Court – in a show of their fierce independence and tenacity of intellect – posed for a selfie and went to Georgetown to get matching tattoos.

Thus ends our make believe.

There was no TomatoCare law, of course, but there WAS an actual Supreme Court decision concerning tomatoes. Oh, you didn’t know?

Back in the 1880s the Port of New York was taxing tomatoes as vegetables. The Nix family, which imported tons of tomatoes, sued. They thought they had the law – and common sense – on their side. After all, science said that tomatoes were fruit. The only party who disagreed was the Collector of the Port of New York, hardly an objective juror.

The tax law in question was The Tariff of 1883, a historical curiosity now long gone, and the case was Nix v Hedden. 

And that is how we came to think of tomatoes as vegetables.

Brilliant legal minds, right?