Executive Summary
The premium assistance tax credit, established under IRC Section 36B as a part of the Affordable Care Act (also known as "Obamacare"), took effect in 2014, and is intended to help make health insurance more affordable by providing a tax credit to subsidize the cost of insurance for “lower” income individuals.
In practice, though, the introduction of the premium assistance tax credit creates a new series of rules that financial planners must be aware of, for a wide range of clients who may potentially be eligible for the credit, which can apply for individuals with income up to $47,080 and a family of four earning $97,000 (in 2015, and adjusted annually for inflation). And given the dollar amounts involved for the credit itself (which can be worth several thousand dollars to a family), the ramifications of effective health insurance tax credit planning can be significant.
While the new health care rules have been controversial, with the new health care exchanges opening for enrollment on October 1st (albeit with some technology glitches and speed bumps so far!), the time is now for advisors to begin to get familiar with the new rules and some of their tax planning implications. For some uninsured clients, this may represent their first opportunity ever to get access to health insurance without medical underwriting - and with a premium subsidy to help - creating a newfound flexibility for employment and retirement decisions. For others, it will be important to comply with the new rules simply to avoid the potential penalties under the so-called "individual mandate."
Michael's Note: This article has been updated for the 2015 tax year, for those preparing their tax returns in early 2016.
Eligibility Rules
For the premium assistance tax credit, “lower” income is defined as those households that earn less than 400% of the Federal Poverty Level (FPL). The Federal Poverty Level thresholds are adjusted for inflation each year, and are determined based on the number of people in the household. For example, in 2015, the FPL was $11,770 for an individual and $24,250 for a family of four, which means at least some premium assistance credit is available for households with incomes up to $47,080 for individuals and $97,000 for a family of four (see table below for further detail). Each year, the premium assistance tax credit thresholds are adjusted for annual inflation-adjusted Federal Poverty Levels.
| Household Size | Federal Poverty Level (Percentage Of) | |||||
|---|---|---|---|---|---|---|
| 100% | 133% | 150% | 200% | 300% | 400% | |
| 1 | $11,770 | $15,654 | $17,655 | $23,540 | $35,310 | $47,080 |
| 2 | $15,930 | $21,187 | $23,895 | $31,860 | $47,790 | $63,720 |
| 3 | $20,090 | $26,720 | $30,135 | $40,180 | $60,270 | $80,360 |
| 4 | $24,250 | $32,253 | $36,375 | $48,500 | $72,750 | $97,000 |
| 5 | $28,410 | $37,785 | $42,615 | $56,820 | $85,230 | $113,640 |
| 6 | $32,570 | $43,318 | $48,855 | $65,140 | $97,710 | $130,280 |
| 7 | $36,730 | $48,851 | $55,095 | $73,460 | $110,190 | $146,920 |
| 8 | $40,890 | $54,384 | $61,335 | $81,780 | $122,670 | $163,560 |
| Each add'l | $4,160 | $5,533 | $6,240 | $8,320 | $12,480 | $16,640 |
Notably, at these thresholds, recent research by Kaiser Family Foundation suggests that as many as 2/3rds of all households in the US would be eligible for at least a partial premium assistance tax credit based on income (though far fewer than that amount will utilize it, as many still receive coverage through an employer plan or government programs instead). Given the breadth of the credit, though, arguably the credit is more of a “lower” and “middle” income credit than just a low income tax credit, and should not be viewed as applying solely to “poor” individuals and families (as the media has sometimes implied).
Defining Income
“Income” for the purposes of the premium assistance tax credit and the FPL is based on modified Adjusted Gross Income (AGI), which means AGI increased by any income not reported due to the foreign earned income or housing cost assistance exclusions, any tax-exempt interest (i.e., municipal bond income), and any Social Security benefits that were otherwise excluded from income. In other words, household income for the purposes of the credit will include Adjusted Gross Income plus all bond interest (taxable or tax-exempt to the extent not already included), and plus all Social Security benefits (taxable or tax-exempt to the extent not already included).
Final regulations on how state exchanges will gather information to verify an applicant’s income indicate that exchanges will rely primarily on IRS and Social Security Administration data (e.g., using the applicant’s prior year tax return will be used initially), and substantiated based on wage data verified through Equifax. Notably, the White House administration has delayed implementation of the income verification rules, leaving income verification for now on the “honor system” (with random checks of a statistically significant sample to verify compliance), but raising concern from many that there may be a higher incidence of fraudulent income reporting to qualify for the subsidy in the coming year (though ultimately, inappropriately reported amounts could still be recaptured by the Federal government when the subsequent tax return is filed later, as discussed below, limiting the potential scope of any fraud).
Notably, individuals are only eligible for the premium assistance tax credit if they are enrolled in a qualifying health plan (QHP), which means coverage that is offered through an exchange, provides essential health benefits, and meets actuarial requirements. In addition, the premium assistance tax credit is available only if the individual is not already receiving "affordable" minimum essential health coverage elsewhere (e.g., from a government program, employer-sponsored plan, etc., that meets the minimum value and affordability requirements). Thus, in practice the premium assistance tax credits are primarily for those who don't otherwise already have access to health insurance, and/or for whom their other (e.g., employer) health insurance is unaffordable after the employer's contribution.
Credit Payments And Amounts
Notably, unlike many other tax credits, the premium assistance tax credit is not paid directly to/received directly by the taxpayer. Instead, premium assistance tax credits are paid directly to the new health insurance exchanges, which in turn make a subsidy payment to the provider of the health plan on behalf of the individual, such that the insured is only billed for only the remaining portion of the insurance premium. In fact, individuals will be able to determine the amount of the credit they’ll be eligible for before even applying for coverage, so they know up front exactly what their share of the premium obligation will be. Once eligibility is determined and the credit amount is calculated, the credit is applied automatically on a monthly basis for every month that the individual remains eligible and paying for coverage.
This approach – where the tax credit is provided directly to the insurer through the exchange to cover a share of the premiums – reduces the upfront out-of-pocket cost of health insurance for eligible lower income individuals. This is a far more cash-flow-friendly approach than requiring them to pay the full amount up front and recover the tax credit later (which might result in unmanageable cash flow constraints).
The goal of the premium assistance tax credit is to limit households to paying no more than a certain percentage of income (as defined earlier) on their health insurance coverage, where any excess above those thresholds are covered by the credit. The chart below shows the thresholds for the premium assistance tax credit; notably, the higher the level of income, the higher the percentage of income that is expected to be paid towards health insurance. The premium assistance tax credit is technically refundable, which means it can apply even for individuals who do not otherwise owe any income taxes.
| Income relative to FPL: | Premiums limited to: |
|---|---|
| 100% to 133% of FPL | 2% of income |
| 133% to 150% of FPL | 3% to 4% of income |
| 150% to 200% of FPL | 4% to 6.3% of income |
| 200% to 250% of FPL | 6.3% to 8.05% of income |
| 250% to 300% of FPL | 8.05% to 9.5% of income |
| 300% to 400% of FPL | 9.5% of income |
For those whose incomes fall between the ranges shown in the chart, their premium limitation moves pro-rata along the range. For instance, a client at 175% of the FPL (mid-way between the 150% and 200% tiers) would have premiums limited to 5.15% of income (mid-way between the 4% and 6.3% thresholds). However, the premium limitation for those under 133% of FPL is a flat 2%; as a result, moving from 132.9% to 133.1% of the FPL does result in a jump up in the threshold (and therefore a jump down in the premium assistance tax credit) from 2% of income to 3% of income. Similarly, those moving from 399.1% to 400.1% of the FPL jump from having premiums capped at 9.5% of income to having no limit at all.
The actual amount of the credit itself is the excess of the premium cost for a “benchmark plan” above the threshold amounts as determined from the chart above. The cost for the benchmark plan is based on the second lowest cost Silver plan available on the exchange to cover the individual’s entire household based on their age, rating area, and number of people in the family (but not adjusted for tobacco use).
Example 1. Bill is a single, 35-year-old non-smoker, and earns $25,000 per year. His income is 212% of the $11,770 FPL (in 2015) for a household size of 1. Accordingly, this puts him roughly midway between the 6.3% and 8.05% threshold for maximum premium; his exact threshold is 12/50ths of the way from 200% to 250% of the FPL, so his maximum premium is 12/50th of the way between 6.3% and 8.05%, which means his maximum premium is 6.72% of his $25,000 income, or $1,680/year. If the actual premium for the second lowest cost Silver plan in his state is $300/month (or $3,600 per year), Bill’s premium assistance tax credit will be $1,920 (which brings his premium down to the maximum cap of $1,680/year). Accordingly, Bill will pay $140/month ($1,680/year) for his health insurance, with the remaining $160/month covered by the premium assistance tax credit. Notably, if Bill chooses to buy a different plan besides the Silver, which may cost more or less, his premium assistance tax credit will continue to be $155.58/month, but his share of the premium will be the remainder left over (whatever that comes out to be).
Example 2. Continuing the above example, assume instead that Bill is a smoker, and as a result while the second-lowest Silver plan is $300/month, his actual premium is $500/month. Because the premium assistance tax credit is based on the cost of a non-smoker, his tax credit will remain $160/month, and his out-of-pocket cost will rise to $340/month instead of $140/month. Accordingly, the increased $200/month premiums attributable to his smoking must be borne entirely on his own.
Example 3. Continuing the first example, assume instead that Bill earned $40,000/year, putting him at 340% of the FPL. His premium threshold would be 9.5% x $40,000 = $3,800. However, his actual premiums, due to his young age and health, are only $3,600/year. Accordingly, Bill would actually not be eligible for a premium assistance tax credit, simply because his premiums are already below the 9.5%-of-income threshold.
Another way to view the premium assistance tax credit is simply to recognize that the formulas effectively cap the maximum amount of premiums that anyone (under 400% of FPL) will be required to pay out of pocket. To the extent that premiums (for a benchmark plan) are higher than the maximum premium, the excess is covered by the premium assistance tax credit. Accordingly, the table below shows the maximum out-of-pocket premium that would be due at various income levels and various family sizes; ultimately, the maximum out-of-pocket amounts for 2016 will be slightly higher based on 2015 FPL thresholds.
| Income Relative To FPL |
Max Prem % of Income |
Family Size | ||||
|---|---|---|---|---|---|---|
| 1 | 2 | 3 | 4 | 5 | ||
| 100% | 2% | $235.40 | $318.60 | $401.80 | $485.00 | $568.20 |
| 132.9% | 2% | $313.08 | $423.74 | $534.39 | $645.05 | $755.71 |
| 133.0% | 3% | $469.62 | $635.61 | $801.59 | $967.58 | $1,133.56/td> |
| 150% | 4% | $706.20 | $955.80 | $1,205.40 | $1,455.00 | $1,704.60 |
| 200% | 6.3% | $1,483.02 | $2,007.18 | $2,531.34 | $3,055.50 | $3,579.66 |
| 250% | 8.05% | $2,368.71 | $3,205.91 | $4,043.11 | $4,880.31 | $5,717.51 |
| 300% | 9.5% | $3,354.45 | $4,540.05 | $5,725.65 | $6,911.25 | $8,096.85 |
| 350% | 9.5% | $3,913.53 | $5,296.73 | $6,679.93 | $8,063.13 | $9,446.33 |
| 400% | 9.5% | $4,472.60 | $6,053.40 | $7,634.20 | $9,215.00 | $10,795.80 |
Reconciling Credit Over- Or Under-Payment
At the end of the year, those eligible for premium assistance tax credits will be required to reconcile the actual credit that should have been earned based on actual income that year, with the amounts that were subsidized to the exchange, and receive either a refund (if more credits are due) or owe an additional tax obligation (if the subsidies were “overpaid” relative to the actual credit earned). The amount of the credit that was applied on the individual’s behalf by the exchange will be reported to the IRS by the end of January after the close of each tax year in the future on the new Form 1095-A.
If the credit was overpaid to the exchange, there is a maximum that can be recovered via the tax return (which would be relevant if there was a significant change in income, or potentially in 2014 if individuals simply underreport income to qualify for the credit before the income verification rules are implemented). The recovery limits are themselves based on the individual’s income for that year; couples/families with income below 200% of the FPL face a maximum recovery amount of $600, while households up to 300% of FPL face a maximum of $1,500 and those up to 400% of FPL may be subject to a $2,500 recovery amount (the limits for a single individual are 50% of these dollar amounts with the same percentage-of-FPL thresholds). These dollar amounts are indexed for inflation. If the household income exceeds 400% of the FPL, the entire amount of any premium assistance credits “accidentally” advanced on behalf of the individual or family must be repaid as an additional tax liability when the tax return is filed.
Notably, these limits only apply if the amount of advanced tax credits was too high, such that the taxpayer was overcredited and needs to pay back the excess amounts received; if the credits were too low, there is no limit on what the taxpayer can receive in additional credits when the tax return is ultimately filed (beyond the limits of the premium assistance tax credit itself) in the event that income dropped significantly and a higher credit was due.
Other Details About Premium Assistance Tax Credits
To the extent that health insurance premiums are covered by a premium assistance tax credit, they are not deductible as medical expenses; however, any remaining premiums actually paid out of pocket are eligible to be deducted (albeit subject to the 10%-of-AGI floor for such deductions).
Thus, for example, if the individual had health insurance for the year that cost $5,000, and received $1,000 of premium assistance tax credits, only the remaining net $4,000 of health insurance premiums that were paid out of pocket could be claimed as a medical expense deduction. In fact, given the high 10%-of-AGI threshold for deducting medical expenses, and the fact that premiums will be partially subsidized for many, it’s unlikely that most clients will be able to obtain much of any deduction at all, especially if they are high income.
On the other hand, the reality is that such an outcome is actually the intent of the law in the first place; the bulk of tax assistance benefits for health insurance will be conveyed through the premium assistance tax credit specifically targeted at lower income individuals (who generally don’t benefit from medical expense deductions due to the simple fact that they don’t itemized deductions at all) while only limited benefits will be available through the medical expense deduction to higher income individuals. On the other hand, some clients may find that health insurance premiums, when added to medical expense deductibles and other payments actually made throughout the year, can still yield some amount of medical expense deductions (especially if the client already itemizes, and has other medical expense deductions such as dental care or permissible long-term care costs).
As a result, the new health insurance rules would essentially break clients into three groups: those above 400% of the Federal poverty level, who pay the full cost of their insurance (and may or may not be able to deduct any of it); those below 400% of the Federal poverty level, who will pay for coverage but receive a premium assistance tax credit to partially ameliorate the cost (and might also partially deduct); and those below 133% of the Federal poverty level, who will potentially owe no premiums at all and will simply be covered by Medicaid. On the other hand, because not all states are adopting the new 133%-of-FPL Medicaid thresholds, some lower income individuals below this threshold but above 100% of FPL will still be expected to purchase insurance through an exchange (albeit subject to the 2%-of-income maximum limit on the cost of coverage), and those below 100% of FPL may be ineligible for the premium assistance tax credit and ineligible for Medicaid!
The bottom line, though, is that the availability of the premium assistance tax credit creates a significant planning opportunity for clients. Given that the new insurance exchanges offer health insurance regardless of actual health or pre-existing conditions, the new rules will shift the health insurance discussion for clients from how to access insurance (e.g., through an employer that offers coverage) to how to afford insurance (through a combination of paying premiums and being eligible for premium assistance tax credits). For many clients, the availability of coverage - and especially the support of premium assistance tax credits - may make it easier for them to change jobs, start a new business or consulting practice, or retire early without worrying about health insurance. In fact, in such situations, not only do the new health insurance exchanges ensure access to coverage, but the decline in income associated with such life transitions may actually result in premium assistance tax credits that make coverage remarkably affordable.
(Michael's Note: This article is an excerpt from the July/August 2013 issue of The Kitces Report. Click here for further information about this and other newsletter issues, including eligibility for CFP CE credit.
