This time last year, taxpayers had to provide health insurance information on their income tax returns for the first time. As with any new tax-reporting provision, the process proved more burdensome for some than for others. The second year could bring its own set of unpleasant surprises.
The Affordable Care Act created a variety of tax consequences for Americans, but one that was little discussed until recently was the possibility of having to repay federal subsidies for health insurance. For many taxpayers, this liability will come as a shock, as will the amount due.
According to a report released by the U.S. Department of Health and Human Services in early 2015, nearly 6.5 million participants on the federal health insurance exchange qualified for advance premium tax credits. While these credits are not the only subsidies available through the health care law, they are by far the most common. Eligibility is largely based on income, meaning that those taking the credits upon purchase — that is, taking advantage of the “advance” part — had to submit estimates of their annual incomes.
Estimates, however, are seldom perfect. This became clear in tax year 2014, when taxpayers who earned more than they projected were required to repay some or all of the credits to which they were no longer entitled.
The law included caps on repayment for those who earned less than 400 percent of the federal poverty line. Those who earned more than 400 percent of the federal poverty line could owe up to the entire subsidies they received. According to a study by the Kaiser Family Foundation, the average amount due for those who had to pay back at least some portion of the credits in 2014 was $794. Whatever amount a taxpayer owes may be deducted from his or her income tax refund. If the taxpayer is not due a refund or the refund is insufficient, the person may have to write a check to the government.
For repeat Health Insurance Marketplace participants, the need to reconcile advance credit payments and premium credit amounts based on actual income may no longer be a surprise. But many people who enrolled in the Marketplace in 2015 were not enrolled for the prior year, so plenty of taxpayers are still risking nasty shocks this spring. For taxpayers who held more than one job, got married, got divorced, had a child or moved (especially between states), matters may be even more complex.
How to avoid Affordable Care Act sticker shock? Unfortunately for taxpayers, the credit reconciliation mechanism is a central part of the law and is unlikely to change in the near future. However, a few steps could at least minimize the pain of having to repay subsidies at tax time.
The government advises taxpayers who are unsure of their incomes to consider taking only part of their premium tax credits up front. While taxpayers are allowed to wait and receive some or all of their credits when filing their income tax returns, this solution assumes the willingness and the ability to pay for insurance out of pocket. Considering that a taxpayer’s income must fall below the appropriate threshold to qualify for credits in the first place, this approach will not work for many, or even most, affected individuals.
The government also recommends that taxpayers report any changes in income, household size, employment, address or eligibility for other health care coverage during the year. Properly updated information will allow exchange administrators to adjust subsidies throughout the year to minimize discrepancies at tax time. Many taxpayers, however, are unaware that they should update their information timely, or are unsure of how to do so. Such changes can be reported through the taxpayer’s online Marketplace account or by phone — unless the change in question is an interstate move. In that case, the taxpayer will have to submit a brand-new application, as eligibility rules vary among states.
If a taxpayer suspects a substantial gap between projected and actual income, he or she can also attempt to minimize modified adjusted gross income. This figure determines eligibility for a variety of federal tax benefits, including advance premium credits. Taxpayers can reduce it by increasing deductions known as “above-the-line deductions,” aptly named for their position on Form 1040 above the calculation for adjusted gross income. These deductions include educator expenses, deductible health savings account contributions, moving expenses, deductible contributions to qualified employer retirement plans (including self-employed SEP and SIMPLE plans), alimony payments, deductible IRA contributions, deductible student loan interest payments and deductible tuition and fee payments.
When tax time arrives, taxpayers who received advance credits or plan to claim credits should be especially careful to provide all necessary information to their tax preparers, or to enter all information correctly in the case of self-preparers. These taxpayers must file federal income tax returns even if they aren’t otherwise required to file in order to complete Form 8962. This form is used to claim or reconcile the credits. Note that taxpayers taking these credits are ineligible to file Form 1040-EZ because of the Form 8962 filing requirement.
Failure to file a return will prevent a taxpayer from receiving advance premium credits in future years. Meanwhile, failure to report any credits taken may result in accuracy penalties, which are calculated as a flat 20 percent of the net understatement of tax. Similarly, failure to pay a tax liability attributable to repayment of the premium tax credit by April 15 may result in late payment penalties of 0.5 percent of the unpaid taxes for each month, or part of a month, after the due date that the tax is not paid, with certain exceptions. This penalty increases to a full 1 percent per month for any tax that remains unpaid the day after the Internal Revenue Service issues a demand for immediate payment, or 10 days after it issues notice of intent to levy certain assets.
Health Insurance Marketplace enrollees will receive Form 1095-A, which will list any household members who had coverage through the federal exchange, the months in which those individuals were covered and relevant premium and subsidy amounts. All of this information will be necessary to prepare Form 8962. Taxpayers who were insured elsewhere (privately or through their employers) may receive Forms 1095-B or 1095-C. The latter is issued by larger employers who are subject to the employer shared responsibility provision in the law. For taxpayers who purchased health insurance coverage through the Marketplace and wish to claim the premium tax credit, the information on these forms will help determine eligibility.
All taxpayers, regardless of Marketplace use, will need to keep an eye out for a particular checkbox on their Forms 1040. That box indicates that everyone in the household had minimum essential coverage for the year. For those who remained uninsured, the penalties rose again this year, which could create yet another unpleasant surprise.
There are a variety of exemptions from the minimum essential coverage requirement, mostly having to do with some sort of hardship as recognized by law. Some exemptions can be applied for directly on Form 8965, while others may require an application through the Marketplace. If a taxpayer’s application is still in process when he or she files a return, the IRS instructs him or her to place “pending” in the exemption code section. However, if the application is rejected, the taxpayer may need to file an amended return.
The Affordable Care Act is about taxes nearly as much as it is about health care. For now, taking the time to understand how the law works is the best way to avoid some nasty sticker shock when tax time rolls around.
