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Nancy Pelosi's famous remark about the Affordable Care Act was that it needed to be passed to see what was in it. The new premium tax credit starting in 2014 is my nominee for the ACA provision that most needed the light of day.
Individuals who buy health insurance through an Exchange furnish an estimate of their income, and the Exchange then subsidizes their monthly insurance premium. The greater the estimated income, the lower the subsidy. After 1040 actual income is computed, the advance subsidy is adjusted up or down as an additional 1040 tax or refund. There's no downside to estimating strong on the income; a shortfall in the monthly subsidy can be corrected with a refundable 1040 tax credit.
CAP ON THE TRUE UP
Let's say a self-employed farmer estimates his income on the low side and gets a $4,000 premium subsidy over the year, but final 1040 income is much greater. There is a cap built into the law on the true-up of the subsidy and it's modest (a maximum $1,250 single; $2,500 joint). Guess what the strategy will be once this little gem gets recognized?
INSURANCE THROUGH AN EXCHANGE
The law says an individual must purchase insurance through a state Exchange to receive the subsidy. But IRS regulations say a federal Exchange can also qualify. As most know, this issue is in the courts and should sort out soon. The less tidy aspect is all the individual waivers. The administration, through Centers for Medicare & Medicaid Services (CMS), has directed (decreed?) that individuals who wanted to access the Exchange may qualify for the subsidy based on their private insurance. Apparently, each Exchange decides which individuals had the proper motive in their heart.
THE SUBSIDY CLIFF
Generosity abounds in this system, but the line between winners and losers is harsh. For 2014, single filers are subsidized on incomes up to $45,960, a family of two up to $62,040, and up to $94,200 for a household of four. The credit is more generous if income is low, but even at the top it's substantial. A single individual exactly at the top of the income threshold is considered affordable on a premium of $4,366 (9.5% of income). If the actual premium is $6,828 (a CBO average for a 55-year-old), the tax credit or subsidy is $2,462. But now add $1 of income: You've gone over the cliff, and the subsidy is zero! If this was a married couple just over the $62,040 threshold, an extra $10 of income might require a subsidy payback of $5,000 or $6,000. Some will find artful solutions at tax time to reduce income if it's close, such as through an IRA deduction; others will be stuck with a giant tax tab.
The law says there is no Exchange subsidy if the individual had affordable insurance offered by an employer. That's to be monitored via notices issued by employers and insurance companies to each individual. But again, the administration issued a blanket one-year waiver until 2015. So 2014 will be the Wild West on this rule.
THE SELF-EMPLOYED CHALLENGE