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Health reform law has a hidden cliff—Watch out!

March 3, 2014

Federal tax law always seems to contain a few cliffs—i.e., rules under which a $1 increase in taxable income, for example, can cost a taxpayer as much as thousands of times that $1. Beginning in 2014, there is a new cliff that will hit middle income individuals who are close to being able to qualify for the health reform law’s premium assistance credit.

Background. Federal tax law contains many rules under which a tax benefit is limited based on some measure of income, e.g., taxable income or adjusted gross income (AGI). For example, the American Opportunity tax credit (AOTC) (one of the education credits) is phased out ratably for taxpayers with modified AGI between $80,000 and $90,000 ($160,000 and $180,000 for married individuals who file a joint return). (Code Sec. 25A(i)(4)) For most such dollar limits, there is a phaseout range like the AOTC’s, i.e., a range of income, etc., over which the benefit phases out and at the end of which the benefit ends altogether. For tax benefits that are subject to a phaseout range, each dollar of additional income (or, in some cases, each dollar of some other relevant amount) results in a small amount, usually less than $1, of lost benefit. For example, for a single person, each dollar of AGI over $80,000 and not more than $90,000 loses him 1/10,000 of AOTC, a loss that varies based on the amount of credit he would otherwise have earned, but which will always be less than $1.

However, there are a few tax benefits that are limited based on some measure of income that don’t have phaseout ranges. Those tax benefits are said to have a “cliff” or “cliffs”—i.e., where like a literal cliff, if one goes past a single point, he will experience a dramatic change in fortune. For tax cliffs, that usually means an increase of a $1 in income can mean hundreds or even thousands of dollars of lost benefits.

The new cliff—the health care premium credit. The Patient Protection and Affordable Care Act (PPACA, P.L. 111-148) and the Health Care and Education Reconciliation Act of 2010 (P.L. 111-152)—collectively, the Affordable Care Act—provide the Code Sec. 36B credit that is designed to make health insurance affordable to individuals with modest incomes (i.e., between 100% and 400% of the federal poverty level, or FPL) who are not eligible for other qualifying coverage, such as Medicare, or “affordable” employer-sponsored health insurance plans that provide “minimum value.” (Code Sec. 36B(b)(3)(A)(i)) The credit applies for tax years that end after Dec. 31, 2013. (Reg. § 1.36B-1(o)) For purposes of the 2014 credit, the FPL to be used is the 2013 FPL. (See IRS’s “Questions and Answers on the Premium Tax Credit” (Feb. 3, 2014). )

For example, for persons whose income is between 300% and 400% of FPL, the credit is equal to the excess of the premium over 9.5% of household income. (Code Sec. 36B(b)(3)(A)(i))

But, a taxpayer whose income is 401% of FPL, for example, gets no credit.

RIA illustration A single individual has 2014 household income of $45,960. This is exactly 400% of the FPL for 2013, and the credit will equal any insurance premium over 9.5% of their income. Say the yearly insurance premium for a single person age 55 is $6,828 (this is an estimate from the Congressional Budget Office). The person pays a premium amount equal to 9.5% of his household income. This 9.5% is equal to $4,366. The government then pays the rest of the premium via the tax credit. In this case, the subsidy is $2,462 ($6,828 – $4,366 = $2,462). However, if the person’s income is $45,961, or $1 over the 400% point, the government pays $0, the person pays all $6,828. The $1 cost him $2,462.

What should you do now about this cliff?

 

1. Consider whether this cliff could conceivably affect you. Remember that it can only affect you if you buy your own health insurance on an exchange and are not eligible for other qualifying insurance.
2. If you answered “yes” at Step (1) above, is it at least somewhat likely to be on the bad side of the cliff? Consider that 400% of FPL, for purposes of the 2014 credit, is $45,960 for one individual; $62,040 for a family of two, and $94,200 for a family of four.
3. If you answered “yes” at Step (2), are you close enough to the edge of the cliff that you think you can take steps to get to the other side of the cliff for 2014?
4. If you answered “yes” at Step (3), take steps to accelerate deductions into 2014 and/or defer income into 2015, until you are no longer on the bad side of the cliff. For many different methods of accomplishing these accelerations and deferrals, see Tax Planning & Practice Guide ¶  101  10/15/2013.