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Potential impact of Supreme Court’s pending premium tax credit decision

In March of 2015, the Supreme Court is to hear oral arguments on a case dealing with whether IRS’s regs under Code Sec. 36B, the Affordable Care Act’s (ACA’s) premium tax credit provision, are valid. A new Congressional Research Service (CRS) report examines the potential implications of the Court’s thumb’s up or thumb’s down decision.

Background on ACA provisions. The Code Sec. 36B credit is designed to make health insurance affordable for taxpayers who meet certain qualifying requirements. It is available for individuals who purchase affordable coverage through Exchanges.

States may establish and operate Exchanges pursuant to 42 U.S.C. § 18031 (ACA §1311), or the federal government may establish and operate an Exchange in place of the state where a state has chosen not to do so consistent with federal standards pursuant to 42 U.S.C. § 18041 (ACA § 1321).

Exchanges make premium assistance payments (also called “subsidy” or “advance” payments) on the individual’s behalf to health plans, based on information available at the time of enrollment; then, at return time, the individual reconciles the actual credit that he is due with the amount of the subsidy payments that were made. (Code Sec. 36B(b)) (See Weekly Alert ¶  18  05/24/2012 for more details on Code Sec. 36B and its regs.)

In describing the premium assistance amount, Code Sec. 36B(b)(2)(A) refers to “the monthly premiums for…qualified health plans offered in the individual market…which were enrolled in through an Exchange established by the State ” (emphasis added) under §1311. However, the regs issued under Code Sec. 36B provide that the premium tax credit isn’t just limited to State Exchanges, but also includes federally-facilitated Exchanges. (Reg. § 1.36B-1(k))

Code Sec. 5000A requires non-exempt U.S. citizens and legal residents for tax years ending after Dec. 31, 2013 to maintain minimum essential health insurance coverage (e.g., government-sponsored programs such as Medicare, Medicaid, Children’s Health Insurance Program; eligible employer-sponsored plans; plans purchased in the Exchange) or pay a penalty. This requirement is referred to as the “individual mandate.”

There are a number of situations in which individuals are exempt from the penalty imposed by Code Sec. 5000A, including where individuals do not have an affordable health insurance coverage option available (i.e., whose required contribution for minimum essential coverage exceeds a percentage of the taxpayer’s household income—8% for 2014, 8.05% for 2015). (Code Sec. 5000A(e)(1))

The issue. In May of 2012, IRS issued regs that interpreted Code Sec. 36B to allow credits for insurance purchased on either a State or federally-established Exchange. Specifically, the regs provide that a taxpayer may receive a tax credit if he is enrolled in one or more qualified health plans through an Exchange, which IRS defined as an Exchange serving the individual market for qualified individuals, regardless of whether the Exchange is established and operated by a State (including a regional Exchange or subsidiary Exchange) or by Health and Human Services (HHS).

By making credits more widely available, the reg gives the individual and employer mandates—key provisions of the ACA—broader effect than they would have if credits were limited to state-established Exchanges. As noted above, the individual mandate requires individuals to maintain “minimum essential coverage,” enforcing that requirement with a penalty. However, the penalty doesn’t apply to individuals for whom the annual cost of the cheapest available coverage, less any tax credits, would exceed 8% of their projected household income. Thus, by making tax credits available in the 36 states with federal Exchanges, IRS through its regs significantly increases the number of people who must purchase health insurance or face a penalty.

The challenge and upcoming resolution. Taxpayers brought suit against IRS and HHS (Health and Human Services) arguing that Reg. § 1.36B-1(k) invalidly interpreted Code Sec. 36B(b)(2)(A). On Nov. 7, 2014, the Supreme Court agreed to resolve a Circuit split between the Fourth Circuit upholding the reg, and the DC Circuit invalidating the reg, by reviewing King v. Burwell, (CA 4 7/22/2014) 114 AFTR 2d 2014-5259.

The Supreme Court is scheduled to hold oral arguments on the case on Mar. 4, 2015.

Implications of Court’s upholding the reg. If the Court finds that the IRS regs at issue are valid, the CRS report says it may be presumed that IRS would not need to amend the regs or take any other action, and that premium tax credits would remain available for individuals participating in state and federally run exchanges in every state and the District of Columbia.

However, such a holding may not preclude IRS from amending the regs at a future date. Assuming that the Court performs a Chevron analysis and finds that the ACA’s statutory language of the ACA is ambiguous and subject to multiple interpretations, IRS would remain free to amend the regs, so long as the amendments are consistent with the Code. Thus, it is possible that if the Supreme Court in King decides to defer to IRS’s interpretation of the ACA, an administration could later amend the regs in a way that affects the provision of premium tax credits in federal and state-run exchanges. The Court’s opinion may address this scenario.

Fallout from invalidation of the reg. The Court may find that the IRS reg at issue in King v. Burwell, is invalid, and, as a result, individuals participating in federally run exchanges would no longer be eligible for the credit. According to the CRS Report, IRS would presumably act to address the problematic aspects of the Code Sec. 36B regs. And IRS (and HHS) might determine that additional rulemaking or guidance is appropriate to address possible issues arising from the interaction between the premium tax credit and other parts of the Code and ACA (discussed below).

IRS, affected taxpayers, and insurance companies might also confront issues due to the timing of the Court’s decision. The decision is likely to be released after Apr. 15, 2015, and, by that time, taxpayers claiming the credit for tax year 2014 will have generally done so. Additionally, some taxpayers will be receiving the credit for tax year 2015 in the form of advanced payments made directly to their insurance companies. Thus, in addition to raising questions about whether taxpayers who received the credit would be required to pay it back (see below), it seems possible the timing of the Court’s decision might present issues with respect to the advanced payments being made for 2015 insurance contracts.

How the ACA would be affected if the reg is invalidated. According to the CRS report, if the Court strikes down the Code Sec. 36B regs at issue, the ACA’s operation could be affected in the following ways:

1. Blow to goal of affordable coverage. The ACA requires health insurers to accept every individual who applies for coverage, prevent them from imposing exclusions from coverage based on preexisting conditions, and restrict insurers from charging higher premiums based on an individual’s health status. Based on these requirements, it is argued that in order to prevent an “adverse selection” scenario, where individuals wait to buy health insurance until they need care, the ACA compels individuals to buy insurance through the individual mandate. To make this required coverage affordable, the ACA provides for premium tax credits and other subsidies. It has been argued that eliminating premium tax credits would be detrimental to this scheme since these provisions work together to achieve the ACA’s fundamental goals of expanding health-insurance coverage and promoting a functioning individual insurance market in each State.
2. Exemption of more individuals from individual mandate. If premium tax credits are unavailable to individuals enrolled in a federally run exchange, fewer individuals will be required to have health insurance under the ACA’s individual mandate. There’s an exemption from the individual mandate for individuals whose contribution to health coverage is more than 8% of household income. The ACA specifies that this contribution is calculated for certain individuals as the annual premium for the lowest cost plan available on an exchange in the state, minus any allowable premium tax credit. If an individual is not allowed the premium credit, coverage becomes more expensive, and the unaffordability exemption may kick in, meaning that the individual does not have to obtain coverage under the individual mandate. It has been predicted that eliminating the premium tax credits in states with federally run exchanges would exempt more individuals from the individual mandate and would make coverage unaffordable for many of these individuals.
3. Debilitating effect on Exchanges. Absent the Code Sec. 36B credits, many healthy people would not buy health coverage. However, individuals with more serious health conditions would probably remain in the market. Thus, some argue that the population in these plans could become skewed toward sicker, more expensive enrollees, and this may lead to a rise in premiums in affected exchanges.
4. Blow to employer mandate. The ACA specifies that liability for the excise tax under the employer mandate is generally triggered when one or more of an employer’s full-time employees is allowed a premium tax credit through a health insurance exchange. As a result, if credits are not available in states with federally run exchanges, large employers may not be subject to penalties if they fail to offer affordable coverage to employees.
5. Impact on taxpayers who already claimed credits. If the Court were to strike the Code Sec. 36B reg so that taxpayers who bought insurance in federally facilitated exchanges were not allowed the credit, it might be argued that these taxpayers could be required to pay back any claimed credit to IRS. On the other hand, these taxpayers claimed the credit due to their reliance on an unambiguous IRS-promulgated reg. As such, it would be arguably unfair to require them to pay back any claimed credit. Even if there might be a legal basis for concluding that taxpayers might have to pay back the credit, the CRS report concludes that it seems possible the Court, Congress, or IRS would take mitigating actions.

References: For the premium tax credit, see FTC 2d/FIN ¶  A-4241  ; United States Tax Reporter ¶  36B4  ; TaxDesk ¶  138,700  ; TG ¶  1381  .

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