In a case of first impression, the Tax Court has concluded that for purposes of determining a taxpayer’s eligibility for a premium tax credit (PTC) under Code Sec. 36B, the taxpayer must include Social Security benefits in his computation of Modified Adjusted Gross Income (MAGI) in spite of a Code Sec. 86(e) election. Accordingly, the taxpayer had to include in his 2014 MAGI all the Social Security benefits received in 2014, including lump-sum amounts relating to 2013 for which he filed a Code Sec. 86(e) election
Background. Under the Affordable Care Act (ACA or Obamacare), a PTC is available to help individuals and families afford the cost of premiums for qualified health plans purchased through a health insurance Marketplace. (Code Sec. 36B) A health insurance Marketplace, also known as an “Exchange,” is a State or federally run program where taxpayers can purchase health insurance. In general, an individual is eligible for the PTC if his or her household income is at least 100% but not more than 400% of the federal poverty level (FPL) for the individual’s family size, no one can claim the individual as a dependent, and, if married, the individual files a joint return.
Observation: In other words, the 400% limitation is a “cliff”; for example, a taxpayer whose income is 401% of FPL doesn’t qualify for any credit.
Household income is: (a) an individual’s MAGI plus (b) that of every other individual in his family for whom he or she can properly claim a personal exemption or deduction as a dependent who is required to file a federal income tax return.(Reg. § 1.36B-1(e)(1)) MAGI is the adjusted gross income on one’s federal income tax return plus any excluded foreign income, tax-exempt interest received or accrued during the tax year, and nontaxable Social Security benefits (within the meaning of Code Sec. 86(d)) not included in gross income under Code Sec. 86. For this purpose, MAGI doesn’t include Supplemental Security Income (SSI). (Code Sec. 36B(d)(2); Reg. § 1.36B-1(e)(2))
Eligible individuals and families can choose to have advance credit payments (i.e., APTCs) paid directly to their insurance company to lower what they pay out-of-pocket for their monthly premiums. Where APTCs paid to taxpayer’s insurer for the tax year exceed the PTC to which the taxpayer is actually entitled for the tax year, the taxpayer generally owes the excess advance payments as an additional income tax liability. (Code Sec. 36B(f)(2)(A))
In general, a Code Sec. 86(e) election affects the amount of Social Security benefits included in gross income for the year of receipt. The amount included in gross income for the year of receipt, by reason of the portion attributable to a prior year, will not exceed the increase in gross income for the prior year that would have resulted if the portion attributable to the prior year had been received in that year. (Code Sec. 86(e)(1))
Facts. In 2014, Levon Johnson received $26,180 of Social Security benefits, of which $11,902 was attributable to a lump-sum payment relating to 2013 and $14,278 was attributable to 2014 Social Security benefits.
During 2014, Mr. Johnson enrolled in a health insurance plan through the health insurance marketplace. From March through December 2014, he received APTCs to cover a portion of the cost of the monthly health insurance premiums. He received a total of $4,460 in APTCs during 2014.
Mr. Johnson timely filed his 2014 Form 1040 (U.S. Individual Income Tax Return) on which he reported $24,450 of wages and $7,509 of taxable Social Security benefits. He did not report any excess APTCs on his 2014 Form 1040 and did not file the required Form 8962 (Premium Tax Credit (PTC)).
In a notice of deficiency dated Nov. 6, 2015, IRS determined that Mr. Johnson had to repay $4,460 of excess APTCs. IRS determined that the taxpayer’s excess PTC was the entire $4,460 because, under Code Sec. 36B, all of his Social Security benefits received during 2014 (including those relating to 2013) had to be included in computing whether he was entitled to the PTC. The inclusion of all Social Security benefits would result in the taxpayer’s having MAGI outside of the range for entitlement to the PTC.
On Mar. 10, 2016, Mr. Johnson made a Code Sec. 86(e) election on an amended Form 1040A (U.S. Individual Income Tax Return). On his 2014 amended return, he reported $31,137 of adjusted gross income, consisting of $24,450 of wages and $6,687 of taxable Social Security benefits. On his Form 8962, he reported MAGI of $38,728, which included his Social Security benefits relating to 2014 and a portion relating to 2013. Mr. Johnson also reported an excess APTC repayment of $1,250 on his amended Form 1040A and Form 8962.
Tax Court’s conclusion. TheTax Court, sustaining IRS’s determination, found that for purposes of determining a taxpayer’s eligibility for a PTC pursuant to Code Sec. 36B, MAGI includes all Social Security benefits received during the tax year irrespective of any Code Sec. 86(e) election. The Court reasoned that the plain text of Code Sec. 36B requires that a taxpayer include, in computing his MAGI, Social Security benefits “which … [were] not included in gross income under section 86 for the taxable year.” (Code Sec. 36B(d)(2)(B)(iii))
Noting that Code Sec. 36B and its accompanying regs do not explicitly address the mechanics or meaning of a Code Sec. 86(e) election, Mr. Johnson contended that Code Sec. 36B was ambiguous because of the confluence of the phrases “for the taxable year” and “under section 86”. He argued that “for the taxable year” references his tax year as defined in Code Sec. 441 (i.e., his calendar year) and, so, his MAGI included only Social Security benefits attributable to 2014, not those attributable to 2013. He argued that the phrase “under section 86” required that Code Sec. 36B must be read to include the entirety of Code Sec. 86, including Code Sec. 86(e).
The Court held that the text of Code Sec. 36B was not ambiguous, rejecting the taxpayer’s argument.
The Court determined that the year of receipt, as opposed to the year to which the Social Security benefits were attributable, was the significant definitive factor. It was an established legal principle that a cash method individual generally reports income in the year it is received, even if the benefits are attributable to a prior year. In that regard, Mr. Johnson agreed that the Social Security benefits attributable to 2013 were “technically taxed” in the year received. Accordingly, the Court concluded that the phrase “for the taxable year” was not ambiguous
The Court also rejected the taxpayer contention that “[a]lthough the lump-sum payment [relating to 2013] is technically taxed in the year the lump-sum payment is received, a portion of it is includible in income only because it is attributable to tax owed in a prior taxable year under [s]ection 86.” That is, the Social Security benefits received in 2014 but attributable to 2013 were not Social Security benefits received “under section 86 for the  taxable year.”
The Court stated that although Code Sec. 36B and its accompanying regs are silent with regard to the effect, if any, on MAGI if a taxpayer makes a Code Sec. 86(e) election, Code Sec. 36B and the underlying regs provide that Social Security benefits received in a tax year that were “not included in gross income under section 86 for the taxable year” must be added to a taxpayer’s MAGI. (Code Sec. 36B(d)(2)(B)(iii); Reg § 1.36B-1(e)(2)) Mr. Johnson, however, misinterpreted the application of Code Sec. 36B when a Code Sec. 86(e) election has been made. A Code Sec. 86(e) election determines the amount included in gross income for the year of receipt. The taxpayer’s Code Sec. 86(e)election simply determined which amount of the lump-sum payment attributable to 2013 should be included in his gross income for 2014. The Court found that the phrase “under section 86” was not ambiguous and the cross-reference requires the consideration of Code Sec. 86 in its entirety, including Code Sec. 86(e).
Accordingly, Mr. Johnson’s MAGI was his adjusted gross income increased by the total amount of Social Security benefits not included in his gross income, $50,630, which was 441% of the Federal poverty line for 2014. Because his household income exceeded 400% of the 2014 Federal poverty line, he did not qualify for the PTC; and the full amount of the APTCs he received during 2014 had to be included as a tax liability on his tax return. (Code Sec. 36B(c)(1)(A), Code Sec. 36B(f)(2)(A); Reg § 1.36B-4(a)(4), Example (5))
References: For the premium tax credit, see FTC 2d/FIN ¶ A-4241; United States Tax Reporter ¶36B4. For modified adjusted gross income used to compute household income for premium tax credit, see FTC 2d/FIN ¶A-4247.1; United States Tax Reporter ¶ 36B4.01.