Tax Credits to Offset Cost of ACA Insurance Hinge on Income Estimates

Accurate forecast of salary can have significant impact on cost of monthly premiums
A central feature of the Affordable Care Act is its system of advance tax credits that subsidize health insurance for middle- and lower-income Americans, in some cases bringing premiums down to as little as $20 or $30 a month.

But experts warn of potential pitfalls involving the requirement that those seeking subsidies provide an estimate of income. A miscalculation could mean higher-than-necessary monthly premiums or too-high subsidies that would have to be repaid.

The subsidies differ from other kinds of tax credits in that they benefit the recipient almost immediately, rather than at tax filing time the following year. Every month, the insurance enrollee pays a smaller premium than he would have otherwise, and the federal government pays the insurance company the difference.

The credit is also unusual in that the monthly payment is initially calculated based on the person’s income the previous year or on an estimate of future income. If the person’s income estimate is too high, their subsidy will too small and they will pay higher premiums than you could have; if their income estimate is too low, they will get a bigger subsidy but will eventually have to pay part of it back.

That means making a correct initial estimate of income is essential. Independent workers, who are among the main targets of the ACA’s effort to boost insurance enrollment, need to take great care in projecting their future earnings, said Michael Greenwald, a partner at Friedman LLP, an accounting firm with offices in New York and New Jersey.

“That’s particularly difficult for freelancers. That’s where the biggest issue comes in,” Greenwald said. “You have someone who’s a freelance writer for a website or a newspaper, or you have someone who is an actor, or any one of a number of professions where your income is not that predictable. Making that estimate and trying to get as good an estimate as possible is really critical.”

Those who could end up getting dinged include, for example, a small business owner who ended up having an unexpectedly good year. The boost in income could retroactively change their eligibility status so that they qualify for a smaller tax credit than what they actually received.

People in that situation will be required to pay back part of the subsidy they received, in the form of a higher tax bill or smaller refund from the IRS.

On the other hand, those whose income comes in lower than expected will learn that they have qualified for a higher subsidy — that is, they could have been paying lower insurance premiums all along — and will get a tax refund as a result.

Many enrollees “would have been eligible for more of a subsidy or less of a subsidy,” said Lew Bivona, a certified public accountant in Cherry Hill who consults for insurance and healthcare companies. “But either way, it could be a rude awakening.”

A big bill at tax time

Individuals and families with incomes between 100 percent and 400 percent of the poverty line are eligible to receive tax credits. In New Jersey, 84 percent of the 161,775 people who bought insurance through the federal healthcare marketplace at by March 31 were deemed eligible. The figure was 85 percent nationally.

Because of the way the subsidy eligibility is structured, even a relatively small increase in income could lead to a substantial boost in tax liability for some people,
Bivona said.

“If you go up in income, your subsidy lessens as you go up,” he said. “So if somebody is just right on the cusp of a subsidy tranche, and then they end up making more money, which puts them into a lower subsidy tranche — it may not seem like a lot money to you, but it’s a lot of money when it comes to the calculation of what the subsidy really means to you.”

Federal law caps the subsidy repayments according to income. At the low end, for those below 200 percent of the federal poverty level ($23,340 for an individual, $47,700 for a family of four), repayment is capped at $300 for an individual and $600 for a family.

The caps increase in several steps to maximums of $1,750/$3,500 for people at 450 to 500 percent of the poverty level. Beyond 500 percent ($58,350 for an individual, $119,250 for a family of four) there is no cap; a person who received subsidies but then earned more than that amount would have to pay it all back as part of his taxes.

An example provided by the Kaiser Family Foundation describes a family with two older working spouses who earn $90,000 a year and have high insurance premiums because of their age. They get subsidies of $933 a month, or $11,200 a year, and pay a $713 monthly premium.

One spouse then gets a bonus at the end of the year, pushing them over the subsidy eligibility limit of $95,400 for a two-person family and making them ineligible for any subsidy at all. The cap limits the repayment to $3,000, but otherwise the couple would owe the entire $11,200 at tax time.

“Even for a family with greater means, having to repay sums of this magnitude would be financially burdensome,” the KFF report says.

Known unknowns

The many variables in the subsidy process mean that people will end up in a number of different situations that federal officials and tax preparers are still trying to anticipate.

For example, some people qualified for subsidies but chose not to apply them to their premiums; as a result, they will receive tax refunds or smaller tax bills next year.

Others will lose their jobs and see their incomes fall so much that they qualify for Medicaid, a phenomenon called “churn.” Some of those people will enroll in Medicaid, but some could continue to pay their subsidized premiums out of their savings, even when they fall below 100 percent of the federal poverty line and are technically ineligible for subsidies.

Tax attorney Lindsey Buchholz, the principal tax research analyst for The Tax Institute at H&R Block, said it is unclear how the IRS will handle such a situation. But she said it is one of many thorny scenarios that are certain to arise.

“I’m certain that it will. And that’s one of the tricky things about this,” Buchholz said, referring to the subsidy program.

“It’s so dependent on things that change in your life all the time: the makeup of your family, how much money you earn, who lives in your house, who doesn’t live in your house, if somebody qualified as your dependent and you thought they were going to be, and then they ended up moving out and you’ve taken the credit for them — I mean, there’s all sorts of crazy things that can happen,” she said.

“We don’t have wonderful information at this point that kind of goes through all those scenarios, that really map everything out. So I think the IRS is probably going to be posting a bunch of Frequently Asked Questions on their website to try to deal with these issues as they pop up,” Buchholz said.

The requirement that subsidy recipients file tax returns to reconcile their tax credits could also lead to a surge in the number of filers, and increased demand for tax preparers, but it is too soon to know how much, she said.

More benefits near the poverty line

Greenwald noted that 0income estimates determine not only the amount of subsidy, but also whether the applicant will benefit from special cost-sharing provisions that give low-income people smaller insurance deductibles, co-pays, co-insurance and out-of-pocket maximums.

Under the ACA, insurance companies cover a greater portion of health costs for people with incomes up to 250 percent of the poverty line ($59,625 for a family of four), provided that the enrollees buy a silver-level plan on the federal marketplace.

Silver plans usually pay an average of 70 percent of covered medical expenses and the enrollee is responsible for 30 percent. But a family at 100 percent to 150 percent of the poverty line will have lower deductibles and other maximums, reducing their responsibility on average to just 6 percent and the insurance company’s obligation to 94 percent.

For those with income equal to 150 percent to 200 percent of the poverty level, the consumer responsibility comes to 13 percent; for those with income that amounts to 200 percent to 250 percent of the poverty level, the consumer share of costs rises to 27 percent for the same silver plan.

While the cost-sharing benefit is determined by estimated income, unlike the subsidy it is not a tax credit and is not reportable when taxes are filed, Buchholz said. People who have to pay back subsidies because their incomes end up higher than expected will not have to reimburse the government for their cost-sharing benefits.

Connecting the private market

For the most part, subsidies have only been available to people who buy insurance through Consumers can buy the same health plans directly from insurance companies, but only if they don’t care about receiving subsidies. Some companies like Aetna declined to participate in the marketplace for New Jersey, so their customers also cannot receive subsidies.

Some people bought directly from insurers because they knew they earned too much to qualify for a tax credit, while others resorted to direct purchases when they ran into technical problems on the website.

“Before January, when the was site not working well, there were a lot of people that went direct and bought, and said, ‘You know what, we’ll deal with it later.’ I know, because I advised two or three to do that,” said David Oscar, an insurance broker with Altigro in Fairfield. “They said, ‘Not a problem, we can afford it. I’ve got to have the coverage, I’ve got to make sure it’s in effect.’”

“Then, as we were going through it, and it got easier to deal with the system, that’s when we discovered it was not exactly the right thing to do,” Oscar said.

People who bought directly for 2014 will still be able to buy their next insurance policy through, after their current plan expires, and get subsidies if they qualify.

Insurers and brokers were supposed to be able to sell subsidized coverage beginning last year, but the effort ran into technical problems, according to the Centers for Medicaid and Medicare Services. The agency said an unspecified number of subsidized policies were sold that way, and it is working on expanding the program.

Insurers in Florida, Texas and Ohio began a pilot program in November, and the Inside CMS news service reported last month that web brokers like eHealth are working to make direct enrollment happen for the 2015 open enrollment period, which begins this November.