Affordable Care Tax Loophole

Barack Obama signs the Affordable Care Act

The United States tax code is complicated. Too complicated. Those of us in the tax preparation industry like it that way. You hear a lot about loopholes and the rich taking advantage of them, but that’s a story line that I think is grossly exaggerated. Regardless, aren’t there any loopholes for the poor? Yes. Thanks to the Affordable Care Act there’s at least one.

The Affordable Care Act utilizes the IRS to help keep track of tax credits paid in advance to those who purchase insurance through Covered California and qualify for assistance in paying their premiums. When someone applies for health insurance on the Covered California website, they provide an estimate of the income they expect to earn through the coming year. Based on that estimate, Covered California determines how much of the insurance premium will be paid out of pocket by the applicant and how much will be paid with an advance of the Premium Tax Credit.

When that individual files a tax return the following April, Form 8962 will be used to reconcile the difference between the Premium Tax Credit the taxpayer already received(through advanced payments to their insurance provider) with the amount of Premium Tax Credit they should have received based on their actual income for the year. If the taxpayer’s actual income was more than the amount they estimated when initially applying at Covered California, they will need to pay back some of that credit. If he or she earned less than estimated, the taxpayer will actually receive an additional credit in the form of an increased tax refund.

The “loophole” comes into effect because based on income, the amount of Premium Tax Credit a taxpayer will have to pay back might be limited to only a fraction of the overpayment. It took a couple years of the law being in place, but I really noticed this year that taxpayers have caught on. Now many individuals are intentionally understating their income when they apply for an ACA policy to receive a larger monthly credit throughout the year knowing they won’t have to pay the entire amount back. For example a married couple with two kids earning $70,000 a year could understate their income on their Covered California application and receive an extra $400 per month in premium assistance or $4800 per year. Once they file their tax return and report their actual income, the $4,800 overpayment in Premium Tax Credit will be apparent, however based on their income, the law only requires them to pay back $1,500 of it. This gives them a $3,300 savings by receiving a tax credit they were not technically entitled to.

Additionally, when parents share a Covered California policy with an adult child, the law allows the taxpayers to divide the Premium Tax Credit among each of the taxpayers on the policy in any amounts they choose. This allows the parents to allocate the entire Premium Tax Credit to a young adult who may have very low earnings and therefore reduce the amount of tax credit to be repaid to as little as $300.

The amount of Premium Tax Credit individuals would have to pay back was limited by congress to assuage ACA applicant’s fears that they may be hit with a large tax bill when they filed their taxes . Taxpayers who do attempt this strategy run the risk of paying the entire amount back if their income is higher than certain levels. Not to mention the damage they will cause to their sense of morality for intentionally misstating their income.