Federal tax law always seems to contain a few cliffs\u2014i.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.<\/p>\n
Background.<\/i> 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<\/p>\n 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<\/p>\n be less than $1.<\/p>\n 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”\u2014i.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.<\/p>\n The new cliff\u2014the health care premium credit.<\/i> 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)\u2014collectively, the Affordable Care Act\u2014provide 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. \u00a7 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). )<\/p>\n 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))<\/p>\n But, a taxpayer whose income is 401% of FPL, for example, gets no credit.<\/p>\n <\/p>\n RIA illustration<\/b> 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.<\/p>\n What should you do now about this cliff?<\/i><\/p>\n 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.<\/li>\n <\/p>\n Courtesy of RIA-ThomsonReuters<\/p>\n\n