MAGI Challenge Fails to Save Premium Tax Credit; Last Minute Adjustments for 2018 Returns

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The Premium Tax Credit can make health insurance affordable for people without other options, but its structure of advance estimated payments combined with a sheer eligibility cliff when the advance payments are reconciled inevitably leads to harsh outcomes in some cases. (A few were discussed on this blog here.) The Tax Court’s recent decision in Johnson v. Commissioner, 152 T.C. No. 6, is another example of the uphill battle taxpayers face in fighting harsh reconciliation outcomes. However, for some taxpayers reconciling 2018 advance payments, it may still be possible to nudge their modified adjusted gross income (MAGI) beneath the eligibility threshold.

According to CMS’s 2019 Open Enrollment Report, 11.4 million people signed up for Marketplace insurance for 2019 during the open enrollment period. The average premium before application of tax credits was $612; but, 87% of customers received advance premium tax credits (APTC) to lower their premiums. For the nearly 10 million people receiving APTC, the average premium is $87/month. That’s an expensive benefit to repay if you are found ineligible at tax time.

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In a previous post, I explained the safety valves in Marketplace regulations that may help taxpayers facing tax deficiencies. Unfortunately, these safety valves are quite narrow. Many taxpayers face APTC repayment because of unanticipated income, including gambling income, retirement account withdrawals, a new job, or unexpected business profits. There is no exception to reconciliation for unexpected income, even if the taxpayer could not have controlled or anticipated the income. If the taxpayer’s annual income turns out to be over the PTC eligibility limit, all APTC must be repaid.

The problem of lump-sum Social Security payments

One of the most sympathetic examples of unanticipated income is lump-sum Social Security Disability. Some people who apply for disability benefits are approved right away based on their initial application, but many are first denied and only receive benefits after a hearing before an Administrative Law Judge. In 2017, the average processing time for an appeal was 602 days, nearly two years. The wait time between an appeal and a hearing varies, but can easily take over a year. It’s very hard for applicants to predict when they will receive benefits. If benefits are approved after an appeal, the initial award often includes payments for earlier years, depending on the date of onset determined by the ALJ. This can result in an initial lump sum payment in the five figures.

An unexpected five-figure jump in income has drastic effects on a taxpayer’s eligibility for the PTC. National Taxpayer Advocate Nina Olson identified this as a serious problem for affected taxpayers in her 2015 Annual Report to Congress and again in her 2017 Objectives Report to Congress. She explains:

When taxpayers receive lump sum Social Security Disability Insurance (SSDI) payments, the additional income may push their household income above 400 percent of the federal poverty line (FPL) for the applicable family size, which will make them ineligible for the PTC. For those taxpayers who received APTC during the tax year, they will need to repay the entire amount because the repayment limitations do not apply if household income is above the 400 percent FPL threshold. … Individuals have little control over how quickly the Social Security Administration will process their disability applications and may even wait years to receive the determination and benefits. Therefore, it is reasonable that many taxpayers did not project to receive the lump sum when applying for the APTC.

(citations omitted). TAS, VITA sites, and LITCs regularly see cases where lump sum SSDI recipients are required to repay large APTC amounts, resulting in significant financial hardship.

In 2016 the NTA asked the IRS Office of Chief Counsel to provide administrative guidance relief for lump sum SSD payments. Senator Angus S. King (I-Maine) also raised the issue to the Secretary of Treasury and the IRS Commissioner. However, in August of 2016

the Office of Legislative Affairs in the Department of Treasury responded to the aforementioned letter from Senator King and indicated that it cannot identify an administrative basis to exclude retroactive lump sum SSDI payments from the calculation of modified adjusted gross income for purposes of the PTC and APTC.

The taxpayer in Johnson v. Commissioner challenged this position with a statutory interpretation argument that income for PTC purposes should not include lump-sump Social Security payments attributable to earlier calendar years. This idea is intuitively appealing on fairness grounds; one of the most frequent PTC questions I see is whether the lump-sum election under section 86(e) can save a taxpayer’s PTC. Unfortunately for affected taxpayers, the Tax Court has now agreed with the Department of Treasury and the IRS on the question: the lump sum election does not help taxpayers.

Johnson v. Commissioner

Mr. Johnson enrolled in a Marketplace plan with premiums subsidized by APTC. Sometime during 2014, he received a lump-sum Social Security payment which included nearly $12,000 in retroactive benefits for calendar year 2013. The IRS argued that the entire Social Security payment counted as MAGI for Mr. Johnson’s 2014 PTC eligibility, putting Mr. Johnson over the 400% FPL cutoff. Mr. Johnson would have been eligible for some PTC if the 2013 benefits were not counted, and his liability to repay excess APTC would have been limited.

Taxation of Social Security payments is determined under IRC 86. Section 86 sets out a formula to determine how much of a Social Security payment will be included in the taxpayer’s gross income. When a taxpayer receives a lump-sum payment, an election under section 86(e) can reduce the taxable portion of the payment. Under the election, the taxability of the funds attributable to earlier calendar years is calculated based on those years’ income rather than normal method of calculating taxability based on the taxpayer’s income in the year of receipt. This is done via worksheets in Publication 915; the taxpayer does not actually amend the prior year’s tax return.

The question in Johnson was whether the definition of Modified Adjusted Gross Income (MAGI) for PTC eligibility includes prior-year SSD payments when the taxpayer makes an election under section 86(e). The Court had to interpret Section 36B:

The term “modified adjusted gross income” means adjusted gross income increased by– … (iii) an amount equal to the portion of the taxpayer’s social security benefits (as defined in section 86(d)) which is not included in gross income under section 86 for the taxable year.

Mr. Johnson argued that section 36B was sufficiently ambiguous to permit the Court to consider the purpose of the Affordable Care Act as expressed by Congress, other legislative history, and public policy consequences of the IRS position. Despite a valiant effort by PT guest blogger Ted Afield who represented Mr. Johnson, the Court finds that the statute unambiguously includes the entire SSD payment received by petitioner.

The textual fight is about the phrase “under section 86 for the taxable year.” Petitioner argues that his taxable year = the calendar year (see section 441), and therefore the payments for the 2013 calendar year are not payments “for the [2014] taxable year.” The Court rejects this argument as contrary to the “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,” citing section 451(a) and sec. 1.451-1(a), Income Tax Regs. The Court goes on:

Petitioner’s section 86(e) election simply determined which amount of the lump-sum payment attributable to 2013 should be included in his gross income for 2014. We find that the phrase “under section 86” is not ambiguous and the cross-reference requires the consideration of section 86 in its entirety, including section 86(e).

Mr. Johnson also argued that the legislative history and purpose of the ACA supported his position, and that the IRS’s interpretation leads to an absurd and unintended result, denying an important benefit to someone who was eligible when he applied for APTC and who could not have foreseen the lump sum income. In response, the Court notes that section 36B’s definition of MAGI did not originally include nontaxable Social Security benefits. In 2011 the statute was amended to specifically include nontaxable Social Security. This is undeniable; unfortunately Congress did not address lump-sum payments or the 86(e) election specifically. Certainly the legislative history shows Congress’s intent to include nontaxable SSD that was paid for the tax year, but it is not clear that Congress considered the lump-sum election. Regardless of what Congress considered or didn’t consider, the Court finds the statute clear and thus finds it cannot consider the taxpayer’s equitable and policy arguments, citing Commissioner v. McCoy, 484 U.S. 3 (1987) and McGuire v. Commissioner, 149 T.C. 254.

Taxpayers in Mr. Johnson’s situation are left to hope that Congress will amend the definition of MAGI. Senator King proposed legislation to do this in August of 2018 (S. 3326), but unfortunately his bill died in committee. It will need to be reintroduced to move forward.

MAGI hacks

For taxpayers with unexpected gross income, not all is lost. Some taxpayers can adjust their MAGI to avoid the PTC eligibility cliff, or simply to increase their PTC.

One strategy is to look for adjustments that will lower AGI. Up to April 15, 2019, qualifying taxpayers can make IRA and HSA contributions for 2018, which will lower 2018 MAGI if deductible. With a lower MAGI, taxpayers will be eligible for higher PTC. The IRS issued a Tax Time Guide on IRAs which may be helpful. Taxpayers who established HSAs and who had qualifying high deductible health insurance in 2018 (which can include Marketplace plans) may want to maximize their contributions now. Earlier this week I received a helpful reminder email from my HSA company, letting me know that their deadline for 2018 contributions is 1pm on April 15th.

The financial savings can be very much worth the hassle of a last-minute contribution. The exact calculations will vary depending on the taxpayer’s available Marketplace plans. The following examples use Vermont, since its statewide community rating makes the calculations easy.

Example: Melanie is single with no dependents. Her 2018 MAGI was $48,300. That’s $60 over the income limit for a premium tax credit. Melanie will have to pay back any advance premium tax credits she got from the Marketplace.

Solution: If Melanie contributes $60 for 2018 to a traditional IRA, her MAGI is now $48,240, the maximum to receive a PTC. She now qualifies for a maximum PTC of $1,454, a net gain of nearly $1,400. In addition, she has increased her retirement savings by $60.

For couples and families, the numbers are even more drastic, because of how the credit is calculated. (A family’s expected contribution is smaller relative to the cost of insurance, than is the case for a single person.)

Example: A married couple with MAGI exactly at the 2018 limit of $64,960 (for a household of 2) has a maximum PTC of $5,922. If the couple’s MAGI were even one dollar over the limit, their PTC is zero and they must repay all APTC received.

Even if the couple is income-eligible, it may be advantageous to minimize their MAGI to the extent possible because the PTC is income-sensitive, even at higher levels.

Example: If one spouse in the last example makes an IRA contribution of $5,000, the couple’s maximum PTC becomes $6,400. That’s $478 in “free money” for making an IRA contribution.

Of course, not all taxpayers will be eligible to make a deductible IRA contribution and not all taxpayers will qualify to make an HSA contribution. Also, this strategy is only possible if the taxpayer is below or within spitting distance of the 400% FPL cutoff. The maximum IRA or HSA contribution is not always high enough to bring MAGI under the cutoff. However, these options are worth fully exploring when your client is facing the prospect of repaying APTC.

Christine Speidel About Christine Speidel

Christine Speidel is Assistant Professor and Director of the Federal Tax Clinic at Villanova University Charles Widger School of Law. Prior to her appointment at Villanova she practiced law at Vermont Legal Aid, Inc. At Vermont Legal Aid Christine directed the Vermont Low-Income Taxpayer Clinic and was a staff attorney for Vermont Legal Aid's Office of the Health Care Advocate.

Comments

  1. Norman Diamond says

    ‘Petitioner argues that his taxable year = the calendar year (see section 441), and therefore the payments for the 2013 calendar year are not payments “for the [2014] taxable year.” The Court rejects this argument as contrary to the “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,” citing section 451(a) and sec. 1.451-1(a), Income Tax Regs.’

    How was it determined if this individual was a cash method individual or not? I once had occasion to read IRS instructions (not regs and therefore not particularly reliable) that if a pay period is longer than 2 weeks then the individual is not a cash basis taxpayer. I don’t recall if the instructions said whether the rule was only for employment income. This lump sum’s pay period was longer than 2 weeks.

  2. A similar problem arises with taxpayers on Medicare whose AGI hits a bump. A single person with $85,000 income pays $135.50 monthly for Medicare Part B. Report income of $85,001 and it increases to $189.60.

    About 35 years ago, my clients included a working couple whose retirement savings were invested in certificates of deposit. Taxes took a third of the interest income. I suggested they put some of the funds into an annuity, to defer the taxes until they were retired and in a lower tax bracket.

    The husband has passed away, but the widow turned 95 last year. She has a modest income but usually pays no tax because of her assisted-living medical expenses. Like most insurance companies, though, the annuity issuer told her she had to cash in the policy at age 95. (Others require this at even earlier ages, like 85.) Their $18,000 investment had grown to $100,000. Add $82,000 income and the result is not just $20,000 due in federal and state income taxes, but a 40% increase in Medicare premiums charged in 2020.

    Could this problem have been avoided? Withdrawal of smaller amounts over several years would have kept the AGI lower. But it would have increased the percentage of Social Security that is taxable.

    Perhaps we could have found an annuity with a later surrender date. Last year I attended the 100th birthday party of a long-time client, whose agent helped her avoid the required redemption at that age of a life insurance policy. For reasons I don’t understand, she did have to take a partial distribution and pay tax on about 10% of its cash value.

    With life insurance, the proceeds are not taxable when paid at death, but lifetime distributions are taxed. For annuities, though, someone eventually has to pay tax on the deferred income. The beneficiaries might be in a higher tax bracket, anyway. But they may not yet be enrolled in Medicare Part B.

    Two things in life are certain: Taxes; and tax problems you did not have to worry about before you grew old.

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