An important piece of the Affordable Care Act is its subsidies for health insurance premiums. These subsidies are meant to help low-income families afford health insurance that they purchase from the health insurance exchanges. The Affordable Care Act provides these subsidies through the taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. code as a refundable tax creditA refundable tax credit can be used to generate a federal tax refund larger than the amount of tax paid throughout the year. In other words, a refundable tax credit creates the possibility of a negative federal tax liability. An example of a refundable tax credit is the Earned Income Tax Credit (EITC). called the Premium Tax CreditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. (PTC).
The PTC is provided to taxpayers with incomes between 100 and 400 percent of the federal poverty level (between $23,850 and $95,400 for a family of four). Those with incomes below 100 percent are eligible for Medicaid. The size of the credit is based on a taxpayer’s income and the cost of their health insurance plan.
Taxpayers don’t directly receive the PTC. Instead, the PTC is sent directly to the insurance company and results in a lower monthly insurance bill for the taxpayer throughout the tax year. This is in contrast to tax credits such as the Child Tax Credit, which is given to taxpayers as a lump sum each year when they file their taxes.
Because taxpayers receive the credit before they file their taxes, it requires them to guess their income for the coming year in order for the IRS to send the correct payment to the insurance company. This can be problematic.
For some taxpayers predicting future income may be very challenging and anyone is bound to guess wrong. Someone may get a raise mid-year or pick up a second job, altering their income. This means that the credit the insurance company is receiving each month from the IRS is too much.
If this happens, it puts the taxpayer in the awkward position of paying back the IRS for the excess credit it sent to the insurance company at the end of the year. When the taxpayer files their taxes (with their actual annual income from their W-2), the IRS will adjust the taxpayer’s tax refundA tax refund is a reimbursement to taxpayers who have overpaid their taxes, often due to having employers withhold too much from paychecks. The U.S. Treasury estimates that nearly three-fourths of taxpayers are over-withheld, resulting in a tax refund for millions. Overpaying taxes can be viewed as an interest-free loan to the government. On the other hand, approximately one-fifth of taxpayers underwithhold; this can occur if a person works multiple jobs and does not appropriately adjust their W-4 to account for additional income, or if spousal income is not appropriately accounted for on W-4s. (or increases their tax bill) in order to get the excess money back that it paid to the insurance company.
Of course, the opposite is true. If a taxpayer ends up losing a job, or his hours are cut back, their income and thus their credit during the year was smaller than it should have been. In this case the IRS sends the adjustment to the taxpayer in the form of a larger end-of-year refund (or reduced tax bill).
Adjustments to a taxpayer’s tax bill at the end of the year are certainly not a new concept (a tax refund itself is an adjustment for overpaying your taxes during the year). However, the ACA’s premium tax credit is a new and less understood provision that could affect many taxpayer’s tax refund or tax bill. The PTC is definitely not an ideal system and it could get messy for the taxpayers, especially for those that have hard-to-predict incomes.
Share