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July 20, 2021

NTA Blog: Inconsistent Tax Treatment Causes Draconian Results for Low- and Middle-Income Purchasers of Marketplace Health Insurance

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Congress enacted the Patient Protection and Affordable Care Act (ACA) to “improve access to and the delivery of health care services for all individuals, particularly low income, underserved, uninsured, minority, health disparity, and rural populations” (Pub. L. No. 111-148, 124 Stat. 119 (2010)). The ACA provides subsidies to low- and middle-income taxpayers to help them purchase health insurance. However, a series of recent cases in the United States Tax Court have highlighted an inequitable provision of the ACA, surprising workers with huge tax bills when they withdraw money from retirement savings or become disabled. (Johnson v. Comm’r, 152 T.C. 121 (2019); Monroe v. Comm’r, T.C. Memo. 2019-41; Argenziano v. Comm’r, T.C. Docket No. 18782-19S (2021); Antilla-Brown v. Comm’r, T.C. Docket No. 14511-19S (2021); and Heston v. Comm’r, T.C. Summ. Op. 2021-13).

When those workers needed money from their retirement savings to pay out-of-pocket medical expenses not covered by insurance, or if a claim for Social Security disability benefits is delayed and paid in a lump-sum, the Internal Revenue Code (Code) treats some of those taxpayers as no longer eligible for health insurance assistance, and requires them to repay all subsidies paid on their behalf to their insurer during the year. The Code treats these taxpayers as no longer eligible for health insurance financial assistance if the distribution from retirement savings or the lump-sum Social Security disability payment increases their household income to over 400% of the Federal Poverty Level (FPL). One judge called it “stupid tax policy” and “deeply unfair” and it’s been roundly criticized by judges that have recognized the law creates an inequitable result (see Antilla-Brown, supra). I raised this issue and recommended Congress amend this provision of the ACA in my 2021 Purple Book to make it more fair and equitable.

Who Does this Lump-Sum Payment Issue Negatively Affect?

More than 10 million people receive insurance through the Health Insurance Marketplace (i.e., an Exchange). To help eligible taxpayers with household incomes between 100 percent and 400 percent of the FPL afford insurance through an Exchange, the ACA provides a “premium tax credit” (PTC), enacted as § 36B of the Code. The larger a taxpayer’s PTC, the less the taxpayer needs to contribute toward the cost of their insurance. Eligible taxpayers are also allowed advance payments of the PTC (called APTC), which are monthly amounts paid directly to the insurance provider to lower the amount the taxpayer must pay for the insurance coverage. The APTC is based in part on the taxpayer’s anticipated household income for the year of coverage. Unfortunately, we were all reminded in 2020 that unanticipated events can significantly affect income.

Taxpayers who get the benefit of APTC must file a federal income tax return for the year of coverage and attach Form 8962, Premium Tax Credit (PTC), to reconcile the APTC with the PTC the taxpayer is allowed for the year. Taxpayers with excess APTC (the excess of APTC over the PTC allowed) must increase their tax liability on their tax return for the year of coverage by the excess APTC amount, subject to a limitation for taxpayers with household income below 400 percent of the FPL for their family size. This is called repaying APTC. Note that the American Rescue Plan Act of 2021 provides that taxpayers with excess APTC for 2020 do not have to repay the excess APTC. More information on the suspension of the requirement to repay excess APTC for 2020 can be found at The Premium Tax Credit – the Basics.

APTC repayments are often due to household income being higher than anticipated, particularly for taxpayers who receive a one-time lump-sum payout from the Social Security Administration (SSA). For these taxpayers, the lump-sum payment amount likely would not have been included in their anticipated household income for purposes of computing APTC. It is, however, included in household income for purposes of computing the taxpayer’s PTC because § 36B requires all social security benefits to be included in household income in the year of receipt and has no relief rule for taxpayers who receive a one-time lump-sum payment. TAS’s website has a Premium Tax Credit Change Estimator to help taxpayers estimate how the premium tax credit will change if their income or family size changes during the year.

TAS Research estimates that more than 234,000 taxpayers were impacted by this lump-sum consequence in tax year 2019, which would have resulted in their disqualification for PTC. We estimate more than 53,000 of those taxpayers would have been below 100 percent of the FPL but for their receipt of the lump-sum Social Security benefit.

Taxability of Lump-Sum Awards

Each year, millions of Americans receive Social Security benefits for the first time. However, taxpayers applying for Social Security disability benefits may not receive a determination from the SSA for one or more years. The SSA may issue a substantial lump-sum award retroactive to the date the application was filed. Taxpayers cannot control the timing of the application review process in order to plan for the month — or year — in which the SSA will issue the benefit award. These variables make it extremely difficult for taxpayers with a pending benefit claim to estimate their household income for a particular year and in turn the amount of APTC to have paid on their behalf for the upcoming year.

Outside of the context of § 36B, Congress recognized that receiving a lump-sum award can produce inequitable tax outcomes, and so they enacted IRC § 86(e), which provides an election to calculate the taxable portion of a lump-sum payment in a manner that allocates the payment over the period of years the payment covers. Essentially, the taxpayer may smooth out the sudden increase in income and calculate the income from the lump-sum payment as if the SSA paid the amount over the period of years the payment covers rather than in the actual year of payment.

However, § 36B(d)(2)(B) does not allocate a multiyear lump-sum payment when computing PTC. Instead, it requires the recipient to include the entire multiyear award in household income in the year of receipt, even if a portion of that award would be excludable from gross income, or included in gross income in a prior tax year, under § 86(e). Because this one-time lump-sum payment is included in household income in the year of payment only, it may push a taxpayer’s household income for the year over 400 percent of the FPL, regardless of whether any portion of the Social Security benefits relates to prior years or whether the benefits are includible in income in the year of receipt.

Aren’t Social Security Beneficiaries on Medicare?

Generally, individuals over age 65 are eligible for Medicare, and individuals under age 65 become eligible for Medicare after receiving 24 months of Social Security disability benefits, but until they become Medicare eligible, they may obtain insurance through an Exchange. Plus, the PTC may be used to purchase insurance on an Exchange for a younger spouse or a child. Over the past fifty years, the number of Social Security recipients between ages 18 and 64 rose steadily, to about 4.7 million as of December 2018. Less than 12 percent of Social Security recipients between ages 18 and 64 receive other earned or unearned income; recipients in that group without other income would likely be eligible for the PTC to purchase insurance on an Exchange. An individual under age 65 who receives a lump-sum Social Security disability benefit covering more than 24 months will be automatically enrolled in Medicare, but there may be an overlap of several months when the individual continues to pay for a policy on an Exchange with APTC before receiving notice of Medicare enrollment. That can cause taxpayers to have to repay APTC in the year they receive a lump-sum benefit award.

Medical Expenses Not Covered by Insurance

Taxpayers who obtain insurance through an Exchange can still face out-of-pocket medical expenses. In the case of Antilla-Brown v. Comm’r, Mrs. Antilla-Brown was a few years short of Medicare eligibility and obtained insurance through an Exchange. Mrs. Antilla-Brown was diagnosed with cancer and faced serious health issues, resulting in thousands of dollars in bills not covered by the Exchange’s insurance. Rather than paying the bills over time, she negotiated with the hospital to pay a lesser amount up front. To pay the medical bills, she withdrew money from her IRA. However, the IRA withdrawal increased her household income to $956 above 400 percent of the FPL. For years other than 2021 and 2022, taxpayers with income over 400 percent of FPL are ineligible for the PTC, and thus Mrs. Antilla-Brown had to repay all her APTC of $7,515. If Mrs. Antilla-Brown had withdrawn $956 less from her IRA, her household income would have fallen between 300 and 400 of FPL and she would have been required to repay $1,900 of her APTC instead of $7,515. The Court pointed out that the resulting tax on the extra $956 amounts to a tax rate of more than 580 percent. The circumstances in Mrs. Antilla-Brown’s case could have also resulted from a withdrawal from a 401(k) or other retirement account. It’s hard to imagine that Congress intended these kinds of unjust outcomes for taxpayers facing emergency situations out of their control.

Recommendation:  Congress Can Fix This Issue

The PTC and APTC were created to assist low- and moderate-income individuals with health insurance premium payments. The impact of receiving Social Security disability benefits in a lump-sum can be so harsh as to not only eliminate this assistance in the year of receipt, but also to create a substantial tax liability. Just as IRC § 86(e) gives taxpayers who receive lump-sum Social Security payments covering multiple years the option of computing their income for the year of the lump-sum payment by, in effect, treating the payment as having been received in the years to which the payment relates, once again, I urge Congress to consider adding a new subsection to IRC § 36B(d)(2) permitting taxpayers to include in Modified Adjusted Gross Income only the taxable portion of a lump-sum Social Security payment calculated pursuant to IRC § 86(e) when determining if a taxpayer is eligible for a PTC and the amount of the PTC allowed.

To address situations where taxpayers are forced to repay APTC because they needed to withdraw money from their IRA to pay for expenses not covered by insurance, Congress could add an additional subsection to IRC § 36B(d)(2) modeled after the exception to the 10 percent penalty for early IRA withdrawals. Taxpayers with unreimbursed medical expenses greater than 10 percent of their adjusted gross income can withdraw money from their retirement savings to pay those expenses (IRC § 72(t)(2)(B)). Unless it’s a Roth IRA, those distributions are still taxable, but aren’t subject to the 10 percent early withdrawal penalty. Similarly, taxpayers unemployed for at least 12 weeks can withdraw money to pay for health insurance premiums without facing the penalty (IRC § 72(t)(2)(D)). However, those types of distributions that are excepted from the early withdrawal penalty are included when calculating household income and can result in unforeseen APTC repayments. The early withdrawal penalty a taxpayer may avoid could be dwarfed by the amount of APTC the taxpayer must repay. Hardship withdrawals from tax-deferred retirement savings should be excluded from the computation of household income under IRC § 36B(d)(2).

Taxpayers required to repay their APTC because of lump-sum social security payments and medical-related IRA withdrawals are generally low- and middle-income taxpayers behaving responsibly; they obtain health insurance coverage and they pay their bills. Taxpayers have little to no control over how long the SSA takes to process their benefit claims and when or if they will receive a one-time lump-sum payment if their claim is approved. Likewise, taxpayers who withdraw money from retirement savings to pay for unreimbursed medical expenses should not be treated as if they are no longer low- or middle-income taxpayers and can afford to repay subsidies for Exchange-purchased health insurance.

Congress should amend IRC § 36B(d)(2) to prevent these unjust outcomes harming the same taxpayers Congress intended to help with their enactment of the ACA.

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The views expressed in this blog are solely those of the National Taxpayer Advocate. The National Taxpayer Advocate presents an independent taxpayer perspective that does not necessarily reflect the position of the IRS, the Treasury Department, or the Office of Management and Budget.

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