How your AGI is used in calculating an ACA subsiity

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My premium subsidy is dependent on my AGI. But I’m self-employed, so my AGI is dependent on my premium. Help!

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Q. Under the ACA, my insurance premium subsidy is dependent on adjusted gross income (AGI). But, for a self-employed person, AGI is dependent on the insurance premium, since premiums are deductible for the self-employed.

For example, my husband and I have an AGI of $70,000 before accounting for health insurance. That’s too high for a subsidy for a household of two, so our tax-deductible insurance premiums (line 29 on the 1040) would be $8,952, which is the full cost of our health plan. Subtracting $8,952 from $70,000, our new AGI is at $61,048. Now, since our AGI  is less than $63,720 (400 percent poverty level for 2 people), we qualify for the subsidy. So our new annual premium would be $5,897 (9.66 percent of our MAGI). But if $5,897 is what we should put in line 29, our AGI would be $64,103, disqualifying us for the subsidy! Help!!

A.  This can be a complex situation, and our answer is intended to serve as an overview of how the subsidy calculation works; always seek help from a qualified tax professional if you have questions about your specific situation.

In July 2014, the IRS released 26 CFR 601.105, in which they acknowledged the circular relationship between self-employed health insurance premium deductions, AGI, and premium tax credits:

“… the amount of the [self-employed health insurance premium] deduction is based on the amount of the … premium tax credit, and the amount of the credit is based on the amount of the deduction – a circular relationship.  Consequently, a taxpayer eligible for both a … deduction for premiums paid for qualified health plans and a … premium tax credit may have difficulty determining the amounts of those items.”

In the regulation, the IRS provides two methods that self-employed taxpayers can use to calculate their deduction and their subsidy.  The iterative calculation will result in a more exact answer, but it is a little more time-consuming to compute.  The alternative calculation is less exact (and appears to favor the IRS just slightly), but less time-consuming and easier to calculate.  You have your choice of which one you want to use, and tax software might have the calculations built in, which would make them both simple to use.

In a nutshell, both methods have you do the calculations repeatedly, getting ever-closer to the correct answer (that’s what iteration means).  But while the iterative calculation has you keep going until the difference between successive answers is less than $1, the alternative calculation lets you stop sooner.

The easiest way to understand how the two calculations work is to start on page 9 of the regulation and work through the examples the IRS has provided.  When they mention the “limitation on additional tax,” they’re just referencing the caps on how much you have to pay back when you file your taxes if it turns out that your advance subsidy (the amount sent to your health insurance company each month) was overpaid because your income ended up being higher than projected.

Those amounts are listed in a table on this page from the Kaiser Family Foundation, and they depend on your income.  So in example 1, the IRS uses $2,500 as the limitation on additional tax, because the family’s household income is between 300 and 400 percent of poverty.

Keep in mind that there is no limit on the repayment amount if your income ends up being above 400 percent of the poverty level; in that case, you’d have to repay the full amount of any subsidy you got during the year (H.R.1270 would change that threshold to 300 percent, requiring all subsidy overpayments to be repaid if household income is in excess of 300 percent of the poverty level; the bill passed the House in July 2016, and if passed by the Senate, would take effect in 2017).

The examples the IRS provides cover scenarios where the filers took advance premium tax credits as well as scenarios where they did not, since you can pay your own premiums in full each month and then claim your total credit for the year when you file your taxes.  The examples make the calculations relatively straightforward, although the standard advice applies:  If in doubt at all, contact a tax professional for assistance.