The Premium Tax Credit Trap

In an effort to reform health insurance, the government implemented a system where it would make payments directly to insurance companies on behalf of taxpayers through the use of premium tax credits. These credits were a part of the Affordable Care Act and intended to make health insurance more affordable for those who might not be able to pay for it on their own.

The government promised that health insurance premiums would decrease for everyone as a result of this legislation. However, this has not been the case for many taxpayers. In fact, the cost of premiums has increased significantly for some, even after the tax credit is applied, making it even more difficult for them to afford coverage.

While the changes to the health insurance laws and the premium tax credits may have increased the number of people with health insurance, it has also resulted in some taxpayers owing money to the IRS because they did not qualify for the credits due to their income or other factors. The Henry v. Commissioner, T.C. Memo. 2023-2 case is an example of this and how the premium tax credit can actually hurt someone financially if they have a financial downturn, leaving them with a significant tax debt owed to the IRS.

Facts & Procedural History

This is a case about a Premium Tax Credit (“PTC”) and whether the taxpayer is required to repay an Advanced Premium Tax Credit (“APTC”).

The taxpayer purchased health insurance from the health insurance marketplace. The coverage was for the first eleven months of 2016. The benefit amount included $655 of APTCs a month for a total of $7,205. These amounts were paid directly to the insurance company by the government and applied to reduce the cost of her monthly health insurance premiums.

The taxpayer filed her income tax return for 2016 and believed she was entitled to a refund. The IRS apparently started a correspondence audit and eventually issued a Statutory Notice of Deficiency. The IRS’s Notice asserted that the taxpayer was not entitled to the PTC and was required to repay the APTC payments.

About the Premium Tax Credit

The Premium Tax Credit or PTC is an income tax credit available to certain individuals and families who purchase health insurance through the health insurance marketplace (also known as the “exchange”).

The PTC is designed to help make health insurance more affordable for people with low or moderate incomes. It can be used to reduce the amount of money that a person owes when they file their taxes, or it can be paid in advance directly to the health insurance company to lower the monthly premiums that the person pays for their health insurance.

To be eligible for the Premium Tax Credit, an individual must meet certain income and other requirements, and they must not be eligible for other types of coverage, such as employer-sponsored insurance or Medicare.

These income limits are based on the federal poverty level (“FPL”) for the applicable year and household size. The FPL is a measure of income used by the federal government to determine eligibility for certain programs and benefits. It is adjusted each year to reflect changes in the cost of living.

The Advanced Premium Tax Credit

The Advanced Premium Tax Credit (“APTC”) is a type of premium tax credit that is paid directly to a person’s health insurance company to lower the amount they pay for their health insurance premiums each month.

The APTC is “advanced” because it is paid in advance to the insurance company, rather than being claimed on a person’s tax return at the end of the year.

If a person is eligible for the APTC and chooses to have it paid in advance, the amount of the credit will be based on their estimated income for the year. At the end of the year, when they file their tax return, they will reconcile the APTC they received with the actual premium tax credit they are entitled to based on their actual income for the year.

If their actual income is lower than their estimated income, they may be entitled to the additional premium tax credit that they can claim on their tax return. We usually do not see these cases. We see this issue when there is a shortfall. If their actual income is higher than their estimated income, they may have to repay some or all of the APTC that was paid to their insurance company. The IRS is authorized to issue a Notice of Deficiency to assess the APTC as a tax and to collect it as it does any other tax owed to the IRS.

That brings us back to this court case.

The Retirement Account Distributions

In this case, the taxpayer was unemployed in 2015 and 2016. She failed to pay her premiums and the health insurance coverage was terminated in November 2016 for nonpayment.

The marketplace sent to the IRS and to the taxpayer a Form 1095-A, Health Insurance Marketplace Statement, for 2016 which reflected the taxpayer’s health insurance coverage information from January 1 to December 31, 2016. The marketplace also included a letter saying that the taxpayer should complete and attach to the return Form 8962, Premium Tax Credit (PTC), which is used to figure the amount of PTC and reconcile it with the APTC. The marketplace also sent to the IRS and to the taxpayer a corrected Form 1095-A, which reflected the taxpayer’s health insurance coverage in 2016.

The taxpayer earned too much in 2016 to qualify for the PTC. This seems to have been due to her retirement account distributions. Retirement account distributions are generally considered income for tax purposes. They can prevent someone from qualifying for the premium tax credit. This is especially true if the taxpayer pulls out the funds in a larger lump sum to pay their expenses as they expect to have an extended period of unemployment.

Evidence That the Health Insurance was Cancelled

According to the court case, the taxpayer did not include the forms with her income tax return as she believed that she had canceled the health insurance prior to 2016. This was the taxpayer’s argument in court. She argued that she had attempted to cancel the health insurance prior to 2016 and, as such, she was not liable for any repayments as apparently the government paid the health insurance company in error.

The taxpayer did not present any evidence in court supporting her claim. And the marketplace records showed that she did have coverage in 2016. Given the admission that she earned too much to qualify for the PTC in 2016 and in the absence of a record that the health insurance was canceled, the tax court concluded that the taxpayer was not entitled to the PTC and had to repay the APTC amounts as determined by the IRS.

This raises an interesting question: if an insurance company makes a mistake, what records might a taxpayer need to show that they did not have health insurance coverage? In cases like this, the burden is on the taxpayer to prove a negative – that they did not have coverage – and without a letter or some other record from the insurance agency, it may be difficult for the IRS to agree that the taxpayer is not liable to repay the APTC.

The Takeaway

The PTC and APTC can result in significant savings on health insurance premiums. These savings can come at a significant cost.

A taxpayer may qualify for the PTC when they purchase their health insurance. This may quickly change. Those who suffer a financial downturn are likely to take actions that trigger taxable income. This case involved distributions from a retirement account to pay living expenses. For others, it may involve selling stocks, bonds, or other investments. These all trigger income, which could result in the taxpayer not qualifying for the premium tax credits. The result is that the taxpayer has to repay amounts advanced by the government to the health insurance companies.

This situation appears to be at odds with the purpose of the policy, which is to provide health care to those who cannot afford it. However, this is the outcome of the current law. Those who have a financial downturn should be aware of this as they plan their finances, as failing to plan could result in a significant amount of back taxes being owed to the IRS.