Do you want that raise or not? A formula for 400 percenters

Because tax credits or subsidies to offset insurance premiums are eliminated for taxpayers with  household incomes over 400% of the federal poverty line, crossing that income threshold creates a potentially large tax penalty, especially for older adults who will be face higher premiums.  This means that a slight gain in the year’s income for a taxpayer on the edge of eligibility could end up costing more than the amount gained.

This can obvious impact decisions as to whether to accept a moderate increase in pay, as well as impact decisions that could result in other taxable income, such as managing investments.

On the other hand, it’s generally better for a person to get more money than less, so it would be foolish for someone to forego an income opportunity that would result in gains that substantially outweigh the loss of a tax credit.  

I am referring to the person buying insurance as a “taxpayer” because I think it’s helpful for upper-middle income insurance buyers to look at the subsidy for what it is:  a tax credit that may or may not be available in a given year.  A $5000 tax credit may look very attractive to someone whose income hovers around $45,000 — but as I will show, it’s not worth turning away the opportunity to make an extra $20,000 in a year.

There’s a fairly easy way to figure out how much extra money you need to make to break even and start to  move ahead.

1.  First, figure out the maximum that you will pay for insurance if you are exactly at the 400% mark. You will do that by determining the product of 9.5% times the 400% poverty line cutoff. I’ve made it easy and done the math for you, at least for a household of up to 5 people.

Household size 400% FPL 9.5% of FPL Monthly
1 $45,960 $4,366 $364
2 $62,040 $5,894 $491
3 $78,120 $7,421 $619
4 $94,200 $8,949 $746
5 $110,280 $10,477 $873

See http://www.familiesusa.org/resources/tools-for-advocates/guides/federal-poverty-guidelines.html

2.  Next, you need to find the benchmark premium for you or your family.  That is the amount of the full premium you would be charged for the second lowest priced  Silver health plan in  your region.  You will have to use the exchange web site for your state to find that, and enter in appropriate information for your family.

For purposes of illustration, I’ll use the benchmark $800 premium amount (P) that our fictional friend, 60-year-old Carol in San Francisco encountered.  We had imagined that she earned $47,000, but lets now assume that her income fluctuates a little bit from one year to the next, and that it’s possible that she will earn under the 400% mark in 2014.

We want to find the difference between the cost of the premium and the maximum (M) that Carol can be asked to pay per month if she earns exactly 400% of the FPL, in order to calculate the value of the tax credit (C) that she could get. From the chart I created above, we can see that for Carol, that amount is $364.

So for Carol, the result of P (800) – M (364) =  C (436)

Now we simply multiply that monthly amount by 12 to get AC, the Annual Tax credit amount. For Carol, that figure is $5,232

3.  Now, we need to figure out Carol’s marginal tax rate. That is, how much money does she pay in state and federal income tax for every dollar she earns above the the 400% mark? In Carol’s income bracket (single taxpayer, earning more than $45,960), that is going to be 34.3%. She will pay 28% federal tax and 9.3%  state income tax on any extra money she earns.  (Technically, the top California income tax rate of 9.3% won’t kick in until her income is $46,766, but for purposes of this post, that slightly reduced state tax on the first $800 isn’t important enough to account for).

4. Now, let’s turn things around and figure out how much extra money Carol would need to gain in order to break even, if the added income caused her to lose her subsidy.  We’ll start by figuring out how much money Carol keeps of every dollar she makes after taxes. That’s easy — her marginal tax rate means that she is taxed 0.343 for every dollar, so she her her net (N) after tax earnings per dollar is 0.657.

So lets take the AC figure (the amount of the potential tax credit) and divide that by N (the net after tax income).

For Carol, that formula is AC (5232) / N (0.657) = BE (7,964)

In other words, Carol breaks even when  her earnings increase to $7,964.

If I was Carol’s financial adviser, I’d tell her to round that number up to $8,000 (easier to remember).  If she thinks that her income is close to that 400% mark, then she should be cautious about choices that would cause her income to increase by anything under $8000.  On the other hand, if her income increases by more than $8000, she will come out ahead, even if she doesn’t get to buy insurance at a reduced rate.

One more piece of advice I would give anyone in Carol’s position: start working with a tax professional, early in 2014.   There may be other things that Carol can do, either to preserve her subsidy, or to forego the subsidy but achieve tax savings in other ways.  This stuff is complicated — that’s why I said at the beginning of the post that it’s important to look at this as just being one more element of the tax system.    No one should focus on the ACA tax credit in isolation — it’s just one of many ways that a taxpayer can reduce each year’s tax bill.

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