Self Employed Health Insurance Deduction – Alternative Calculation

This post is my continuing effort to translate an IRS regulation  from legalese  into English.  The source document is here:   26 CFR 601.105: Examination of returns and claims for refund, credit, or abatement;

This post won’t make any sense at all unless you read my previous explanation of the Iterative Calculation.

If you have read that post, you know that the problem, mathematically, is that calculation of the correct insurance premium tax credit together with the self-employed health insurance deduction creates a circular reference.  As the CREDIT increases, the amount that might be claimed as a DEDUCTION for payment of premiums is reduced, but when the DEDUCTION is diminished, the MAGI is increased, which in turn reduces the amount of available CREDIT.

If a taxpayer has accepted and advance premium subsidy in excess of the amount of the actual CREDIT to which he is entitled, then the impact of clawback limitations may effectively prevent the need for repeat calculations.

But in the case of a taxpayer who has not taken the advance premium credits — or one who has accepted less money in advance payments than the amount allowed based on family income– an exact calculation when done by hand will require multiple repetitions until an exact figure is reached. The IRS “Iterative Calculation” requires that the taxpayer repeat the calculation until the difference between the new calculation and the previous result is less than $1.  As IRS practice always allows for rounding of figures to the nearest dollars, this procedure will result in the taxpayer receiving the maximum possible credit mathematically.

However, IRS also sets forth an “Alternative Calculation”.  I am not going to go through a step-by-step analysis of the Alternative, because the instructions are the essentially the same as what is printed on a shampoo bottle:  “lather once, rinse, repeat.”

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Self-Employed Health Insurance Deduction — the Iterative Calculation

This post is my continuing effort to translate an IRS regulation  from legalese  into English.  The source document is here:   26 CFR 601.105: Examination of returns and claims for refund, credit, or abatement;

The IRS has figured out that the interplay between the ACA premium tax CREDIT and the self-employed health insurance DEDUCTION is “circular” –the amount of each is influenced by changes in the amount of the other.   IRS says that taxpayers can use any approach they choose to figure this out, but IRS suggests two possible approaches.  The first is called the “Iterative Calculation”

IRS says:

Specified premiums are premiums for a specified qualified health plan or plans for which the taxpayer may otherwise claim a deduction under § 162(l). A specified qualified health plan is a qualified health plan, as defined in §1.36B-1(c), covering the taxpayer, the taxpayer’s spouse, or a dependent of the taxpayer (enrolled family member) for a month that is a coverage month within the meaning of § 1.36B-3(c) for the enrolled family member

This means:

The SPECIFIED PREMIUM amount is the actual total premiums charged for health insurance coverage from a qualified health plan.  For our purposes we will assume a single taxpayer, buying insurance via an exchange, and that if the taxpayer paid the full cost of the premium, it would cost $8000 for a year of coverage.

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Household Income and the Self-Employed Health Care Deduction

This post is my effort to translate an IRS regulation  from legalese  into English.  It’s going to take a while.  The source document is here:   26 CFR 601.105: Examination of returns and claims for refund, credit, or abatement;

1.  Some taxpayers are eligible to claim both a self-employed health insurance deduction and an insurance premium tax  credit:

IRS says:

.03 Some taxpayers enrolled in a qualified health plan and eligible for the premium tax credit may also be allowed a deduction under § 162(l). Section 1.162(l)-1T of the Temporary Income Tax Regulations provides rules for taxpayers who claim a §162(l) deduction and also may be eligible for a § 36B credit for the same qualified health plan or plans. Under § 1.162(l)-1T(a)(1), a taxpayer is allowed a § 162(l) deduction for specified premiums not to exceed an amount equal to the lesser of (1) the specified premiums less the premium tax credit attributable to the specified premiums, and (2) the sum of the specified remiums not paid through advance credit payments and the additional tax imposed under § 36B(f)(2)(A) and § 1.36B-4(a)(1) with respect to the  specified premiums after the application of the limitation on additional tax in §36B(f)(2)(B) and § 1.36B-4(a)(3)

This means: 

If a self-employed taxpayer is eligible for an insurance premium tax CREDIT,  then the amount of the DEDUCTION is calculated by subtracting the amount of the tax CREDIT from the maximum allowable DEDUCTION.   Example:  Taxpayer earns $40,000 and pays $8,000 for health insurance purchased from an exchange. If the calculation shows that the taxpayer is eligible for a $3000 premium tax credit, then the maximum allowable insurance deduction would $5,000.

If a self-employed taxpayer who bought insurance from an exchange has already received an ADVANCE CREDIT, and if that credit is more than the taxpayer is entitled to, then the maximum allowable DEDUCTION is equal to the sum actually paid out-of-pocket for the reduced premium, plus the sum of the total amount of any clawback tax owed because of the excess ADVANCE CREDIT payments.   Example: Taxpayer claimed a credit based on an anticipated $40,000 income, but taxpayer in fact earned $70,000 in 2014.  Taxpayer received $4500 in advance credits, and paid $3500 directly to the insurance company.   Because of taxpayer’s higher income, no tax credit is allowed, and taxpayer owes an additional $4500 in taxes.  However, that amount may be added to the out-of-pocket expenses to calculate the deduction — taxpayer then deducts the full $8000 deduction  ($3500 paid in premiums plus $4500 of tax owed).

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The IRS has Spoken…..

…. or at least added more confusion to the mix.

I’m not going to be able to address this in one post, so I’ll start with a link:

IRS Revenue Procedure 2014-41 — PDF at http://www.irs.gov/pub/irs-drop/rp-14-41.pdf

“26 CFR 601.105: Examination of returns and claims for refund, credit, or abatement;
determination of correct tax liability.”

This addresses the issue raised back in my post, “Figuring your Household Income (Part Two)“:   How to calculate AGI and premium tax credit when you are self-employed and also eligible for the self-employed health insurance deduction.   As I pointed out “This is one area where the present wording of the law seems to provide an extra benefit for the self-employed, if in fact you can use the full cost of the premiums reduce AGI for purposes of subsidy eligibility.”

I commented, “The double-benefit from being able to deduct 100% of health insurance premiums in order to reduce AGI, and then used the same deduction to qualify for a substantial tax credit seems to fly in the face of the way the tax law usually works. Generally the laws are written to prevent taxpayers from applying the same expense to benefit in multiple ways.”

And I gave some advice:   “The safest choice for self-employed individuals who are unsure of subsidy eligibility is to buy insurance through an exchange, opt to pay the full cost premium cost, with a plan of maximizing tax deductions with the possibility of a substantial tax refund down the line. That way you will not be caught with a huge tax bill in 2015 because your calculations were off the mark.”

And, more important:

Above all. Do not rely on this blog or any other for tax advice!!!  It’s possible that the very best investment you can make for your business in 2014 will be to hire a tax professional to help guide you through this maze.”

Now the IRS has added its explanation as to how you can do this calculation, maybe.  If you happen to be self-employed as an accountant or software programmer, you might be able to figure this out   The rest of us may feel very grateful that we do have health insurance under ACA, because we may need to see a doctor to treat the headache we are all going to get from trying to do the mathematical gymnastics IRS suggests.   More to come– in the meantime, you can read this yourself at the link above.

Two other new ACA related docs to peruse while you are at it:

Revenue Procedure 2014-46   (provides the 2014 monthly national average premium for qualified health plans that have a bronze level of coverage for taxpayers to use in determining their maximum individual shared responsibility)

Revenue Procedure 2014-37 (provides the methodology to determine the applicable percentage table in IRS § 36B(b)(3)(A) used to calculate an individual’s premium assistance credit amount.)