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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Figuring your household income (Part One)

One of the first questions you will need to answer to purchase insurance on or off the new exchanges is your income.  You can skip this question if you don’t want to claim an advance tax credit (subsidy) — but even the private insurance companies will encourage you to provide enough information to determine if you are eligible for a subsidy.

If you enroll via an exchange and opt to take a subsidy, that will be reconciled the following year when you file your tax return.  If it turns out that your tax returns show that your 2014 income is higher than the number you reported, you may have to pay back some or all of the subsidy you receive in the form of a tax payment due in April 2015.  If it turns out that your income is less — or if you enrolled via an exchange but opted not to take an advance tax credit — then you may be entitled to an additional tax credit, that will be paid to you in the form of a tax refund.

So it is important to get things right: but if you are applying for insurance now, you are answering questions about 2013 income when, in the end, it will be your 2014 income that counts.  You will be able to report any changes of income during the year, but that could end up being rather cumbersome if you have some types of income that are fluctuating or subject to change – for example, if part of your earnings depends on earning commissions, or your work hours vary from one week to the next.

This is a complicated topic, but I will start by breaking it down in steps:

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