Tax time has always been an ordeal for many Americans, with a host of complex tax law provisions forcing you to know the ins and outs of various tax breaks in order to make sure you pay as little as possible to the IRS. With the advent of the Patient Protection & Affordable Care Act, better known as Obamacare, tax time just got a whole lot more complicated -- and for millions of Americans, it'll also bring some unwelcome news in the form of a lower tax refund or a higher tax bill.
The reason why many people are getting an extra tax headache this year stems from the subsidies that Obamacare provided to some of its participants. Specifically, the fact that Obamacare calculated those subsidies early in the year left them vulnerable to revision later in the year, and what a recent study from the Kaiser Family Foundation found is that the government's assumption that income levels would remain relatively similar from year to year has turned out to be incorrect.
The big problem for Obamacare at tax time: advance premium tax credits
The challenge that Obamacare faced was getting people to enroll in the program who couldn't afford to pay the full amount of their premiums. The law provided for subsidies for those who earned between 100%-400% of the federal poverty level, with the exact credit amount tailored to ensure that participants would pay a set maximum out-of-pocket amount on insurance based on a sliding percentage of their income.
Technically, the subsidy took the form of a premium tax credit. But because policymakers knew that many people couldn't afford to pay premiums now and wait until the following April to claim the premium tax credit on their returns, the law allowed eligible enrollees to take advance payments on the credit. Specifically, the law let people estimate their 2014 income in advance using a combination of documentation, including their most recent 2012 or 2013 tax return as well as paystubs or other proof of income.
Underlying this method is the assumption that Obamacare participants' 2014 income would be similar to their income in previous years. Yet as the Kaiser study found, that turned out not to be the case. Using Kaiser's methodology, between 20%-25% of households in the income zone defined by Obamacare subsidies likely experienced a drop of at least 20% in their income between 2013-2014, while between 20%-30% probably saw their incomes jump 20% or more over the course of the year.
The problem with such wide disparities between estimated and actual income is that it changes the subsidy amounts Obamacare participants were entitled to receive. If income rose, then subsidy amounts dropped, and participants are required to repay the advance credit. If income dropped, then participants are entitled to larger subsidies, which will give them a refund.
Big money, big problem
If the dollar amounts involved were minimal, then the fact that subsidy refunds or repayments would be required wouldn't be all that big a deal. But many of the payments required will be substantial. Only about a third of repayments and refunds are projected to be smaller than $200, with almost half exceeding $500. One in five of those who will owe repayments will have to pay $1,000 or more, according to Kaiser estimates. Overall, the average repayment is estimated at $794, while average refund amount will be $773.
The Obamacare law tried to anticipate such problems by limiting the maximum repayment amounts that low-income individuals and families would have to make. Under the law, those earning between 100%-200% of the poverty level have repayment limits of $300 for singles and $600 for families, while the corresponding amounts are $750 and $1,500 for those earning 200%-300% of poverty and $1,250 and $2,500 for earners between 300%-400% of poverty. Yet even those limits are extremely high in relation to the small amounts of discretionary income most families in those income ranges have. Those who climb above the range for subsidies entirely have no limit on the amount they'd have to pay, although those who fall below 100% of the poverty level aren't expected to repay any advance credit received.
With the U.S. Treasury estimating that between 3%-5% of 150 million American taxpayers received advance premium tax credits in 2014, as many as 7.5 million households could have the headache of figuring out how much they owe or are owed on their Obamacare subsidies. For those who were expecting a tax refund that might largely disappear as a result of repayment obligations, the added problem of a big financial hit will pose a substantial challenge.
In order to avoid this problem, the best solution would tie advanced premium tax credits to actual income earned during the current year. Unfortunately, even if that's possible, it's not something that the government could implement quickly. With the numbers of Obamacare participants expected to rise this year and into the future, the issue of advance premium tax credits is likely to get more widespread before it's solved.
Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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