On August 12, the Departments of Health and Human Services and Treasury (Internal Revenue Service) issued three notices of proposed rulemaking (NPRM) as part of their continuing effort to implement the Affordable Care Act (ACA). The proposed rules will be formally published in the Federal Register on August 17 for comment.

One NPRM issued by the Treasury Department lays out the rules under which the new premium tax credits will be calculated and administered beginning in 2014 to make health insurance more affordable for uninsured lower- and middle-income Americans. HHS issued two NPRMs. One implements the Medicaid expansions under the ACA and will greatly simplify the current Medicaid program and coordinate eligibility determinations between the Medicaid program and the exchanges. The second HHS NPRM governs eligibility determinations by the exchanges for the ACA premium tax credits and cost reduction subsidies and coordinates.

HHS simultaneously published fact sheets on each of the NPRMs and a description of thirteen establishment grants totaling $185 million awarded on the same day. It was a good day’s work for a hot day in August when most of us were on vacation or wanted to be.

This post will describe the Treasury NPRM, the shortest of the NPRMs but also the one that deals with the most complex and unsettled issues. A second post will analyze the exchange and Medicaid eligibility NPRMs.

The Basic Rules Regarding The Tax Credit

Who is eligible? The ACA provides that, beginning in 2014, individuals who are not eligible for health insurance coverage through their employment or through a government program, who are citizens or lawfully present in the United States and not incarcerated (other than pending final disposition of charges), and who have modified adjusted gross  household incomes (MAGI) between 100 and 400 percent of the federal poverty level will be eligible for refundable premium tax credits. The credits will be paid on a monthly basis directly to the qualified health plan that they enroll in through the exchange. Aliens lawfully present in the United States who are not eligible for Medicaid can receive tax credits even though their household income is less than 100 percent of the FPL.

To be eligible for the tax credit, the individual must be an “applicable taxpayer,” that is, must file a return whether or not taxes are owed, must meet the financial eligibility requirements, must file a joint return if married, and must not be claimed as a dependent on anyone else’s return. The applicable taxpayer’s “household” includes all persons whom the taxpayer claims as dependents, regardless of their relationship to the taxpayer. Individuals who have an offer of coverage through their employment are generally not eligible for the premium tax credit, but can be if the employment-based coverage is unaffordable (i.e. costs more than 9.5 percent of income) or does not provide minimum value (i.e. covers less than 60 percent of total allowed costs of benefits).

It is estimated that when the tax credit is fully phased in, 20 million Americans will receive an average of $5,000 in tax credits.

Calculating the amount of the credit. To determine the amount of the premium tax credit, it is first necessary to determine the applicable taxpayer’s household income by summing the total of MAGI for all members of the household required to file tax returns. (Income of dependents not required to file returns can be ignored). The household must spend a certain percentage of MAGI, determined by a table found in the statute and regulation, on qualified health coverage. For 2014, this applicable percentage begins at 2 percent for taxpayers with income below 133 percent of the federal poverty limit and increases to 9.5 percent for taxpayers with incomes up to 400 percent of the FPL. The premium tax credit that will be paid on behalf of the household for health insurance coverage will be the difference between the amount calculated by applying the applicable percentage to household income and the cost of the monthly premium of the “benchmark plan,” i.e. the second lowest-cost silver plan (a plan with an actuarial value of 70 percent) available to the taxpayer, adjusted for age rating (or the actual cost of coverage, if less).

Although eligibility for the tax credits will be determined normally on an annual basis, technically eligibility is determined on a “coverage month” basis, as the premium tax credits are paid to the insurer on a monthly basis and any of the eligibility requirements can change from month to month.  The FPL used to calculate the premium tax credit will be that which was in effect on the first day of open enrollment for the taxable year, which means it will usually be the FPL for the year prior to the year in which the credit is awarded.

The consequences of underpayments and overpayments. Although the tax credit is paid on a monthly basis, the actual amount of the credit will in fact be finally determined based on the household’s income as determined on the annual income tax return.  At that point “reconciliation” must occur.   If over the course of the year household income turns out to have been greater or less than projected, or if household composition or compliance with other eligibility requirements has changed, the final tax credit may turn out to be greater or less than the amount already paid. If the taxpayer turns out to have been eligible for more than had been paid, the taxpayer gets a refund.

If, however, the government has paid more than the taxpayer in fact turns out to be entitled to, the taxpayer must pay the money back. There are limits to this liability for taxpayers with household incomes up to 400 percent of the FPL (which have been amended twice since the ACA was adopted to increase liability), but the amount owed back can be substantial (up to $2500 for families at the upper ranges), and if final income exceeds 400 percent of poverty, even by one dollar, the entire premium tax credit must be paid back.

Dealing With Statutorily Unresolved Issues

These are the basic rules for the premium tax credit, all of which were reasonably clear from the statute. How precisely these rules would be applied in particular situations, however, was far from clear, and has provoked considerable debate. The NPRM begins to resolve several of these disputed issues.

Will employer-sponsored coverage be deemed affordable even if family coverage is not? The most controversial issue addressed by the NPRM is how to determined whether employer-sponsored coverage is unaffordable. Taxpayers who have an offer of coverage from their employer but who would have to pay more than 9.5 percent of their household income for their share of the premiums can decline that coverage and receive a premium tax credit to purchase insurance through the exchange. When this happens, the employer owes a penalty of $3,000 for each employee who does this up to a total of $2,000 times the number of all full-time employees in excess of 30. The statute is not entirely clear, however, whether the 9.5 percent applies only to the cost of self-only coverage or also to the cost of family coverage when the taxpayer has a family. This is obviously a significant question as employers usually charge employees much higher premiums for family than for single coverage.

This issue has received a great deal of discussion recently following the publication of a paper by three economists sponsored by the Employment Policies Institute (an organization that opposes the minimum wage and other employer mandates). The paper claimed that defining affordability in terms of the cost of family coverage would dramatically increase the number of persons receiving premium tax credits and decrease the availability of employer coverage, adding $50 billion to the cost of the ACA. The NPRM clarifies that taxpayers — and their households — who are offered self-only coverage for less than 9.5 percent of their household income are ineligible for the tax credit, even though family coverage is in fact unaffordable. The problem identified by EPI, therefore, goes away.

While this resolution may please employers and reduce the cost of the ACA, it does mean that many American families will be denied tax credits even though they cannot afford family coverage. It will also tempt employers to manipulate their premium structure to ensure that self-only coverage is affordable, even if it means increasing the cost of family coverage.

The only bright spot is that the preamble to the NPRM states that families who would have to spend more than 8 percent of household income to purchase family coverage through their employer will not be penalized for not doing so under the minimum coverage requirement. Treasury claims that the statute compels this resolution of this affordability issue, but since the ACA seems to apply the same rules to determine affordability under the minimum coverage requirement as it does to the tax credit eligibility provisions, this result seems questionable.

Other issues relating to employer-sponsored coverage. The NPRM contains several other rules for evaluating employer coverage.  First, an employee who opts for employer-sponsored coverage is ineligible for a premium tax credit even though employer coverage is in fact unaffordable. Second, an individual is treated as having employer coverage available even though enrollment in the employer’s plan is currently closed if the employee could have enrolled during the last open enrollment period. Third, if an exchange determines employer coverage is not affordable, the employee is eligible for tax credit eligibility for the entire year, even if it is subsequently determined that employer coverage would have been affordable  In this situation, however, it is anticipated that the employer will not be penalized.

Fourth, the preamble notes that the employer penalty regulations will offer a safe harbor to employers such that, if an employer offers coverage that costs less than 9.5 percent of an employee’s income, the employer will not be penalized even if the coverage ends up costing more than 9.5 percent of the employee’s entire household income (because, for example, another family member had negative income) and the employee receives a premium tax credit.  Fifth, the availability of COBRA continuation coverage does not disqualify a taxpayer from receiving a premium tax credit unless the taxpayer actually purchases it.

Finally, the NPRM requests comments on how to determine when employer coverage is inadequate, i.e. when it covers less than 60 percent of total allowed costs of benefits. Since large employers are not subject to the minimum essential benefits requirement, it is not clear how the allowable cost of benefits is supposed to be determined. The preamble states Treasury’s intent to ensure that employers meet their responsibilities while still preserving our employer-based system, and offers the possibility of transition relief.

Interactions with public coverage programs. A taxpayer is not eligible for the premium tax credit for any member of the household who is eligible for coverage under a government program. If, however, an exchange determines a taxpayer to be ineligible for Medicaid and eligible for a premium tax credit, but at the end of the year it turns out that in fact the household’s MAGI was low enough that the taxpayer was in fact eligible for Medicaid, the taxpayer does not need to pay the credit back unless the taxpayer received a larger credit than the taxpayer was entitled to, and will have no liability if the taxpayer’s household income was less than 100 percent of the FPL. Veterans who may be eligible for veterans’ coverage are disqualified only if they are actually enrolled in a veterans’ health program. Individuals who apply for government coverage are disqualified from receiving tax credits only once their application is actually approved, even if it is approved retroactively.

The NPRM sets out a number of rules for calculating the premium tax credit that will only be summarized here.  First, a taxpayer is only eligible for a tax credit for months that the taxpayer’s household is actually enrolled in a qualified health plan through the exchange.  The appropriate benchmark plan that will be used for calculating the tax credit will be determined based on the coverage category offered by the exchange that is most appropriate for the taxpayer’s household (self-only, one adult plus one child, one adult plus children, etc.)  If more than one QHP is necessary to cover the household because of family composition (e.g. the household includes members that can be claimed as tax dependents but not for family coverage), the tax credit will be calculated based on the sum of the premiums of all plans needed to cover the household.

If a QHP covers more than one family (e.g. covers adult children under age 26 who are not tax dependents), the premium will be allocated among the family members.  If the benchmark plan used to determined eligibility closes or terminates over the course of an eligibility year, it will continue to form the basis for determining the tax credit for persons determined eligible for the tax credit before it terminated or closed (unless they were enrollees in that plan), but not for new tax credit applicants.

The NPRM describes in detail how tax credits will be handled when taxpayers marry or divorce during a coverage year.  Divorced spouses have some discretion in allocating credits and household income, and domestic relations attorneys will have to become intimately familiar with these rules.  The NPRM also provides that a taxpayer parent may claim a tax credit for the cost of covering a child if the taxpayer claims the child as a dependent, even though another divorced or separated parent is legally obligated to pay for the child’s health insurance.  Married taxpayers must file a joint return to receive the credit, although the preamble notes that some provision may be made for taxpayers who cannot do so, for example because one spouse is abusive or incarcerated.

No help for those who owe money back because of overpayments. A taxpayer must file a return to claim a tax credit, even though the taxpayer otherwise has no obligation to file a return.  As noted above, at the time the return is filed, the tax credit will be reconciled with actual reported household income and the taxpayer will have to pay the IRS if there was an overpayment in tax credits.  Overpayments in fact will be common, not only because income and household composition will change over the course of a year, but also because a person who loses or gains a well-paying job over the course of the year may end up with a high end-of-the year income even though, at the time the taxpayer applied, the credit was accurate for the taxpayer’s then-current income level. A taxpayer with income under 400 percent of poverty level could receive a credit through out the year based on anticipated income, but then receive an end-of-year bonus putting the taxpayer  over the 400 percent limit and have to pay back the entire credit for the entire year.

Consumer advocates hoped that Treasury would use its statutory rule-making authority to meliorate these consequences, but Treasury does not believe it has the authority to do so and offers no mercy.  The Exchange NPRM, however, allows taxpayers to claim a lower tax credit than they are entitled to so as to lessen the likelihood of end-of-the year liability, and encourages exchanges to impress upon enrollees the importance of promptly reporting any changes in income or household composition.