At the heart of the Affordable Care Act (ACA) health care reforms are the premium tax credits, which will extend health insurance coverage to 18 million lower and middle-income Americans.  The idea of using tax credits to purchase private health insurance for the uninsured is one of a number of the historically conservative policy positions adopted by the ACA.  Both the Paul Ryan Roadmap and a recent proposal by James Capretta and Robert Moffit on How to Replace Obamacare also support premium tax credits to make health insurance accessible to Americans.

To create tax credits that are sufficiently substantial to in fact make health insurance affordable to lower-income Americans, without creating a program so costly that it is unaffordable to the country, tax credits must be means-tested and must be structured so as not to crowd out employment-based insurance.  This turns out, not surprisingly, to be very complicated.

On May 18, 2012, the Department of the Treasury published final rules implementing the premium tax credit provisions of the ACA.  These rules finalize rules proposed by Treasury on August 12, 2011, which I blogged about at that time.  The final regulations leave most of the proposed regulation intact, but do make a few important changes.  They also leave many questions unanswered.

Who is eligible?  The ACA provides that, beginning in 2014, individuals will be eligible for refundable premium tax credits if they 1) are not eligible for health insurance coverage through an employer or through a government program; 2) are citizens of or lawfully present in the United States and not incarcerated (other than pending final disposition of charges); and 3) have modified adjusted gross  household incomes (MAGI) between 100 percent and 400 percent of the federal poverty level.  The tax credits will be paid on a monthly basis directly to the qualified health plan (QHP) that an individual enrolls in through the exchange.

To be eligible, the individual must be an “applicable taxpayer,” that is, must file a tax return (a joint return if married) and not be claimed as a dependent on anyone else’s return.  The applicable taxpayer’s family, which is also covered by the tax credit, includes all persons for whom the taxpayer claims a dependent tax deduction.

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 medical costs).  Guidance on determining the minimum value of employer sponsored coverage was published in April, and is not covered by this rule.

Determining the amount of the tax credits.  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 applicable percentage of this income, 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 only for age rating (or the actual cost of coverage, if less).

Eligibility for the tax credits will be determined normally on an annual basis, but 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.

Reconciliation.  Although the tax credit is paid in advance directly to an insurer on a monthly basis, it is in fact a tax credit that must be claimed on the taxpayer’s annual income tax return.  Final eligibility for the credit, therefore, cannot be known until the taxpayer files his or her annual return, at which point household income for the year will be finally determined. A “reconciliation” must then occur between the tax credit already received and that to which the individual is actually entitled.   If over the course of the year household income turns out to be 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 found in the statute 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.

How The Final Rule Addresses — And Doesn’t Address — Disputed Issues

These are the basic rules for the premium tax credit, all of which were 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 final rule resolves several, but not all of these, disputed issues.

Affordability of employer-sponsored coverage.  The most controversial issue addressed by the proposed rule was how to determine 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 employer coverage and get a tax credit through the exchange.  “Large employers” (that is, employers with more than 50 employees) will owe a penalty of $3,000 for each employee who receives premium tax credits because employer coverage is unaffordable  up to a total of $2,000 for all full-time employees.

In its proposed rule, Treasury interpreted the statute to apply the 9.5 percent limit to the cost of self-only coverage rather than family coverage when the taxpayer has a family.   This is obviously a significant issue as employers often charge employees much higher premiums for family than for single coverage.   The proposed rule would have meant that many employees would have been denied premium tax credits even though the premium they would have to pay to insure their family through their employer-sponsored coverage far exceeded 9.5 percent of household income.  This in turn would have increased the number of uninsured Americans.

The proposed rule would also have encouraged employers to charge more for family coverage and less for self-only coverage to avoid the penalty. On the other hand, a rule that allows premium tax credits to families if family coverage through an employer costs more than 9.5 percent of income would increase eligibility for premium tax credits and thus the cost of the program, as well as increasing the number of employers paying penalties for not offering affordable coverage.

This aspect of the proposed rule was sharply criticized by consumer advocates.  In the final rule, Treasury decided to leave the question open for now.  An employee has affordable coverage if the employer offers self-only coverage for 9.5 percent of less of household income.  The question of whether coverage is affordable for the employee’s family is “reserved” for later resolution.   The final rule does determine that employer health savings account contributions do not affect the affordability of employer-sponsored coverage because HSA contributions do not affect the cost of premiums to employees, but health reimbursement accounts that can be used to pay for premiums might make employer-sponsored coverage more affordable.  The effect of wellness incentives on affordability is also left for future guidance.

The affordability safe harbor does not apply if an individual misrepresents the cost of employer coverage or provides incorrect information with reckless disregard of the actual facts.  If employer coverage becomes affordable during the course of a year, eligibility for premium tax credits cease.  A determination that employer-sponsored coverage is unaffordable must be redetermined each year and is not automatically extended.  If an employer imposes a waiting period of up to ninety days before coverage can begin, as permitted by the ACA, premium tax credit eligibility continues until employer-sponsored coverage is available.

Employees who enroll in employer-sponsored coverage that is not affordable or in unaffordable COBRA continuation coverage are not eligible for premium tax credits as long as they are enrolled, but are eligible as soon as they discontinue coverage.  Employees who are automatically enrolled in unaffordable employer coverage can get premium tax credits if they promptly disenroll. An employer is not subject to a penalty merely because an employee receives a premium tax credit if affordable coverage was in fact available.

The consequences of good-faith errors.  Consumer advocates were not successful, in arguing that some allowance should be made for taxpayers who in good faith apply for premium tax credits believing that their MAGI will be less than 400 percent for the year, but in fact at the end of the year have MAGI exceeding 400 percent, and thus are required to pay back all premium tax credits.  A Christmas bonus could result in a taxpayer having to refund thousands of dollars in premium tax credits.  Treasury concluded that it had no discretion to avoid this result (although it might be able to work with the taxpayer with respect to the terms of repayment).

The effect of CHIP other other premiums on affordability.  Consumer advocates had also asked that the cost of premiums for non-QHP coverage for certain family members (in particular CHIP coverage) be considered in determining premium tax credits.  Treasury determined in the final rule that it lacked discretion under the statute to do this.  This will raise serious affordability concerns for some families, as a many families in the exchange with children (some estimate as many as 75 percent) will have children with Medicaid or CHIP coverage.

Addressing eligibility for government-sponsored coverage.  An individual eligible for government-sponsored coverage (for example, Medicare, Medicaid, CHIP, or Veterans benefits) is not eligible for premium tax credits.  Premium tax credit applicants and recipients may not always know they are eligible for government coverage or may experience some delay in applying for coverage or receiving an eligibility determination.

The final rules allow an individual up to three months to apply for government-sponsored coverage after the individual becomes eligible and continues eligibility for premium tax credits until the first month in which the individual is actually determined eligible for government-sponsored coverage.  A veteran is not considered to be receiving government-sponsored coverage unless the veteran actually receives coverage through the VA.  The final rule leaves open for later resolution how government-sponsored coverage for specific medical conditions (such as Medicare end-stage renal disease coverage) or for limited services (such as Medicaid coverage for some pregnant women) will be handled.

The effect of marriage and divorce on premium tax credits.  Another problem addressed by the final rule is what happens when a taxpayer is married during the course of a coverage year.   As long as a taxpayer is single, eligibility for advance premium tax credits is calculated based on the single taxpayer’s household income.  At the end of the year, however, premium tax credits for individuals who marry during the year will normally be based on joint household income as shown on the joint return.   Because premium assistance is significantly greater for lower- than for higher-income households, there was the possibility under the proposed rule of a substantial “marriage penalty” for premium tax credit applicants who got married, thus combining their incomes.

The final rule mitigates this by allowing the calculation of premium tax credits on a monthly basis comparing one twelfth of annual joint income to the cost of a benchmark silver plans for the married family for months during the year that a couple is married but comparing one twelfth of one half of joint annual income to the cost of the benchmark plan for each of the two individuals for months before the couple married. (The final rule offers several examples of this calculation for those who find this explanation incomprehensible).  The effect is to reduce, although not necessarily eliminate, the amount of a premium tax credit that a couple may need to repay if they marry over the course of a year.  Couples who divorce during a coverage year may allocate the premium for the applicable benchmark plan, the premium for the plan in which the taxpayers enroll, and the advance credit payments in proportion to household income if they choose, or simply split them 50-50.

The ACA prohibits married couples who file separately rather than jointly from receiving premium tax credits.  This poses problems where filing a joint return is not possible, for example because of domestic violence, abandonment, or other circumstances.  This issue will be addressed by future rulemaking.

Other issues.  The final rule also addresses a number of other questions.  A family may only include children whom the taxpayer may claim as dependents under the tax code, although a non-dependent child may claim a tax credit independently. Congress amended the ACA under the 3 percent Withholding Repeal and Job Creation Act to include Social Security income in MAGI, and the final rule is amended accordingly.   The rule reiterates that premium tax credits will be available from the federally facilitated exchange as well as from state exchanges, an interpretation of the ACA that continues to be questioned by ACA opponents.

The final rule leaves open the definition of the rating area that will be used for determining the benchmark plan. The proposed rule had defined rating area as the exchange service area.

Individuals who are eligible for employer-sponsored coverage because of their relationship to another individual, but who are not tax dependents of that individual (for example, adult children under age 26 or domestic partners) are not for that reason disqualified from receiving premium tax credits.  An individual is eligible for a premium tax credit for a month if there is at least one day during that month that the individual is not eligible for employer or government sponsored coverage, as long as the individual is enrolled in a QHP on the first day of the month.  The individual’s monthly share of the premium for the QHP must also be paid for a premium tax credit to be paid for that month.  The ACA gives an individual up to three months to pay delinquent premium obligations before losing coverage, but if the premiums are never paid, the individual is not eligible for premium tax credits for those months.

If a least one silver QHP in an exchange will not cover an entire family (because of nontraditional relationships, for example), the benchmark premium for determining eligibility will be the combination of premiums that offers the second lowest-cost silver option for covering the entire family.  The rule reserves the question of how the benchmark premium should be determined for families with members that live in different geographic locations.  However, if adults compose two separate households for tax purposes, they may not use a family benchmark plan for determining eligibility, even though they are in fact eligible for a single family QHP.

In sum, the “final rule” on premium tax credit eligibility settles some issues left outstanding by the proposed rule. In several instances it improves access to premium tax credits, and thus will reduce the number of the uninsured.  Some of the most important and controversial issues are left open for future resolutions.  Treasury has a way to go yet to get to 2014