A Tax Credit Can Defray Premium Costs

Early retirees or the self-employed who have limited income or who live primarily by tapping their nest eggs could be eligible for an unexpected windfall: a substantial federal subsidy for their health care premiums. If you are too young for Medicare and are buying coverage on the health insurance exchanges created under the new health care law, you could qualify.

When you apply for insurance on a state-based exchange, you'll learn whether you'll get a federal tax credit to defray part or all of the premiums. Coverage begins January 1.

Premium tax credits will be available to people with modified adjusted gross incomes that are between 100% and 400% of the federal poverty level. For married couples the range for 2013 is $15,510 to $62,040. Modified AGI includes wages, investment income, Social Security benefits, and any tax-exempt interest and foreign income generally treated as tax free.

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Married couples must file a joint return to qualify for a credit. And a couple cannot qualify if they are eligible for employer-based coverage that is considered to provide "minimum essential coverage."

Plans offered on the exchange will be categorized as platinum, gold, silver and bronze, based on the percentage of average health care costs they cover. The size of the tax credit will be tied to the premium of your area's second-lowest-cost silver plan—the one designed to cover 70% of average costs. If you qualify for the credit, you will not pay more than a certain percentage of your income for your share of the premium (see table). You can get an idea of the size of your potential subsidy by using the Kaiser Family Foundation's calculator at www.kff.org/interactive/subsidy-calculator.

Judith Solomon, vice-president for health policy at the Center on Budget and Policy Priorities, says that the subsidies can be especially large for older applicants. The law allows insurers to charge older applicants more than younger ones, with some restrictions. Because the amount the insured must pay is capped as a percentage of income, regardless of age, the subsidy must rise to fill in the gap.

Consider a husband and wife, both age 62, with a modified AGI of $60,000, which is 387% of the poverty level, who live in an area where the second-lowest-cost silver plan for their age costs $17,342 a year. Because the law limits their cost to 9.5% of income, they pay $5,700 of the cost. The tax credit covers the remaining $11,642. Younger applicants will usually get smaller subsidies because their premiums will generally be less. A 55-year-old couple with $60,000 in income also would pay the same $5,700 out of pocket, but would need a $7,761 credit to cover the rest of their lower premium, according to the Kaiser calculator.

The premiums—and the size of the credit—will vary from state to state, in part because of differences in health care costs. A new study by Kaiser analyzes premiums recently submitted by 17 states and the District of Columbia—and the impact of tax credits.

For example, in Los Angeles, the monthly premium for the second-lowest-cost silver plan for a 60-year-old couple is expected to be $1,082. Assuming the couple's income is $30,000 (or 193% of the poverty level), they will receive a tax credit of $932 a month. Their out-of-pocket premium costs will be $150 a month—or 6% of their income—if they enroll in this silver plan. If they instead enroll in the cheaper bronze plan, with its $797 monthly premium, the couple can use the tax credit to eliminate the premium.

In addition to the premium subsidies, people with incomes of between 100% and 250% of the poverty line will be eligible for cost-sharing subsidies to reduce co-payments and other costs.

The Application Process

Most people will find out whether they qualify for a tax credit when they apply for coverage, either online, by phone or in person. On your application, you will note your estimated income for 2014. Using your Social Security number, the exchange's computer will check several databases to verify your estimate.

One database is that of the IRS, which will check the income you reported on your 2012 tax return (the most recent available). The marketplace "is not seeing the entire tax return, just the income number," says Cheryl Fish-Parcham, deputy director of health policy for Families USA. The exchange also will check with the Social Security Administration and state wage and unemployment compensation agencies. And it will use the Work Number, a salary-verification database used by prospective employers, car dealers and credit-card companies. (The Work Number is owned by Equifax, one of the three credit-reporting companies.)

Because any subsidy will be based on your 2014 income, you need a solid estimate. The IRS will not be able to review your 2014 return for any discrepancies—between your actual income in 2014 and the one you projected—until you file the return in 2015. If you believe your income will drop in 2014—say, you or your spouse plan to retire—but your records show a much higher income now, you'll have 90 days to show proof of the expected income decline.

Getting the estimate wrong could cost you. An applicant who receives a generous tax credit based on a lowball income projection will owe all or part of the subsidy when she files her 2014 return. She will either get a lower refund in 2014 or write a check to the IRS. If your income is higher than projected, but still below 400% of the poverty level, the amount you're dunned will be capped—at up to $2,500 for a couple. However, Solomon says, "if your income turns out being over 400% of poverty, you'll pay back the entire amount."

Conversely, if your income turns out to be lower than you had projected, the IRS will either boost your 2014 refund or lower what you owe with your return.You can receive the tax credit one of two ways. You can take an "advance" credit, which the exchange pays directly to the health plan each month to reduce your premium payment. Or you can pay the entire premium out of pocket and then claim your tax credit on your 2014 return—a difficult proposition if you can't afford to lay out the full premium tab. If you choose the advance payment, be sure you notify the exchange if your income changes during the year so the exchange can adjust the subsidy for the subsequent months.

Or you could hedge your bets—taking just part of the credit as payment to your insurer during the year while paying a larger share out of pocket. "If you think your income will increase, you could take less in advance to provide a cushion," says Fish-Parcham.

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