Yesterday the Internal Revenue Service posted guidance outlining its intent to enforce Obamacare’s “individual mandate” – a tax on those who don’t sign up by the end of March for health insurance that meets the law’s requirements. It was part of the plan all along, that health officials would raise noise around the tax penalty heading into the closing days of Obamacare’s open enrollment. The idea is to use the specter of this tax as a way to coerce a few more stragglers and holdouts into the insurance market.
But the individual mandate is a weak penalty, amounting $95 per adult and $47.50 per child (up to $285 for a family) or 1% of your taxable income — whichever is greater. The penalty increases over time, reaching $695 per person per year by 2016, or 2.5% of your income. But still, with a penalty that small, it might be cheaper for some families to bypass the Obamacare plans that comply with the law, and buy skinnier plans that don’t meet Washington’s mandates (and pay the penalty on the side).
As a consequence, for many consumers, the biggest hit they’ll face on their 2014 and 2015 tax returns won’t be the tax hit for spurning Obamacare (the so-called individual mandate). Rather, it will be the penalty they take for complying with the law’s dictates, and miscalculating their subsidies.
That’s because the Obamacare subsidies are structure as refundable tax credits, apportioned according to your income. As your income rises, your subsidy falls. But the subsidies are calculated off your trailing tax return. So if you end up earning more money in 2014, and deserve a lower subsidy than your 2013 tax return entitled you to, the difference will be “clawed back” when you file your tax return in 2015.
The same principle applies in reverse. Consumers who get subsidies that were too small relative to their actual income will get additional tax refunds (or refundable credits).
There’s a section in the Obamacare application process that requires you to report “Family Income Changes” so the IRS can figure out how much you are owed, or owe back to the government.
So how many families will find themselves caught up owing more than they were initially promised? About 38% of households that qualify for subsidies, according to researchers, might have to pay something back to the IRS. Some of them could owe big sums of money, even on small gains in income.
At biggest risk are people whose annual household income put them near the thresholds where the Obamacare subsidies make steep declines. These cliffs are steepest for those people who earn 150% of the federal poverty level (a family of four earning $35,000 in annual household income); 250% (a family of four earning about $55,000 annually); and 400% (a family of four earning about $95,000 annually).
When consumers grow their income above these thresholds, they could see sharp drops in the amount of subsidy money they receive. So if they are right near one of these cliffs, and earn a little extra money this year than last, they could find themselves owing back thousands of dollars on their 2015 tax return.
The thresholds at 150% and 250% are the most acute because that’s where the special “cost sharing” subsidies kick in. These are special subsidies (in addition to the premium subsidies) that are designed to help offset the expense of out of pocket costs and deductibles. But the “clawback” is going to be painful even for those who don’t benefit from these additional monies; even people who just get subsidies to offset some of the cost of paying for the Obamacare premiums.
Take this example: A family of four whose annual household income is $90,000 will get a $3,700 premium subsidy to buy Obamacare. If their household income rises to $96,000, they get nothing. So if they have already received (and spent) that $3,700 subsidy on health insurance, then in 2015 they’ll owe the money back to the IRS.
Even as the IRS starts to lift the veil on the individual mandate tax, the biggest bite from Obamacare lies ahead. It is another furtive “tax” buried in the law — one that won’t hit those who sit out this market, but the people who choose to get in.