Among the most attractive features of the Affordable Care Act (aka Obamacare) are the tax credits that are available to low income families to make health insurance more affordable. If you purchased your health insurance through one of the Exchanges (either Federal or state-based), you qualified for a tax credit or other subsidies if your household falls below 400% of the Federal Poverty Guidelines.
However, those tax credits and subsidies depend on your estimate of earnings for the coverage year.
The amount of tax credit that you actually qualify for can change throughout the year, in two ways:
- Change in Earnings – Examples are raises or pay cuts, layoffs, changing of jobs to a higher or lower income job, or the loss of a job. Whether higher or lower, your income will be off from your original estimate.
- Change in Household Status – Getting married, divorced, or having a baby are examples of a changed household status. The poverty levels are scaled based on the number of people in the household, and you may end up in a different tax credit classification.
It is hard to celebrate a pay cut, but at least you may be able to receive more of a tax refund based on overestimating your income and having too much tax withheld. Your financial situation already has your attention, and you are likely to consider your tax refund as you assess your finances.
However, most people don’t consider the tax aspects if their income increases. You may get an unpleasant surprise at tax time if you find out that you have used more tax credits than you were entitled to receive. You could end up losing part or all of your refund, or owe money to the IRS.
Why would you potentially have to pay money back to the IRS? Because the tax credit can be applied in advance toward your premium payments throughout the year. Most recipients will choose that path – after all, you probably have trouble affording your health premiums or you would not have qualified for a tax credit in the first place.
You can choose to not take any of your credits until you file your taxes, in which case the adjustment is taken into account at the end. The amount of tax credit that you qualify for may still be reduced, but at least you haven’t claimed a portion of it that you might have to pay back.
The impact on unsuspecting taxpayers could be substantial. The average annual tax credit is around $3,168 and the average refund is $2,690. It does not take much of a change in the tax credit to put a significant dent in your refund.
How can you prevent this? Keep your status updated with healthcare.gov or your state exchange as soon as possible, especially if your income has increased over expectations.
It is up to you to update your status through the exchanges so your tax credit can be automatically recalculated. There may be some repayment necessary based on tax credits already claimed but the impact will be minimized.
There are caps on the repayment amounts within the lower income categories, but if your increase bumps you over the 400% level, you are no longer eligible and thus are responsible to pay back all credits you have received during that time.
In short, if you are receiving a subsidy, make sure you notify the exchanges as soon as possible if your income or household status changes to prevent a massively unpleasant tax-time surprise.