Psychology, Loopholes, Welfare Traps, and Other Considerations of the Affordable Care Act’s Advanced Premium Tax Credits
When it comes to Advanced Premium Tax Credits, it is always tempting to take the maximum amount you qualify for. However, repayment limits can mean owing back credits. This has a lot of complex implications.
On this page we look at tax strategy and psychology related to Advanced Premium Tax Credits and the corresponding repayment limits.
The Problems and Loopholes With Advanced Premium Tax Credits
On paper, those making between 100% – 400% FPL are better off taking the maximum amount of Advanced Premium Tax Credits up front, and then paying back the IRS as needed, than they are being “conservative” and taking a reduced amount or waiting to take them until the end of the year.
This is especially true if a person is self employed, takes contract work, or otherwise has income they can’t predict.
Essentially, borrowing money from the government at zero interest and paying it back later (if needed; and even if not needed, potentially not even the full amount)… is better than paying money upfront and then taking the credits at tax time (or in the case of Medicaid/CHIP, getting that up front until you don’t qualify for it any more).
This is true for a few different reasons:
- Many people can’t properly predict their income, thus estimated toward the low end works if it ends up that way and only results in you having to make up the difference if you make more money. It is like a useful zero interest loan from the IRS. Great for the self employed!
- Repayment limits mean that in some income brackets you won’t have to pay back the full amount of the tax credit borrowed if you end up making more than you projected.
- You don’t have to pay back cost sharing reduction subsidies (CSR) AKA out-of-pocket assistance (meaning if you can reasonably qualify for it, you should generally take it).
- Inflation is a thing, and thus borrowing money interest free and then paying it back over a year later is always in your favor.
- If you know you won’t have income for the first part of the year, you and/or your family may qualify for free or low income Medicaid/CHIP in the meantime (taking this assistance may be a better choice than predicting you’ll make enough to need credits).
With that said, all of that is just “on paper.”
In reality, the complexity of the tax code and tax credits mean that people are bound not to fully understand their choices and the consequences of their actions regarding Advanced Tax Credits.
This can lead to people having a negative experience in owing back tax credits, even when overestimating the amount they needed was a net benefit to them.
Let me illustrate the above with a few examples (all based on real stories):
Consider a situation where a family saves $20k on premiums via Advanced Tax Credits, but then draws $11k out of the 401k in December only to push their total income over the 400% poverty level, thus triggering an event where they owe back the $20k on their tax returns.
That is a bad situation to be in. Had they waited one month to draw money out of their 401k, they would have kept their assistance. Instead, because they didn’t understand one part of the tax code, they owe back $20k for taking $11k.
Or, consider an example where a self-employed person who makes over just 400% of the poverty level goes without tax credits, but then loses income later in the year and ends up qualifying for tax credits at tax time. They miss out on a year worth of “zero interest loans.” Not the end of the world, but not ideal.
Or, consider the story of a self-employed gentlemen who paid his full premiums all year thinking that he would get payment from a big contract in December. The payment didn’t come until after the 1st of January, and given this, his income for the previous year was about $5,000. This means he should have qualified for Medicaid the whole year, for free. Had he projected say “110%” FPL he would have gotten nearly free coverage through the marketplace after tax credits and out-of-pocket subsidies (100% a legal and legitimate thing to project in his shoes).
Had the payment come in in December, oh well, so he pays back the part of the tax credit he owed (cost sharing isn’t owed back). No big deal if planned for. The IRS only wants the full amount back if you go over 400% FPL, otherwise limits are reasonable (see repayment limits).
On the flip side, go below 100% and the IRS doesn’t even care if you file taxes (as you are below the tax filing threshold).
NOTE: The exact limits are subject to change each year, please see the current repayment limits.
The Negative Psychology of Repayment (and the Positive Psychology of Refund)
I think in general we all understand that repaying excess tax credits feels bad and getting a refund feels good.
Sure, this logically doesn’t make a ton of sense. A refund is money you didn’t owe but paid, a repayment is money you weren’t owed but were given.
So logically, a refund should feel bad and a repayment should feel good.
However, we know that human psychology doesn’t work like this.
Especially when the system behind it is confusing, like the tax system is, people are bound to appreciate a refund and get upset over a repayment.
There is a lot of positive psychology in a refund, and some people get refunds, but repayment actually eats in to people’s overarching refund about 1/2 the time in practice with the ACA, and these people tend to be more vocal.
This means every year people are upset with the ACA in practice.
This is made worse by high deductibles and insurance people feel like they aren’t using.
So while the mechanics aren’t broke mathematically speaking, when we factor in the human condition, we see a glaring problem with the way Advanced Credits work.
In Truth, on Paper, This is All Fair
As I hope I’ve already made the case, advanced tax credits are a smart and fair system that favors the user, the government, and the industry on paper.
The faults of this aspect are largely just psychological (negative for under- and over-taking) and incentive-based (it incentivizes “hogging” and disincentives thrift) and technical (in respect to people not understanding how taking a lump sum payment will cause repayment or losing income can mean missing out on assistance).
The root of the problem and the benefit is found in the fact that the system incentivizes borrowing tax credits from the government, which get paid to insurers today, for coverage today, but with repercussions tomorrow.
And while the repercussions are clear if you know the tax code, most people don’t and thus they are not clear.
Heck, it is even hard to figure out how to adjust your credits on the website if you wanted to. So people will just estimate their income once and not touch the site again for a year. That means many people end up with refunds or repayments.
The reality is, a year and a half later when taxes and credits are owed people no longer feel the “value” of their coverage or loan, and instead are just pissed about owing money, or pissed about not taking enough up-front, or happy for a day about the extra money in their return until it is spent.
Then, this is only made more complex by the inflation in plan costs.
Would someone making $40,000 a year really want to spend $3,500 on coverage if it wasn’t subsidized? How can you get someone to value you that? This is largely an issue of psychology over economics.
Tax Tips For Avoiding the Repayment Blues and Refund Should-be-Blues
I am a blogger, and our team helps people understand the ACA, we aren’t “insiders” and we aren’t beholden to a party or industry.
In our years of studying the law and helping people, a few sticking points have popped up. This is one glaring sticking point in respect to the different ways you can take advantage of Advanced Credits and the different ways they can really feel like they are taking advantage of you.
How credits relate to inflation in health insurance costs aside, the overarching problem with the credits isn’t that they don’t work or aren’t fair, it is that the complex system they are part of means that people people end can end up in really psychologically intense situations without ever understanding how they got there.
In fact, the range of situations and what to do about them are so complex, I can’t even fit them in this page and keep it at a reasonable length.
I will say this though, be careful of the subsidy cliff. Going over 400% FPL after taking credits can mean repaying a ton of money. And that means going over it by a little is almost never the right move… yet, still, if you think you might go over and want health insurance, it is still a good move to project under and just be ready to pay back your credits. Odd, but that is the reality.
TIP: The ACA gets a lot right, but it also has a few sticking points like the psychological effect of having to repay tax credits when one’s income changes. We cover the major ACA sticking points, so click that link to learn more about other problems with the ACA.