The high price tag of health insurance can sometimes make conversations regarding the corresponding tax code provisions challenging, especially if they don’t end in the taxpayer’s favor. After the initial discussion about IRC § 162(l) eligibility, it’s time to help taxpayers understand how IRC § 162(l) sometimes bleeds into other code sections.
Two common code sections that interact with IRC § 162(l) that tax practitioners should be ready to discuss with clients are Medicare and the Premium Tax Credit.
It’s not uncommon to serve business owners on Medicare. More and more retirees are postponing traditional retirement in favor of either starting their own business or working as contractors for other companies. It’s also no secret that Medicare is heavily subsidized by the government, but the costs can add up, prompting some clients to ask if their premiums are eligible for the self-employed health insurance deduction.
When it comes to IRC § 162(l), all Medicare Parts, including A,B,C,D, and Medigap, are considered qualifying medical insurance because the IRS treats Medicare as the taxpayer’s own private policy. Accordingly, self-employed individuals may deduct Medicare premiums—including Parts A, B, C, D, Medicare Advantage, Medigap, and any IRMAA surcharges, under IRC §162(l), provided all other requirements of §162(l) are met, including the employer-plan eligibility rules. IRS Publication 535 specifically treats Medicare premiums as health insurance premiums for purposes of the self-employed health insurance deduction. However, when the taxpayer provides the amount of premiums they paid, make sure to inform them that some Medicare costs, like deductibles and copayments, are not considered premiums and are not eligible for deduction.
Even though Medicare coverage qualifies for the IRC § 162(l) deduction, don’t be too quick to tell your client they are eligible for an above-the-line deduction before inquiring about their spouse’s coverage first. It’s not uncommon for a self-employed taxpayer with Medicare coverage to have a spouse who is still working with access to private health insurance through their employer. Taxpayers with an employed spouse often fall into the trap of IRC § 162(l)(2)(B) because the employer plan eligibility rule still applies to Medicare.
Let’s consider a common scenario. One spouse is a 66-year-old self-employed taxpayer on Medicare, and the other is a 60-year-old W-2 employee who works for a company that offers a subsidized health insurance plan. If the self-employed taxpayer is eligible to participate in their spouse’s employer-sponsored health insurance plan, they lose the benefit of the IRC § 162(l) deduction. Instead, their premiums are only deductible on Schedule A as unreimbursed medical expenses. Since the Schedule A deduction has an AGI floor, it’s unlikely the taxpayer will receive any benefit.
This outcome can be frustrating for taxpayers because Medicare itself is substantially subsidized by the federal government. However, IRC §162(l)(2)(B) focuses on eligibility for an employer-subsidized plan rather than whether the taxpayer’s current coverage is subsidized. As a result, a taxpayer may be enrolled in Medicare yet still lose the above-the-line deduction if they are eligible to participate in a spouse’s employer-sponsored plan.
The Premium Tax Credit (PTC) is financial assistance for taxpayers who pay premiums for health insurance purchased through the Marketplace. Self-employed taxpayers who purchase health insurance through the Marketplace may be eligible for both the IRC § 162(l) deduction and the PTC.
The difficulty in taking both the deduction and the credit is that the PTC depends on the self-employed health insurance deduction, and the self-employed health insurance deduction can affect the amount of the PTC. If it sounds like a circular problem, it’s because it is. Calculations like these can be challenging for taxpayers to understand.
The gist of the circular math is that IRC § 162(l) deduction lowers adjusted gross income (AGI), and a lower AGI increases the PTC. A higher PTC means the taxpayer paid less out of their own pocket, so the IRC § 162(l) deduction is less, which means AGI is higher. A higher AGI means the PTC is less, and the loop continues.
So, how does one resolve this continuous problem? Luckily for practitioners, tax software will complete the circular calculation, so the headaches don’t pile on. For everyone else, the IRS provides two calculation methods in Revenue Procedure 2014-41. Even though the software does the heavy lifting, practitioners need to understand these two calculation methods to explain them to taxpayers and why their deduction doesn’t match their Form 1095-A premium. Clients often assume the full amount reported on Form 1095-A will be deductible; however, the interaction between the deduction and the credit means the final deduction and credit are frequently lower or higher than expected after the circular calculation is completed.
The Revenue Procedure outlines the two methods: the iterative calculation and the simplified method, with an example to illustrate. The percentages used in the following example are taken from the Revenue Procedure’s illustration and are intended to demonstrate the mechanics of the calculation rather than current Premium Tax Credit percentages.
The calculation starts with a simplified calculation, which is broken down into four steps.
Step 2: Calculate the PTC based on the household income from Step 1.
Step 3: The IRC § 162(l)deduction is recalculated based on the PTC from Step 2. AGI is then also recalculated based on the reduced IRC § 162(l) deduction.
Step 4: The PTC is recalculated based on the household income from step 3.
If the taxpayer uses the simplified method, the calculation stops at Step 4. However, if the taxpayer chooses to use the iterative calculation, steps 3 and 4 repeat until the changes between iterations of steps 3 and 4 are less than $1.
| IRC § 162(l) | PTC | |
| Simplified | $6,322 | $6,770 |
| Iterative | $6,849 | $7,151 |
The additional work of the iterative calculation pays off with an increased deduction and credit, which is valuable to highlight to your taxpayer.
With more taxpayers feeling the burden of the cost of healthcare, the self-employed health insurance deduction can be a helpful benefit, but it’s not as simple as many expect. As tax practitioners, we need to be aware of the qualifications, limitations, and overlapping code sections to better advise our clients. Being proactive and having conversations in November and December during open enrollment can help taxpayers make decisions that work in their favor rather than waiting until March or April to learn the damage is already done.
Missed Part 1? Read Part 1: Self-Employed Health Insurance Deduction: Understanding the Eligibility Trap in IRC §162(l) for additional background on the eligibility rules.
By Ashley Akin, CPA
Sources
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