Employee Retention Credit: Providing Clarity and Examples
In an effort to answer your more pressing questions regarding ERC, I am offering information which was presented during our 2021 Fall Tax School as well as our topic specific…
December 20th, 2021
It’s time for fourth quarter planning.
In today’s blog, Tom O’Saben discusses how fourth quarter planning will be influenced by the tax law changes impacting clients who purchased health insurance on the marketplace, and how these changes can affect the projected estimated tax payments, or perhaps even purchases or other decisions that taxpayers might make as 2021 winds down.
by Tom O’Saben, EA
Hello again, everybody. Tom O’Saben coming to you from the University of Illinois Tax School with our blog of the week.
What we’re going to talk about today is fourth quarter planning, with the tax law changes impacting our clients who purchased health insurance on the marketplace, and what impact could that have on projected estimated tax payments, or perhaps even purchases or other decisions that taxpayers might make as the as the waning days of 2021 are upon us.
Once again, my name is Tom O’Saben, I’m an enrolled agent and the Assistant Director for Professional Education and Outreach for Tax School. I’m also a Fall Tax School instructor, and an author and reviewer of the University of Illinois Federal Tax Workbook. I’ve also been a tax practitioner for more than 30 years.
Let’s begin with an overview of our discussion. It’s critical to understand that when I’m talking about planning with premium assistance, we’re talking about only those taxpayers who purchased their health insurance through the Marketplace. This doesn’t apply to all taxpayers
What we need to understand is that the American Rescue Plan for 2021 and 2022, has, in fact eliminated the 401% of the federal poverty line “tripwire” for those clients who received premium assistance from the marketplace, if their family income hit four times, or 4.1 times the federal poverty line, would owe it all back. Or if they didn’t get any premium assistance, they certainly weren’t entitled to any.
The discussion is not the same as the 2020 ARPA provision which said that nobody owed any advanced premium tax credit back, even if they were over 400% of the federal poverty line. Remember that was a 2020 provision only.
The provision we’re talking about today is the fact that there’s no tripwire, and that fact might provide some planning opportunities for our clients.
The American Rescue Plan says, no one should pay more than 8.5% of their household income for health insurance purchased through the marketplace in 2021 and 2022 only. The provision is §9661. And again, it’s only for 2021 and 2022.
So, let’s talk first of all about what is the federal poverty line. Now, the chart we have for you is from our small business chapter in the 2021 Federal Tax workbook on page 382. And these guidelines are coming to us as of 2021. These limits will change for 2022. But say, for example, that you do have a family size of two, the federal poverty line is $17,420, as I show you right there. That being said, to determine what four times the poverty line is, you take 17,420, and multiply it by four, you’re going to be right below $70,000. That results used to represent the tripwire, which for 2021 and 2022 is in fact gone. I wanted you to understand the poverty line as we go forward.
Now, here’s what ARPA has done for 2021 and 2022. Rather than saying, if you looked at what the chart used to say, (which I didn’t produce for you, so as not to confuse the situation) is that there is no premium assistance once we hit 401% of the federal poverty line. But what you see here is it says that if we’re at 400% and higher of the federal poverty line, then that’s the supporting statement to what I just mentioned, from PL 117-2, which says, for those taxpayers who purchase health insurance on the marketplace, they should not have to pay more than 8.5% of their household income. This means that even higher income taxpayers may in fact, qualify for Premium Assistance.
That’s the takeaway today and it will impact your decision about whether or not clients are going to have to pay a fourth quarter estimate, in addition to some other planning ideas, which we’ll get into in just a moment.
So, let’s look at an example that I put together here and includes information from the 2021 form 8962. In particular, I want you to see that we have a household family of two, and their income was $125,387. That’s what we’re projecting their income is going to be this year. When you look at what the federal poverty line was before – remember that chart? It was $17,240? Well, look what’s happening here, they are at 727% over the federal poverty line. Everybody see that? Maybe I should do a little bit of erasing here. They’re at 727%. And to get back to my marker here, 727% of the federal poverty line, which if this was not tax year 2021 or 2022, there’s no way they would be eligible for any premium assistance. In fact, the law says, thanks to ARPA that even though we’re at 727% of the federal poverty line, these taxpayers should not pay more than 8.5% of their income, which on an annual basis comes out to be $10,658 or 888 per month, I would think that is absolutely fascinating to you.
Let me show you down here what happened in our example. This taxpayer, still living under the guise of, oh my gosh, if we get to 400% of the poverty line, I’m going to owe everything back that I that I got in premium assistance, so they didn’t request any premium assistance.
This taxpayer went ahead and purchased their insurance on the marketplace, and they paid $23,988, which I have there for you at the bottom of the page. One of the things that you might then have to do is go out and find what the second lowest cost silver plan might cost. You may have to go to the marketplace in order to get that information if you have the client’s 1095-A, and this part is blank.
Well, here’s where the rubber meets the road. Look what happens right here. This taxpayer should only have to pay $10,658. And that’s reconciled down here as well. So, what that says is, if you take that $10,658 contribution, and compare it to the second lowest cost silver plan, that difference is $19,342. Okay, that’s the maximum amount of premium assistance that the client could be entitled to. And guess what; the client is entitled to a $19,342 premium assistance now when their 2021 return is filed.
Are you kidding me?
This is exactly what’s going on in this new law for 2021 and 2022 only. I actually had this circumstance in discussion with a client just this past Saturday. And we were projecting based on the $125,000 of income, that they would have about a $13,000 tax liability. And I told them, I’m not going to have you pay in a fourth quarter estimate, but I want to be able to test this in software, which I was just able to do with the early release of our software. And I said at the very least what I was thinking was that the client should be entitled to the difference between what the $10,658 expected contribution should be and what they actually paid. So that would be about a $13,000 difference. And that’s what I told the client, but I said I want to be able to test that. But in fact, what it says is that the maximum assistance now is based on that second lowest cost silver plan. So that’s why it’s going to be important to check that out. Because instead of a $13,000 credit, we’re looking at a $19,000 credit. This is just fascinating to me.
So how does this impact you’re planning with that client here in the fourth quarter as we wrap up 2021? Well, just as I described earlier, should the client in fact be thinking about making a fourth quarter estimated tax payment? Or can they skip it?
Is there any benefit to going ahead and expensing equipment this year? Well, there could be if you think about it in terms of the chart I showed you earlier. Is it possible that we could actually get the client’s Expected Family Contribution lower than 8.5%?
Remember the chart earlier where it said 6% or 4% or 2% or zero?
Would that also get into the implication of funding retirement, lowering taxable income, which would possibly bring that 8.5% down?
Is there a benefit in in doing one of these choices?
You’re going to have to have that discussion with the client. What we decided was, we weren’t going to go ahead and do a fourth quarter estimate, because it looks like we’ll get enough premium assistance on the 1040. We didn’t get any advance. Remember, again, the client asked for no advance. We decided not to write off any equipment this year because of the fact that we’re already at zero, and the client didn’t want to spend any more money.
Would funding retirement make any sense? I suggested that if they did want to fund their retirement that they actually fund Roth. They have a solo 401k. They’re self-employed people. I said, “talk to your broker about maybe funding a Roth alternative this year, because of the fact that with this premium assistance, your net federal tax is going to be zero.” So, it doesn’t make any sense to me, for the taxpayer to fund a deductible 401k, other than the fact of getting more premium assistance back, and we know down the road, when they go to make withdrawals that would be taxed at whatever the ordinary income tax rate is at the time. I don’t think there’s that much bang for the buck, except in our world in the state of Illinois where potentially they could have an Illinois tax savings as well.
But it’s really, really important. Probably the biggest conversation we had is we have been doing for a number of years with this client. When we’ve been having large equipment purchases, we’ve been doing some Roth conversions. And we actually decided that for this year, we’re not going to do a Roth conversion. And let me tell you why. Think about the income impact that that would have. We’re going to raise the adjusted gross income. And typically with this client we convert between $25,000 and $30,000. So let’s just say that we convert $30,000. Look at the impact that’s going to have. Number one, it’s going to put them into a higher tax bracket. We can’t exceed the 8.5% expected contribution. But now it’s going to be 8.5% on another $30,000, which is going to lower that premium assistance credit. So I think when you look at those two factors, I personally think the impact of a Roth conversion in this environment didn’t make any sense. But I wanted to throw it out there to you, as some thoughts in working with that client.
A second and third point to consider. Would it make sense to write off equipment and fund retirement from the standpoint of lowering that 8.5%? It didn’t make sense in this analysis, but it’s something that you might want to think about. And then this Roth conversion was actually the determination that no, we don’t want to accelerate income into this tax year, even though we are probably in the lowest tax bracket we may ever see. But it’s going to cause us to have a higher 8.5% expected contribution, which is going to lower that premium assistance. And it’s also going to throw us into a higher tax bracket. Now I could certainly see the argument which would say, this year or next year are the absolute years to do Roth conversions, because we’re still going to have some assistance coming back to this specific client. They’ve never gotten any premium assistance and didn’t ask for any, and the premium assistance would help to offset the tax consequence of the Roth inclusion as income.
So, parting thoughts for you to consider. Share them with your client. Have a discussion. But I want to leave you with as much information as possible. And I’ll tell you more importantly, I wanted to test the application of the American Rescue Plan on this ability for clients to get premium assistance now, no matter what their income is. But I want to caution you that for those clients who under projected their income to the marketplace, you know, when that’s compared to 8.5% or 6%, or 4%, wherever their final income falls, they could still owe some premium assistance back.
The example I’ve given you in these slides here really deals with the fact that the client did not receive any premium assistance and didn’t ask for any. But I do want you to understand there will still be a reconciliation, where clients could owe money back. But like in our case, they’re getting a whopping assistance now, even though their income is way beyond four times the poverty line, which you saw on the form 8962 earlier where it actually was more than seven times the federal poverty line.
Thoughts to ponder as you’re dealing with your clients here going into the 2021 filing season. Best of luck to all of you. Thanks for your attention.
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