How a Health Insurance Subsidy Could Cost You Big Time

If you buy your health insurance through the exchange in your state and a premium subsidy (advance premium tax credit, or APTC) is paid on your behalf to offset the premium amount you have to pay each month, it's important to understand how this gets reconciled on your tax return.

If your actual income for the year ends up being more than you projected when you enrolled, you might have to pay back part or all of your health insurance premium subsidy when you file your taxes.

For 2020, people do not have to repay any excess APCT, thanks to the American Rescue Plan (ARP). The ARP has also made changes to general subsidy eligibility for 2021 and 2022, although premium tax credits for those two years still have to be reconciled on tax returns. This article explains how it all works and what you need to know.

Doctor discussing health insurance subsidies with patient
Pattanaphong Khuankaew / EyeEm / Getty Images 

Actual vs. Estimated Income

The amount of premium tax credit health insurance subsidy you were awarded when you enrolled in your health plan (or when you reported a change in circumstances to the exchange mid-year) is based on an estimate of your income for the year you’re receiving the subsidy.

Income is calculated as an ACA-specific version of modified adjusted gross income. If the estimate matches what you actually make, you won’t have a problem. But, if you get a raise, a bonus, an inheritance or other windfall, or your income varies from year to year, you could accidentally underestimate your income.

If you get married, your total household income for the year (which is what the IRS counts) could increase significantly.

Regardless of the reason, if you underestimate your income when you enroll in your health coverage, the health insurance subsidy that's paid on your behalf throughout the year might be larger than the actual amount you’re supposed to get, which won't be determined until you file your tax return.

Advanced Payment Option Raises Risk

As its name suggests, the premium tax credit health insurance subsidy is a tax credit; it’s credited to you when you file your taxes after the year is over.

However, because it’s hard to pay your health insurance premium this month using funds you won’t receive until next spring when you file your taxes, the Affordable Care Act allows the tax credit to be paid in advance.

If you choose the advanced payment option, the subsidy money is sent directly to your health insurance company each month. This decreases the monthly premium you pay for health insurance. You don't have to wait until you file your taxes; the advanced payment option helps you afford health insurance right now.

Because they need the subsidy money to help make their monthly health insurance payments, most people take their health insurance subsidy as an advance payment (this is called an advance premium tax credit, or APTC). However, with the advanced payment option, if you underestimate your income on your subsidy application, you risk receiving an entire year’s subsidy based on an incorrect income estimate.

Having to Pay the Subsidy Back

When you receive the premium tax credit health insurance subsidy, part of preparing your federal income tax return is a process called reconciliation.

In this process, you compare the amount of subsidy the government actually paid your health insurance company with the amount it should have paid based on your true income for the year. If those two amounts are different, you will “reconcile” them when you file your taxes.

Overestimating Your Income

If you overestimated your income for the year, then the subsidy the government paid in advance to your insurer was smaller than it should have been. No harm; no foul. The difference will be added to your tax refund or will decrease the amount of taxes you owe.

Note that if you overestimated your income and then your actual income ends up being under the poverty level (ie, too low to be eligible for subsidies at all) the IRS will not make you repay your subsidy, but you also won't get any additional subsidy when you file your taxes.

And if that happens, you will also have to prove your projected income when you renew your coverage for the coming year; if you let your plan auto-renew and the most recent tax return on file shows your income as being under the poverty level, your plan will be auto-renewed but without a premium subsidy.

(As is always the case, you'll be able to claim the premium tax credit when you file your next tax return, assuming you do end up with a subsidy-eligible income that year. And if you have proof of your higher projected income, you can submit it to the exchange/marketplace in order to start receiving APTC in real-time throughout the year.)

Underestimating Your Income

If you underestimated your income for the year, then the subsidy the government paid in advance to your insurer was more than it should have been. You’ll have to reconcile that by​ paying back some or all of the excess when you file your taxes.

If the amount you have to repay is $15, it probably isn’t that big of a deal. But, if it’s $1,500 and you have to come up with it unexpectedly on April 15, it’s a much bigger deal.

Even worse, the "subsidy cliff" that existed from 2014 through 2020 (and that will exist again after 2022 unless additional legislation is enacted to extend the American Rescue Plan's provisions) meant that some people had to repay the entire amount of the APTC that was paid on their behalf during the year. This was the case if the household's income went over 400% of the prior year's poverty level, even if that happened due to an income increase or unexpected windfall right at the end of the year. This could be thousands of dollars if you badly underestimated your income or if you live in an area of high health insurance premiums.

Fortunately, the American Rescue Plan has eliminated the "subsidy cliff" for 2021 and 2022. Instead of having premium tax credits end abruptly when income reaches 400% of the poverty level, the ARP ensures that people who earn more than that amount can receive a premium tax credit if the cost of the benchmark plan would otherwise amount to more than 8.5% of their household income.

And since the COVID pandemic made it so challenging to accurately predict income amounts for 2020, the American Rescue Plan also ensures that marketplace enrollees do not have to repay excess APTC from 2020, regardless of the amount or reason they would otherwise have had to do so.

Cap for Subsidy Repayment

Form 8962 is used to reconcile premium tax credits. And in most cases, the IRS has limits on how much of your overpaid subsidy you'll have to repay (detailed in Table 5 of the instructions for Form 8962; note that these amounts are indexed each year for inflation).

Prior to the American Rescue Plan's changes, the cap on subsidy repayments only extended to households earning up to 400% of the poverty level; enrollees with income above that level had to repay their entire advance premium tax credit.

In 2021, the IRS is reviewing Publication 974 (which pertains to tax credits) to see what changes are necessary under the American Rescue Plan. So we don't yet know whether households with income over 400% of the poverty level—some of whom are eligible for premium subsidies in 2021 and 2022—will have a cap on how much excess APTC has to be repaid. But because many of these households are now subsidy-eligible, they will not face the prospect of losing the entire subsidy due to just a few dollars of additional income (as was the case when the subsidy cliff was in place).

Depending on your income and your tax filing status, the maximum amount you'd have to pay back varies from about $320 to $2,700, depending on your tax filing status and your actual income assuming your income makes you eligible for at least some amount of premium subsidy. (The repayment caps are indexed for inflation; those numbers would have applied to 2020 tax returns, but the American Rescue Plan has eliminated all APTC repayments for 2020.)

Even if your subsidy was $10,000 for the year and it turns out that it should have only been $5,000—they won't make you pay it all back unless it turns out that you shouldn't have received any subsidy at all.

IRA Contributions Might Help

It's also important to understand that "income" means Modified Adjusted Gross Income (MAGI) and the calculation for that is specific to the ACA—it's not the same as general MAGI calculations that are used for other tax purposes.

So if it's looking like your income is going to be higher than you anticipated, know that a contribution to a traditional IRA (and/or an HSA if you have HSA-qualified health insurance) will reduce your MAGI and help you limit how much of your premium subsidy has to be repaid to the IRS.

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Article Sources
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  1. Internal Revenue Service. Premium tax credit: claiming the credit and reconciling advance credit payments.

  2. Norris, Louise. If my income is less than expected this year, I might be eligible for Medicaid. What can I do to cover my bases? June 17, 2020.

  3. Federal Register. Department of Health and Human Services. Patient Protection and Affordable Care Act; HHS Notice of Benefit and Payment Parameters for 2019. April 17, 2018.

  4. Advance premium tax credit (APTC).

  5. Internal Revenue Service. Premium Tax Credit - The Basics.

  6. Internal Revenue Service. 2020 Instructions for Form 8962.

  7. Internal Revenue Service. Instructions for Form 8962, Table 5.

  8. UC Berkeley Labor Center. Modified adjusted gross income under the affordable care act. July 2014.

  9. Norris, Louise. With my income, I’m barely over the eligibility limit for a premium subsidy. Is there anything I can do to lower my income so I become eligible? May 10, 2020.