Q. Under the ACA, my insurance premium subsidy is dependent on adjusted gross income (AGI). But, for a self-employed person, AGI is dependent on the insurance premium, since premiums are deductible for the self-employed. How does this work, given how circular it is?
(NOTE: The following example includes the American Rescue Plan’s temporary elimination of the “subsidy cliff,” which has been extended through 2025 by the Inflation Reduction Act. This may or may not be further extended by Congress, so it’s important to understand that unless the ARP’s changes are made permanent, the subsidy cliff would reappear in 2026. This would mean that subsidy eligibility would end altogether at 400% of the poverty level, as opposed to just being reduced.)
Here’s the example scenario:
My husband and I are both 55 and have an AGI of $70,000 before accounting for health insurance. Where we live in Illinois (60647 zip code), that results in a 2024 premium subsidy of $962 per month, and an after-subsidy premium of $432 per month for the benchmark plan, which is the plan we selected for 2024.
Since we’re self-employed, we can deduct that $432 per month (the amount we pay after the subsidy) using the self-employed health insurance deduction (line 17 on Schedule 1 of Form 1040). But that brings our ACA-specific MAGI down to $64,816. That, in turn, increases our premium subsidy to $1,029 per month, which reduces the amount that we pay ourselves and thus reduces our deduction. So the calculation becomes circular — how do we determine how much our premium tax credit is and how much we can actually deduct using the self-employed health insurance deduction?
A. This can be a complex situation, and our answer is intended to serve as an overview of how the subsidy calculation works; always seek help from a qualified tax professional if you have questions about your specific situation.
First, it has to be noted that a Marketplace enrollee’s total out-of-pocket health insurance premiums (and thus the maximum amount that can be deducted using the self-employed health insurance deduction) is determined after final premium tax credit calculations are completed. In other words, it doesn’t matter how much you pay each month after your advance premium tax credit (APTC) is applied. What matters is how much you actually paid for your coverage after your APTC has been reconciled on your tax return. This is clarified in Publication 502, in the section about premium tax credits.
So for example, if your total premiums were $10,000 for the year and your APTC was $4,000, you paid $6,000 for your plan throughout the year. But if you ultimately have to repay $2,000 in excess APTC to the IRS, you actually paid $8,000 for your health insurance and that’s the amount you can deduct in self-employed health insurance premiums. Conversely, if your APTC was underpaid and the IRS gives you an additional $2,000 in premium tax credit when you file your taxes, your maximum self-employed health insurance deduction will only be $4,000.
Now let’s take a look at the circular relationship between self-employed health insurance premium deductions, AGI, and premium tax credits. In July 2014, the IRS released 26 CFR 601.105, addressing this issue:
“… the amount of the [self-employed health insurance premium] deduction is based on the amount of the … premium tax credit, and the amount of the credit is based on the amount of the deduction – a circular relationship. Consequently, a taxpayer eligible for both a … deduction for premiums paid for qualified health plans and a … premium tax credit may have difficulty determining the amounts of those items.”
In the regulation, the IRS provides two methods that self-employed taxpayers can use to calculate their deduction and their subsidy. The iterative calculation will result in a more exact answer, but it is a little more time-consuming to compute. The alternative calculation is less exact (and appears to favor the IRS just slightly), but less time-consuming and easier to calculate. You have your choice of which one you want to use, and tax software should have the calculations built-in, which would make them both simple to use.
In a nutshell, both methods have you do the calculations repeatedly, getting ever closer to the correct answer (that’s what iteration means). But while the iterative calculation has you keep going until the difference between successive answers is less than $1, the alternative calculation lets you stop sooner.
The easiest way to understand how the two calculations work is to start on page 9 of the regulation and work through the examples the IRS has provided.
Note that when they mention the “limitation on additional tax,” they’re just referencing the caps on how much you have to pay back when you file your taxes if it turns out that your advance premium tax credit/subsidy (the amount sent to your health insurance company each month) was overpaid because your income ended up being higher than projected.
So in example 1 on page 9, the IRS uses $2,500 as the limitation on additional tax, because the family’s household income is between 300% and 400% of poverty (these limits vary by year; for the 2020 tax year, excess subsidy repayments were eliminated altogether, but they returned as of the 2021 tax year; for 2022, the repayment limitation for that income bracket increased to $2,800, and for 2023, it increased again, to $3,0001).
In addressing the question of the circular relationship between AGI and premium subsidies for self-employed people, the examples the IRS provides cover scenarios where the filers took advance premium tax credits as well as scenarios where they did not, since you can pay your premiums in full each month and then claim your total credit for the year when you file your taxes. The examples make the calculations relatively straightforward, although the standard advice applies: If in doubt at all, contact a tax professional for assistance.
Louise Norris is an individual health insurance broker who has been writing about health insurance and health reform since 2006. She has written dozens of opinions and educational pieces about the Affordable Care Act for healthinsurance.org.
Footnotes
- ”Part III Administrative, Procedural, and Miscellaneous, 26 CFR 601.602” p. 11, IRS.gov. Accessed February 12, 2024 ⤶
