How the Health Insurance Premium Assistance Tax Credit Impacts the Self-Employed Health Insurance Income Tax Deduction

Starting in 2014, taxpayers having household income below 400% of the Federal poverty line will receive a premium assistance tax credit if they purchase health insurance on a government health insurance exchange or marketplace.  Currently there is a legal challenge as to whether this credit is permitted if the purchase is made on the Federal exchange instead of on a State exchange (see my previous blog article for a brief description of the challenge).

Generally, self-employed individuals may deduct the cost of health insurance premiums as an adjustment for Adjusted Gross Income.  How is this deduction calculated if a premium assistance tax credit is received?  Surprisingly, the calculation is extremely complicated!  The deduction is limited to the lesser of:  1) the amount of the premiums paid less the premium credit claimed on the tax return, or 2) the sum of the premiums paid as reduced by an advance of the premium credit plus any required repayment of excess premium credits advanced once the income tax return is completed.  Many people ask for the premium assistance tax credit to be advanced in order to reduce their monthly premium cash expense.  Since the amount of the premium credit is based upon an estimate of AGI, a portion of the advance may be required to be repaid on the income tax return if the estimate of household income was too low.  Because household income is based upon modified AGI, and because AGI is reduced by the amount of the self-employed health insurance deduction, the amount of the premium tax credit changes based upon the amount of the deduction, and the deduction changes based upon the amount of the credit!  This is a circular calculation.

In Revenue Procedure 2014-41, the Internal Revenue Service provides instructions on how to compute the self-employed health insurance deduction as impacted by the premium tax credit.  The revenue procedure provides an iterative and an alternative calculation method in an attempt to resolve the circular computation.  Either method may be used.  Based upon the examples provided in the revenue procedure, the amount of the deduction and the amount of the premium credit may both be larger in many cases if the more complex iterative calculation method is used.  These complex calculations will require the use of a computer!  Thus, self-employed taxpayers who qualify for both the deduction and the premium tax credit will need good tax software and/or the services of a tax advisor in order to calculate the deduction and the credit.