When you are self-employed, your health insurance premium is tax deductible above the line. If you are getting a premium subsidy tax credit when you buy insurance from the exchange under Obamacare, you can’t double-dip. You can only deduct the net, unsubsidized premium.
The subsidy of course depends on your MAGI, which depends on your above-the-line deductions. We have this nice circle going.
So how do you figure out how much you are allowed to deduct?
I don’t know whether the law or the regulations already spelled this out. Mathematically you can solve it by iteration.
You start out with the full health insurance premium as the tentative deduction (D0). It lowers your MAGI, which gives you a subsidy, which lowers your unsubsidized premium allowed as a deduction (D1).
Then you start reducing the tentative deduction D0, which increases your MAGI, which lowers your subsidy, which raises your allowed deduction D1. This narrows the gap between D0 and D1.
You do this over and over again until the two numbers D0 and D1 converge to the same value.
Here’s a math exercise for the numerically inclined:
Suppose your modified adjusted gross income before any self-employed health insurance deduction is $60k and it falls between 300% and 400% FPL for a family of two. Suppose the second least expensive Silver plan for you costs $9,600 a year and that’s also the plan you choose. How much of the $9,600 can you deduct? Remember the formula for the subsidy:
Subsidy = Cost of 2nd least expensive Silver – MAGI * X%
This simple example can be solved algebraically. When that X% number depends on a lookup table, it gets more complicated.
|up to 133% FPL||2.0% of MAGI|
|133-150% FPL||3.0 – 4.0% of MAGI|
|150-200% FPL||4.0 – 6.3% of MAGI|
|200-250% FPL||6.3 – 8.05% of MAGI|
|250-300% FPL||8.05 – 9.5% of MAGI|
|300-400% FPL||9.5% of MAGI|
|above 400% FPL||full cost|
It would still be very easy for a computer to get the answer by trial and error. I’m sure tax software will be able to do the iterations under one second. I don’t know how the IRS will come up with instructions for people to do it with pencil and paper though.
[Updates:] The IRS issued guidance on how to calculate the subsidy tax credit and the deduction. Read more in IRS Guidance On Circular Reference in Obamacare Premium Subsidy and Deduction. Some tax software programs incorporated the iterative calculations. See Tax Software Bake-Off: Self-Employed Health Insurance and ACA Premium Tax Credit.
[Photo credit: Flickr user jieq]