Some of you may remember this post I wrote last year: Circular Reference In Self-Employed Health Insurance Deduction Under Obamacare Premium Subsidy. It pointed out a circular reference math problem between the premium subsidy under Obamacare and the health care premium deduction for the self-employed.
If you are self-employed, the health care premium is deductible, which lowers your MAGI, which potentially qualifies you for a premium subsidy, which lowers the amount you can deduct because you can’t double dip, which raises your MAGI and reduces your premium subsidy, which increases the amount you can deduct, and on and on.
I wrote last year the math problem can be solved iteratively by a computer but it would be difficult to do on paper forms and worksheets.
The IRS issued guidance on this issue recently in Rev Proc 2014-41. First it acknowledged the circular reference problem:
Thus, the amount of the § 162(l) deduction is based on the amount of the § 36B premium tax credit, and the amount of the credit is based on the amount of the deduction – a circular relationship.
It confirmed iterations are the right way to solve it:
… … If the change in either the § 162(l) deduction or the premium tax credit from Steps 2 and 3 to Steps 4 and 5 is not less than $1, repeat Steps 4 and 5 (using amounts determined in the immediately preceding iteration) until changes in both the § 162(l) deduction and the premium tax credit between iterations are less than $1.
For those who don’t want to do the math over and over, the IRS also gave an alternative method, which basically stops after two iterations. Unfortunately, the alternative method gives you a lower subsidy and a lower deduction. If you want the full credit, don’t be lazy — do the math!
Graphically speaking, the alternative method and the iterative method work like this, using one of the examples given by the IRS:
First you take the whole unsubsidized premium as a deduction. It gives you a tax credit, leaving the rest as your deduction. Taking the smaller deduction gives you a smaller tax credit. The alternative method just stops there.
More iterations will drive up both your deduction and your tax credit. Eventually they converge. In the example given by the IRS, if you don’t do the extra iterations you will leave on the table $381 in tax credit plus $527 in tax deduction.
Iterations are easy to do for a computer. I expect the tax prep programs such as TurboTax, HR Block, and TaxACT will incorporate this when they come out later this year. It will be an interesting test to see who’s on the ball, because not doing it the right way can mean a difference of $500 in how much tax you pay.
[Update:] Now we know which software programs took on the challenge and which dropped the ball. See Tax Software Bake-Off: Self-Employed Health Insurance and ACA Premium Tax Credit.
Reference: Rev Proc 2014-41, Internal Revenue Service