The Tax Cut and Jobs Act, passed in December 2017, added a new 20% income deduction for some self-employed and small business owners complicating the task of estimating their Modified Adjusted Gross Income for the Covered California tax credit subsidy. All the IRS guidance as of October 2018 indicates that the income deduction will reduce the Adjusted Gross Income for small business owners, which will in turn, impact their Premium Tax Credit and eligibility.
I am not a tax professional and I am not giving tax advice. I offer the following thoughts to help Covered California health insurance consumers consider the implications of the new tax reform laws and how it might impact their Premium Tax Credit.
Self-Employed Income Estimating
Once of the most difficult tasks for self-employed and small business owner’s is estimating their future income on the Covered California application. If you estimate too high, based on optimistic business scenarios, the Modified Adjusted Gross Income (MAGI) is over 400% of the federal poverty level and no monthly subsidy is awarded to reduce the health insurance premiums. If you estimate the MAGI too low, below 138% of the federal poverty level, the individual or household is deemed Medi-Cal eligible.
Trump Tax Cuts Could Drop Covered California Consumers Into Medi-Cal
The new tax reform legislation that applies to the 2018 tax year that includes a 20% income deduction for self-employed individuals and small business owners may affect both 2018 and 2019 tax credit subsidies. For 2018 income estimates through Covered California, the final MAGI and any monthly tax credit subsidies will be reconcile on the tax payer’s tax return in 2019. Retroactively reducing the 2018 MAGI may put the household income below the threshold for actually being eligible for the Premium Tax Credits in 2018. Conversely, households who thought their MAGI would be too high for the Covered California subsidy may realize that they were eligible if they factored in the new 20% income deduction.
20% Income Deduction For 2018 and 2019
All of this hinges on where the IRS puts the 20% income deduction on the revised 1040 tax form. If they put the deduction above the Adjusted Gross Income (AGI) calculation (line 37 of 2017 Form 1040) then it will certainly reduce the MAGI. If they put it after the AGI line it will have no effect. The other wildcard is if the IRS modifies Form 8962 the Premium Tax Credit reconciliation worksheet not to include the 20% income deduction.
Unfortunately, the IRS usually doesn’t release the updated current year tax form until December of the current year or January of the next year. This may be too late for some households to enter Covered California if they realize that their income will be lower and they do indeed qualify for the tax credit subsidy. January 15, 2019, is the last day to apply for a Covered California health plan during open enrollment and qualify for the subsidy.
Consumers currently in Covered California will be able to adjust their income lower after the new year and receive a larger premium tax credit subsidy. But what if the lower MAGI makes the individual or household eligible for Medi-Cal? I have not seen any guidance on IF a tax payer has to take the 20% income deduction. Some tax payers have speculated that they can increase their annual income by not taking certain deductions to lower their MAGI. However, there are IRS rules that require some business expenses and capitalization be included in the income calculation for a small business.
We don’t know if the 20% income deduction must be taken on the federal tax return. One situation might be an individual who has self-employed income of $18,000 per year. This individual is older and receives $500 per month subsidy or $6,000 annually. If this person takes the 20% income deduction of $3,600 ($18,000 x 20%), and reports that income change to Covered California, the new income would be $14,400. They would then be Medi-Cal eligible. If they are not mandated to take the 20% income deduction, they can keep their private health insurance plan and the Covered California subsidy.
Lower MAGI May Make Children Medi-Cal Eligible
For the family of a small business owner, the reduction of the MAGI because of the 20% deduction could drop any dependents under 18 years old into Medi-Cal. A family of four earning $70,000 makes all the household members eligible the tax credit subsidy through Covered California. If the family reduces their income by the 20% deduction, the new income is $56,000. That is below 266% of the federal poverty level for a family of four and all dependents 18 and younger are then deemed eligible for Medi-Cal.
Lower Income, More Subsidy From Covered California
On a bright note, the 20% deduction may lower a household income below 400% of the federal poverty line making them eligible for the premium tax credit subsidy through Covered California. Similarly, many households will see their MAGI decrease which means their premium tax credit subsidy will increase. They may even be eligible for an Enhanced Silver Plan 73, 87, or 94 with the reduced cost-sharing benefits. But making accurate changes to the income is dependent on the IRS making available the instructions for the 20% income deduction.
All of technical conditions of the 20% pass through income deduction for self-employed and small business owners are complicated. As of October 2018, we are still waiting for more guidance from the IRS and Covered California. Because this deduction, and tax reform changes, will affect a family’s Modified Adjusted Gross Income, for people with self-employed (Schedule C) income, I thought it best to at least get the information out there.
The best case scenario is that the tax changes will have little effect qualifying for the subsidies through Covered California. The worst case scenario is that people will have to really study their tax situation in order to better estimate their 2019 income when receiving subsidies from Covered California.