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Net Investment Income Tax (NIIT)

By Bob Palechek, CPA | October 2, 2020

Today’s blog is about Net Investment Income Tax, otherwise referred to as “NIIT”.   NIIT came into existence on January 1, 2013, and applies to individuals, estates, and trusts.  The focus for today is on individuals.

NIIT is a tax on certain types of investment income applied at 3.8% if the taxpayer has income above certain income thresholds.   The income thresholds for single filers is Modified Adjusted Gross Income (MAGI) above $200,000.   For married filing jointly files, the MAGI amount is $250,000.  These thresholds have been the same since 2013 and are not indexed for inflation.

The 3.8% is applied to the lower of net investment income or the amount of your MAGI that exceeds the applicable threshold amount.   For example, if a married couple has net investment income of $150,000 with a MAGI of $305,000, then the 3.8% tax will be applied to $55,000 (since $305,000-$250,000 is lower than $150,000).   In this scenario, the NIIT tax reported and owed will be $2,090.  The calculation and reporting of NIIT is found on IRS Form 8960.

Types of Investment Income included in NIIT:

-Interest and dividends (including qualified dividends)

-Capital gains and capital gain distributions

-Rent and royalty income

-Non-qualified annuities

-Income and gains from passive activities (where the owner is not involved)

-Gains from the sale or disposition of those passive activities

Types of Investment Income not included in NIIT:

-Tax-exempt interest

-Distributions from qualified plans (typical IRA’s ROTH’s, and 401(k)’s)

-Any portion of the gain on your home if excluded under Section 121.

So RMD’s from my IRA are not subject to NIIT?   Correct, but if the RMD amount raises your MAGI above the applicable threshold, it will trigger NIIT on your net investment income.  This is especially important when looking at Roth Conversions!  If this causes an additional 3.8% tax on your investment income, it should be factored into the current cost of the Roth Conversion.  Fortunately, the tax planning software we utilize factors all of this into the Roth Conversion Analysis plans we perform for our clients.

One last common item that I see preparers miss on tax returns:   If a business that you own and operate rents from real estate that you also own, a sale of that real estate that generates a capital gain is excluded from NIIT.  The IRS allows the gain to be considered as part of the business activity and not subject to the 3.8% additional tax, if applicable.

Tax Planning With Charitable Donations

By Bob Palechek, CPA | August 7, 2020

This article is to provide you a summary of how charitable deductions work, what is allowed and not allowed, limitations, and new items (see end of article).

Charitable donations are deducted on Sch A as itemized deductions.  With the increase in standard deduction amounts (now $24,800 for married filing jointly) along with a $10,000 limit on State and Local Taxes (SALT), breaking the threshold for claiming itemized deductions versus the standard deduction is harder than ever.  This means while your charitable intent is a good thing, it may not necessarily bring tax savings.  At least through 2025, after that we go back to the old rules.

It can therefore make tax planning sense to lump or bunch together charitable donations in every other year.  Trying to max out a year to receive a tax benefit.  Charity paid with a credit card counts in the year of the credit card charge and not when you pay the credit card.  Donor-advised funding can help with breaking the threshold in the year of the donation then spread the gift in smaller amounts to specific charities over several years.

Allowable donations include; money or property donated to churches, synagogues, temples, mosques, other religious organizations, non-profit schools and hospitals, public parks, and public charities.  If you are unsure, please visit WWW.IRS.GOV.  The IRS maintains a database of qualifying charities.

Non-Allowable donations include; money or property donated to civic leagues, sports clubs, chambers of commerce, most foreign organizations, individuals and politicians.  If you are unsure, please ask your tax person.  An addition to this category began in 2018, if you make a payment to a college for the right to purchase sporting event tickets, that payment is no longer deductible!

Substantiation of donations that do not exceed $250 in any one day to anyone organization can be supported by bank records.  Cash donations require written acknowledgment from the Charity as well as all donations that exceed the $250 rule.

Non-cash donations, the most popular being made to resellers of thrift goods.  Think clothing, books, household items, electronics, etc.  Best practice is to keep detailed records of precisely what you donated, exact quantities, and fair market value of each item.  Larger claimed deductions should have the best records.  The IRS has taken several taxpayers to court previously and were successful in their efforts.  The Courts believed the donations occurred but denied the deduction because there were no detailed records to back-up the donation deduction.

If you make a donation but receive something in value in return, the fair market value of what you receive needs to be deducted from the donation amount.  For example, if you bid on a gift basket at a charitable auction, only the amount you actually pay above the value of the gift basket is deductible.

There are limitations in how much you can deduct each year.  Cash donations are limited at 60% of adjusted gross income currently through 2025, then back to 50%.  Capital gains property, for example, stock in a public company is limited to 30% of adjusted gross income.  This can be a nice tax planning tool if you have some highly appreciated stock, as you get the fair market value as a possible deduction on Sch A and can avoid paying capital gains tax on the appreciation.  If you choose to only deduct the cost of the stock, you can obtain a 50% limitation, but this would be kind of unusual.  The good news, anything not allowed by virtue of a limitation can carry forward for up to five years.  The same percentage limits carry forward as well.

New for this year only (CARES Act):  The limitation for cash donations is now 100% of AGI, not 60%.  You can shelter all of your taxable income this year with a charitable donation.  The same five-year carryover rule applies.  Also, under CARES Act, anyone can claim a $300 charitable deduction without having to itemize.

Medicare Part B Benefits, IRMAA, and Tax Impacts

By Bob Palechek, CPA | June 19, 2020

Medicare benefits provided to eligible retirees come in various “parts” that apply benefits to various different health-related services.  Two parts, parts B & D, are funded primarily by general revenues (transfers from the U.S. Treasury) and premiums paid by enrollees.  Premiums paid by enrollees are either deducted from monthly social security benefits or billed separately if the enrollee is currently not receiving monthly social security benefits.

Part B beneficiary premiums are set each year to approximately equal 25% of the average expected Part B program costs for the year.  For 2020, the standard monthly Part B premium is $144.60.   Just for reference, Part B premiums started in 1966 at $3 a month!  The current estimate is for Part B premiums to increase to $234.10 a month by 2029.

Beginning in 2007, people receiving Part B benefits who are considered high-income earners can be subject to higher premiums on their monthly Part B portions.  These higher premiums are designated as income-related monthly adjustment amounts (IRMAA).  Initially, there were four levels, 35%, 50%, 65% and 80%.  So instead of paying 25% of the average expected annual costs, the “co-pay” increases to one of these higher rates, depending on income.  Beginning in 2019, a fifth bracket was added for 85%.  For 2020, the current co-pay monthly amounts for the five higher brackets are $202.40, $289.40, $376.00, $462.70, and $491.60.

For married filing jointly returns, the income test is Modified Adjusted Gross Income (MAGI) and the first tier (35%) currently begins at $174,001.  This is indexed for inflation, but legislation has been passed in the past to lock the thresholds in place.  This has been done to increase revenues, as retiree’s income rises more and more folks run into these thresholds or into higher tiers.  There is no phasing within these tiers, one dollar over the minimum or threshold level subjects you to the whole increase.

The Social Security Administration (SSA) borrows information from the IRS to find out who is subject to IRMAA.  The IRS shares MAGI for each taxpayer from the tax return filed two years in the past.   For example, for calendar year 2020 the SSA will use the MAGI from your 2018 tax return.  MAGI is essentially your Adjusted Gross Income (AGI) plus tax-exempt interest and some foreign earned income.  Once you are subject to IRMAA, it will last the full year but will be adjusted again on January of the next year based upon the amounts from the subsequent years tax return filed  (still two years behind).  There are about eight life-changing events the SSA allows for you to estimate your new current income to escape the IRMAA grasp, but you have to file a form with the SSA and provide support for your life-changing event.

Can you catch a tax deduction for either the standard Part B premium or a higher adjusted Part B premium under IRMAA?  Well perhaps!!  First of all, the premium can be deducted as a medical expense or an itemized deduction on Sch A of your 1040.  There are a couple of hurdles to jump to obtain a tax benefit this way.  Only medical expenses that exceed 7.5% of your AGI (currently expected to increase to 10% in 2021) are counted toward itemized deductions.  And the medical expenses that are allowed plus your remaining itemized deductions have to exceed your standard deduction.  Which as you know has doubled for the years 2018 to 2025.

Another better option is if you have net self-employed income, say from part-time freelance or consulting income.  Then the Part B premiums are deducted as self-employed health insurance, deductions allowed towards computing your AGI, to the extent of your self-employed net income.  This is a valuable tax benefit and should not be missed!

Why You Might Want a Solo 401(k) Retirement Plan

By Bob Palechek, CPA | May 15, 2020

A Solo 401(k) – also called a one-participant 401(k) — is much like a regular 401(k) plan, and has the same rules and requirements of any other 401(k). But, it is designed for the self-employed or small business owner without eligible employees. It does allow a business owner’s employee spouse to be part of the plan and not be considered an “employee” under the plan’s rules.

Your business can also have part-time employees or employees under age 21. However, if anyone becomes eligible, they become part of the plan, and it is no longer a Solo 401(k). That means you have to manage these employees carefully. For example, a young worker can age out. Or, if a part-time employee provides enough hours of service to be considered a full-time employee, he or she becomes eligible.


A Solo 401(k) plan offers several advantages, which is why a self-employed or small business owner should look at it carefully as a retirement vehicle.

Like a regular 401(k), the plan can accept pre-tax or after-tax (or Roth) contributions. It allows for hardship withdrawals and loans, and the distribution requirements also typically follow a triggering event. (A triggering event can be death, disability, or separation of service.)

A significant advantage of the Solo 401(k) over other self-employed retirement plan options is the ability of the business owner to contribute both as the employee and the employer. That is, the business owner wears two hats.

That allows a considerably higher total contribution to a tax-advantaged retirement account than would be possible with a traditional 401(k) plan. That limit for 2020 is $19,500, plus $6,500 as an over-50 catch-up.

For starters, the 2020 contribution limits for a Solo 401(k) are also a maximum employee deferral of $19,500, plus $6,500 as a catch-up if you are age 50 or over. There must be enough wages paid, or “earned income” if a sole proprietor, to allow for the maximum employee deferral portion.

But, here is where the “two hats” come into play. As the employer, you can contribute up to either 25% of wages paid or about 20% of net self-employment income. (It is best to rely on tax software to make this calculation.) So, depending on the profits of the business or wages paid, by choosing a Solo 401(k), you can put away up to $57,000 in total funds for retirement in one year. And $63,500 for someone over age 50!

(Keep in mind that if the business owner or employee spouse is also an employee of another company and participates in that company’s 401(k) plan, the elective deferrals for their own company’s Solo 401(k) will be limited. Contribution limits are per person and not per plan.)

Here’s another advantage: by hiring your spouse, you can increase your retirement savings even more. The same contribution limits apply to each spouse. Also, as spouses, you can combine retirement funds for alternative investments, something that is not allowed in IRAs. But, as with any spouse hired in a business, it is best to be able to support the compensation with a reasonable salary for the efforts spent.

With a Solo 401(k), contributions by the business owner and spouse (if eligible) are not age-limited. This fact used to be an advantage over traditional IRAs, where you could only contribute up to age 70½. But, the late-2019 passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act removed the age requirement for IRAs.

Easy and Straightforward

The Solo 401(k) is easy to set up, carries low administrative fees, and has no filing requirements until the asset value exceeds $250,000. After that, the rules require the annual filing of a Form 5500-SF (short-form), which is a much simpler version of the full Form 5500.

You have to form a Solo 401(k) plan before December 31 of the applicable tax year. And, any employee deferrals must be made through payroll or formally elected by December 31 of the same year. However, the funding of the retirement can be up until the personal filing deadline, including extensions.

One last thought: Remember that a Solo 401(k) is just a vehicle you use for retirement savings. As a plan participant, you still have to choose the investments that will be used within the account to build wealth for your retirement.

If you would like more information on Solo 401(k)s or if you would like to open your own Solo 401(k), feel free to reach out to our office at (970) 530-0556 for assistance. We’d be happy to help!

IRA Rollover Rules and Taxation

By Bob Palechek, CPA | April 3, 2020

You own your retirement funds.  That grants you some flexibility in what you do with the funds and where you put them.  But with flexibility comes responsibility, and you are responsible for following all of the IRS’s rules.

You may get help from plan custodians, administrators, or bankers, but that does not relieve you of the responsibility of getting it right.  And a word of caution: many actions cannot be undone.

You may decide to move your retirement funds (1) between plan types, (2) to new accounts, or (3) to a new holder or custodian of your assets.  If so, your goal is generally to achieve this without creating a taxable event and, done correctly, that should be achievable.

Our goal is to provide you with that knowledge.  Or to show why you might want to consult with a tax pro before you start.

Transfers versus Rollovers

The transfer process is relatively straightforward.  The rollover process is more complicated.  Let’s look at both.


A transfer is typically done between IRAs.  You let your new IRA know of your wish for it to ‘receive funds’ from another IRA, and you provide all the details of your original IRA.  The new IRA will pull the funds across.  No taxes are withheld, and you receive no funds.  It is a safe and easy way to transfer retirement funds.  You do not need to report a direct transfer on the IRS’s Form 1099-R, so you shouldn’t be alarmed if you don’t receive one.


All movements of funds that do not qualify as transfers are considered rollovers.  And, they are more open to having something go wrong if not handled correctly.

Employer 401(k)-related rollovers

A typical rollover occurs when you reach out to your employer 401(k) plan and request all or a portion of that money.  This may occur through an in-service withdrawal (if the employer plan allows it) or after departing from that employer.

  • If you want to preserve your funds in a retirement account, you will request a rollover and provide the name of the new qualified plan or IRA account.  The original holder of the funds will issue a direct payment to the plan or account electronically, if available, or via check.  No taxes need to be withheld. You will receive a Form 1099-R to use when reporting the rollover on your taxes.  The distribution amount is shown in Box 1, but none of the amount should be taxable, and the code in Box 7 will be a ‘G.’  All is good.
  • If you receive a check to deliver to the new custodian, you will want the check to be payable to the new custodian, and not to you personally.  That way, this will be considered a direct rollover, and no tax withholdings are required.  The same reporting of the Form 1099-R will occur.
  • If you receive the check payable to you, a 20-percent federal withholding is required.  If your goal is a tax-free transaction, you have 60 days from the ‘constructive receipt’ of the check to deposit it into the new qualified plan or IRA account.  (‘Constructive receipt’ is when you have reasonable access to possession of a check.)
  • If you should miss the 60-day window to deposit, the distribution will be taxable to you and may be subject to a 10-percent penalty if you are below age 59½.  There are no exceptions.  If the 60-day window is missed because of cause, the IRS does provide a relief process but only under strict circumstances.  It should not be relied upon if the deadline was accidentally missed or if you changed your mind.

To remedy the situation and to achieve a complete tax-free rollover in these circumstances, you will have to make up the 20-percent withholdings with other funds.  You will be able to recover the 20-percent withholdings when you file your taxes the following year if you are overpaid.

IRA-to-IRA or Roth-to-Roth rollovers

The other typical rollover is from one traditional IRA to another, or from Roth to Roth.  These rollovers can either be direct (where the check is made payable to the new custodian or IRA) or indirect (where the check is made payable to you).  The first option is preferred because the 60-day window rule is not an issue.

  • On indirect rollovers of a traditional IRA, a 10-percent federal withholding rule is standard but not mandatory.  As in the remedy described above, the 10-percent withholdings would have to be made up with other funds to achieve a tax-free rollover.
  • One inconvenience of the indirect rollover of traditional or Roth IRAs is that you are only allowed one rollover per year.  The rule that introduced that limitation in 2015 exempted rollovers from 401(k)s.
  • If you do an indirect rollover, it will generate a Form 1099-R to use when reporting the rollover on your taxes.  Since an indirect rollover is where the check is received by you and payable to you, the Form 1099-R will come with a taxable distribution code on the form.  The code in Box 7 will typically be a ‘1’ or ‘7.’ However, the issuer has no way of knowing your intentions.  It also does not know if you met the 60-day window rule or the once-per-year rule.
  • If you have someone preparing your taxes, make sure to provide them with all the details of your rollovers so you will not get taxed as though you took the money from your plan.

And if you would like help to ensure that you have followed all the rules, make sure to reach out to your tax professional.  It’s always a good idea to make sure your T’s are crossed and your I’s dotted.

Five Positives and a Negative about the SECURE Act

By Bob Palechek, CPA | February 7, 2020

The U.S. Government is finally reacting to its concern that Americans are not saving enough for retirement. (About one-quarter of working Americans have no retirement savings.) So, Congress started writing bills and resolutions that would make it easier for certain employers to offer retirement plans to their employees – and for workers to save more money.

The name they gave it was the SECURE Act: the “Setting Every Community Up for Retirement Enhancement” Act of 2019. After months of delays, Congress finally passed the Act in December 2019 by tucking it into an Appropriations bill that had a year-end deadline.

But, not all of the parts of the new law will “enhance” everyone’s retirement, especially someone planning to use a specific strategy that benefits future generations. First, let’s see the five key positive changes, and then the one that may call for some crucial retirement plan adjustments.

Five Key Positive Changes

  • Before the SECURE Act, you had to distribute a minimum amount of your qualified retirement accounts (called RMDs) beginning in the year you turned 70½. (In the first year, the percentage to be distributed is about 3.65% and increases each year.) For higher net worth taxpayers, being forced to add this income to Social Security benefits can create a sudden jump in the taxes due. This Act raises the starting age to 72 for anyone younger than 70½ at the end of 2019.
  • Until this Act passed, you were allowed to contribute to a Roth IRA after age 70½, but not to a tax-advantaged traditional IRA. The Act removes the age limit on traditional IRAs. Yeah! Please keep in mind that you still need “earned” income to contribute. Part-time wages or consulting income (Sch C) works just fine.
  • Thanks to the Act, you now have increased access to lifetime income options (annuities) inside qualified retirement accounts.
  • If student loans somehow figure into your finances and you own a 529 Plan, you can now take a tax-free distribution from the plan to pay toward qualified student loans. The lifetime limit of $10,000 per child means a maximum of $40,000 for four children, for example. You cannot take a deduction for any student loan interest associated with these payments, but that deduction was phased out for many taxpayers in any case. What isn’t clear yet is how the states will handle this and which ones will conform or not.
  • The Kiddie Tax is going back to the old rules, starting in the tax year 2020. Changes in the Tax Cuts and Jobs Act of 2017 had some undesired tax effects as soon as they were implemented in 2018. Some families with minor or college-age dependents found they were hit with high tax rates on their Social Security benefits or taxable scholarships received by the kids. Taxpayers can opt out when filing for 2019, and can also amend their 2018 returns if it makes sense.

A Change with Cause for Concern

This change – the elimination of the lifetime Stretch IRA – was placed in the law to help offset the government’s overall decrease in tax revenues caused by the Act’s various positive changes. (And if it is good for the government, you should question if it’ll be good for you.) Before the Act, you could use the Stretch IRA provision when leaving an IRA to your kids.

It allowed them to spread the required distributions (RMDs) over their lifetime. For a middle-aged child with good earnings, for example, this protected the inherited money from very high tax rates. Now, instead of lifetime distribution, the new Act says the IRA has to be distributed in 10 years or less. Ouch!

A good Certified Financial Planner can find workarounds for retiring and retired clients. For example, by making Roth conversions during low tax rate years before death, you can leave more tax-friendly IRAs to the kids. This change only applies to IRAs inherited after January 1, 2020. And, the Act exempts surviving spouses, minor children, and individuals who are not more than 10 years younger than the decedent.

If any of these changes can potentially impact your existing retirement plans, be sure to check with your financial advisor for a re-evaluation. Besides what is in this summary, many nuances exist that could be even more beneficial to you.

Claiming ‘Other Dependent’ Tax Credit

By Bob Palechek, CPA | October 11, 2019

Tax Credit for Other Dependents: Tests and Tips

Tax preparers are seeing more and more people caring for their adult children or aging parents and want to claim the ‘Other Dependent’ tax credit. Let’s take a closer look at how it works.

Starting in the tax year 2018, the Tax Cuts and Jobs Act (TCJA) brought with it some good news related to taking the tax credit on other dependents who cannot be claimed for the Child Tax Credit. The new tax credit is valued at $500, plus possibly dependent care expenses. However, this is the tax code so – no surprise – a series of ‘tests’ must first be satisfied.

Tests You Must Pass to Claim a Dependent

There is really only one test you must pass to be able to claim a dependent: you cannot be claimed simultaneously as a dependent by someone else. All other tests fall upon the person who you want to take as a dependent.

Tests Your Dependent Must Pass for You to Claim Them

Assuming you are qualified to claim a dependent, then your child (or another qualifying person) must pass seven tests. For simplicity, we will refer to this person as ‘the child.’

  • Relationship Test
    • Son, daughter or a descendant of them.
    • Brother, sister or a descendant of them.
    • Parents, grandparents, siblings of parents or in-laws can also qualify as a qualifying relative.
    • A person not related to you in any way can still be claimed as your qualifying relative if they lived with you the entire year.
  • Age Test
    • Below age 19.
    • Below age 24 and a full-time student.
    • Any age and permanently and totally disabled. An individual is considered ‘permanently and totally disabled’ if he or she meets Social Security’s requirements as being unable to engage in any substantial gainful activity because of any medically determinable physical or mental impairment that can be expected to last for a continuous period of at least 12 months. A physician should substantiate the impairment. It’s a good idea to get a note from your doctor and keep it in your tax file.
  • Residency Test: The child must live with you for at least half of the year. Temporary absences due to illness, education, etc., are not considered.
  • Nationality Test: The child must be either:
  • A U.S. citizen, national or resident alien.
  • A resident of Canada or Mexico.
  • Support Test: The child cannot be providing more than half their support (scholarships, whether taxable or not, are not included in this).
  • Joint Return Test: The child cannot be filing a Married Filing Jointly return with a spouse (unless they are only doing so to claim a refund of tax withheld).
  • Tie-breaker Rules: If the child is a dependent of more than one person (as in the case of divorced parents), the tie-breaker rules will need to be followed.

While most of these tests are pretty straightforward, the Support Test warrants a little more discussion.

How to Determine the ‘Support’ Aspect

Determining the ‘support’ aspect of the qualifying tests for the ‘Other Dependent’ tax credit follows a specific process:

  • Total up all the expenses the child has (not their income). Include all of the following that they would be paying if they lived on their own:
    • Shelter, including rent at fair market value, utilities, repairs. Do not include your mortgage, property tax or insurance.
    • Medical and dental expenses above and beyond what is being paid by insurance.
    • Educational costs.
    • Other, such as travel and recreation.
  • Next, identify who is paying for which of the above: you or the child? All sources of income, even those excludable from taxable income, are included. For example, they would consider Social Security disability benefits if they are using them to cover their expenses. Also, you would include tax-exempt interest income and payments received under a state Medicaid program if you are using them to cover the child’s expenses.
  • It’s important to remember that you are identifying what source of money is actually being used to pay the expenses. If you have decided as a family that the child will put their disability income away into savings and that you will cover all of their living expenses, then none of their disability is considered support.
  • When you total up all of the child’s expenses, if you are covering more than half of their support, then the Support Test has been met.

How to Handle the Cost of Shelter

It is usually beneficial to charge the child rent because doing so will maximize their Social Security disability benefit. If you don’t, the value of the fair market rent they are not paying will be considered income to them and will be included in their income and resources for benefit amount purposes.

Rental income received from your child – or anyone – must be reported on your tax return. Where it goes on the return, however, makes a big difference in how and what can be reported.

Rent at fair market value – This is the amount of rent most people would pay in your area for the space provided. Amounts will vary greatly depending on whether you are renting the child a guesthouse, a basement or perhaps just a bedroom. If you are renting at fair market value, then you are deemed to be conducting business in pursuit of profit. Business income of the rental type is reported on Schedule E.

Here you can report not only income but all associated expenses like the utilities, cleaning, repairs, mortgage interest, property tax, insurance and depreciation as a proportion of the whole based on square footage. All of these expenses can get you down to no taxable income and sometimes even result in a tax loss.

Rent below fair market value – Rents below fair market value are not considered business income but rather Other Income and are reported directly on the 1040 form by way of Schedule 1. The limitation here is that you cannot take any expenses against this income, so the full rent amount is taxable.

Before enactment of the TCJA, expenses against Other Income could be taken on the Schedule A as Miscellaneous Itemized Deductions (but only the amount exceeding 2% of AGI, of course). Since 2018, however, itemized deductions are no longer allowed.

Taking the ‘Other Dependent’ Tax Credit

Assuming all the required tests are met, you can claim a $500 credit for each ‘other dependent.’ Do note that this credit is non-refundable so, if you didn’t have any taxes withheld or otherwise pay in anything during the year, you would not be able to get this credit.

Also, since this is a credit and not a deduction, you calculate your taxes owed and subtract $500 right off the top!

How to Put the Premium Tax Credit to Work

By Bob Palechek, CPA | July 19, 2019

The Affordable Care Act (ACA) – nicknamed Obamacare – was disappointing for some, but a godsend for others. If today it is your solution for healthcare coverage, you will want to take maximum advantage of one aspect of it called the ‘Premium Tax Credit,’ assuming you qualify.

The Premium Tax Credit (PTC) is a tax credit ‘advance’ that qualifying taxpayers can receive to help pay the cost of the private health insurance they are purchasing through a Health Insurance Marketplace.

It is considered an ‘advance’ because you can choose to benefit from it every month as a reduction in the cost of your monthly health insurance premium. Whatever sum is determined for you by the HHS formula will be paid directly to the insurance company to lessen how much you have to pay out of your pocket for premiums.

You can also choose not to apply the credit to your insurance premiums. Instead, you can wait to receive it when you file your tax return. In that case, if the amount of the annual credit is higher than your tax liability, the difference will come back to you as a tax refund. And if you owe no taxes, the full amount of the year’s credit will be refunded to you.

Who Can the Premium Tax Credit Benefit?

This tax credit may be available to those paying for their own health insurance. For example:

  • Those whose employers do not offer to pay for health insurance;
  • The self-employed; or
  • People retiring before the age of 65 (when Medicare kicks in), whether they are giving up employer-paid health insurance or not.

However, their household income cannot exceed 400% of the ‘Federal Poverty Line,’ or FPL. The FPL is affected by:

  • Where you live (Alaska and Hawaii’s ‘lines’ differ from the rest of the country);
  • Your family size, which is the number of people you will include on your tax return for the year; and
  • Your income which, for PTC purposes, equals your AGI plus tax-exempt interest.

For example, if you and your spouse live in one of the 48 contiguous states or Washington, D.C., in 2019 the FPL is $16,910. So, if just the two of you file a joint tax return and your AGI + tax-exempt interest income is $67,640 (400% of $16,910) or less, you may qualify.

Understanding AGI

AGI is not only the total of those incomes that are taxed at ordinary income tax rates. If income from any source is taxed at all, it is included in your AGI. Also, AGI is your income before the standard deduction.

Your AGI includes:

  • both qualified and ordinary dividends;
  • the net of both short-term and long-term capital gains;
  • business income or losses;
  • rental income or losses; and
  • deductible contributions to your Health Savings Account.

Your AGI never includes:

  • The portion of your Social Security that is not taxable; or
  • Qualified distributions from a retirement account, like direct rollovers to a new plan or Roth distributions.

However, don’t forget that you must ‘add back’ any tax-free interest received during the year.

When Might You Benefit from the PTC?

The people most likely to benefit from the PTC are those younger than 65 who:

  • are keeping their AGI low by primarily living off Roth distributions and Social Security; or
  • are self-employed and can control when their business losses occur.

To qualify for the PTC, you or a family member also must:

  • Have health insurance purchased through the Health Insurance Marketplace;
  • Pay the balance of the premium (after applying the advance credit payments);
  • Not be eligible for affordable insurance through an employer; and
  • Not be eligible for a government program like Medicaid, Medicare, and others.

These four qualifications must be met for a period of at least one month and must all be occurring during the same month. Some additional requirements include:

  • Having income between 100% and 400% of the FPL for your family size;
  • Not filing taxes as Married Filing Separately (with a few exceptions); and
  • Not being claimed by someone else as a dependent.

If you have any questions about whether you are getting the maximum out of the Premium Tax Credit, call us at 1-844-4-Ask-Jim (1-844-427-5546) and let our Tax Planning Department review it for you.