Over at Bogleheads we read: ACA Income Tax Planning Strategies
by JohnDoh » Sat Dec 21, 2013 1:16 pm
As discussed in this NYT article "New Health Law Frustrates Many in Middle Class" and illustrated in the incorporated charts, there can be a sharp cost to exceeding the ACA premium credit threshold by "a small amount".
According to the IRS's Questions and Answers on the Premium Tax Credit:
This of course invites the question (not "begs the question"
)
of planning strategies to get under and/or stay under the tax credit
income ceiling as part of an overall income tax planning strategy
(which, in turn, will be part of an overall personal wealth management
strategy).
The following are my current thoughts on the matter. Please correct, comment and add as you see fit. Thanks.
John Doh
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As I currently understand ACA, there seem to be three (3) primary strategies to maximizing the premium subsidy / tax credit:
1) Since the ACA premium credit is based on the taxpayer's MAGI [PDF], the first goal is to minimize MAGI (which will be the same as AGI for most taxpayers), 1040 Line 37/38. The principal strategies are straightforward and have been discussed widely:
For most people in the relevant situation, this is likely to be a substantial reduction in take-home income available for day-to-day expenses. In general, though, it seems advisable to make up the shortfall from taxable savings (assuming they exist) in order to qualify for the premium tax credit. The net effect, therefore, is a kind of arbitrage from taxable to tax-deferred savings and over time such a taxpayer should expect to accumulate a predominantly tax-deferred portfolio (especially since Roth conversions add to one's MAGI and are thus counter-indicated). This, in turn, may have further consequences when entering the distribution phase.
2) Another way of minimizing MAGI is reducing taxable investment income. This can be done by shifting taxable investments into tax-deferred vehicles such as savings bonds and low-cost variable annuities (such as offered by Vanguard and Jefferson National) -- and, of course, by aggressive tax-loss harvesting.
Of course the appropriateness of this strategy will be highly situation-dependent, but for those who happen to be asset-rich but salary-poor (e.g. modest income folks who have inherited) -- and especially for those closer to the distribution phase -- this would seem desirable. Again, the effect is to reduce the taxable portfolio and increase the tax-sheltered portfolio.
3) A standard, pre-ACA income tax strategy is "deduction bunching". In a post-ACA world this would continue to be important (especially if the taxpayer's MAGI has been reduced through the above strategies) although it may be harder to use advantageously since for most people (but not seniors) the threshold for deductible medical expenses has been raised to 10% of AGI from 7.5%.
For most people in the relevant situation, the largest potentially-deductible expense will be health care in general and health insurance premiums in particular. Therefore, it would seem desirable to bunch health expenses into alternating years to the extent possible. For example, pay one's 2014 premiums monthly during 2014 but pay one's entire 2015 premium in December 2014 and arrange for periodic expenses (e.g. eye exams, new glasses, dental work, etc.) to be paid in 2014. (I presume, but am not certain, that the ACA premium subsidy / tax credit does not alter the deductibility of health insurance premiums. Is this correct?)
------------------------------------------------------------------------------------------------------------------
Well, that's it. Are there other major strategies? Are there other important consequences to these strategies that I have not considered? Thanks again.
According to the IRS's Questions and Answers on the Premium Tax Credit:
For 2013, for residents of one of the 48 contiguous states or Washington, D.C., the following illustrates when household income would be between 100 percent and 400 percent of the federal poverty line:
$11,490 (100%) up to $45,960 (400%) for one individual.
$15,510 (100%) up to $62,040 (400%) for a family of two.
$23,550 (100%) up to $94,200 (400%) for a family of four.
This of course invites the question (not "begs the question"
)
of planning strategies to get under and/or stay under the tax credit
income ceiling as part of an overall income tax planning strategy
(which, in turn, will be part of an overall personal wealth management
strategy).The following are my current thoughts on the matter. Please correct, comment and add as you see fit. Thanks.
John Doh
------------------------------------------------------------------------------------------------------------------
As I currently understand ACA, there seem to be three (3) primary strategies to maximizing the premium subsidy / tax credit:
1) Since the ACA premium credit is based on the taxpayer's MAGI [PDF], the first goal is to minimize MAGI (which will be the same as AGI for most taxpayers), 1040 Line 37/38. The principal strategies are straightforward and have been discussed widely:
- Maximize elective salary deferrals to eligible retirement plans (401k, 403b, etc) - 2014: $17,500/$23,000 per person
- Maximize deductible traditional IRA contributions - 2014: $5,500/$6,500 per person
- Maximize deductible HSA contribution (if eligible) - 2014: $3,300/$4,300 per person or $6,550/$7,550 per family
http://www.irs.gov/uac/IRS-Announces-2014-Pension-Plan-Limitations;-Taxpayers-May-Contribute-up-to-$17,500-to-their-401%28k%29-plans-in-2014
http://www.hsabank.com/hsabank/education/irs-limits-and-guidelines
For most people in the relevant situation, this is likely to be a substantial reduction in take-home income available for day-to-day expenses. In general, though, it seems advisable to make up the shortfall from taxable savings (assuming they exist) in order to qualify for the premium tax credit. The net effect, therefore, is a kind of arbitrage from taxable to tax-deferred savings and over time such a taxpayer should expect to accumulate a predominantly tax-deferred portfolio (especially since Roth conversions add to one's MAGI and are thus counter-indicated). This, in turn, may have further consequences when entering the distribution phase.
2) Another way of minimizing MAGI is reducing taxable investment income. This can be done by shifting taxable investments into tax-deferred vehicles such as savings bonds and low-cost variable annuities (such as offered by Vanguard and Jefferson National) -- and, of course, by aggressive tax-loss harvesting.
Of course the appropriateness of this strategy will be highly situation-dependent, but for those who happen to be asset-rich but salary-poor (e.g. modest income folks who have inherited) -- and especially for those closer to the distribution phase -- this would seem desirable. Again, the effect is to reduce the taxable portfolio and increase the tax-sheltered portfolio.
3) A standard, pre-ACA income tax strategy is "deduction bunching". In a post-ACA world this would continue to be important (especially if the taxpayer's MAGI has been reduced through the above strategies) although it may be harder to use advantageously since for most people (but not seniors) the threshold for deductible medical expenses has been raised to 10% of AGI from 7.5%.
For most people in the relevant situation, the largest potentially-deductible expense will be health care in general and health insurance premiums in particular. Therefore, it would seem desirable to bunch health expenses into alternating years to the extent possible. For example, pay one's 2014 premiums monthly during 2014 but pay one's entire 2015 premium in December 2014 and arrange for periodic expenses (e.g. eye exams, new glasses, dental work, etc.) to be paid in 2014. (I presume, but am not certain, that the ACA premium subsidy / tax credit does not alter the deductibility of health insurance premiums. Is this correct?)
------------------------------------------------------------------------------------------------------------------
Well, that's it. Are there other major strategies? Are there other important consequences to these strategies that I have not considered? Thanks again.
- JohnDoh
- Posts: 5
- Joined: 30 Nov 2013
Re: ACA Income Tax Planning Strategies
by WhyNotUs » Sat Dec 21, 2013 1:27 pm
Not close enough to ever qualify, glad there is some support to help people who NEED it, glad I never will.
I do not look to pay extra taxes but also do not look to use complicated strategies to avoid them, have been lucky enough not to rely on direct government benefits but realize (most days
) I benefit from the gov't as a whole and am willing to pay my share.
Not looking to help someone strategize to add themselves to my support
group. Best wishes.
I do not look to pay extra taxes but also do not look to use complicated strategies to avoid them, have been lucky enough not to rely on direct government benefits but realize (most days
) I benefit from the gov't as a whole and am willing to pay my share.
Not looking to help someone strategize to add themselves to my support
group. Best wishes.
I own the next hot stock- VTSAX
-
WhyNotUs
- Posts: 191
- Joined: 14 Apr 2013
Re: ACA Income Tax Planning Strategies
by SteveKL » Sat Dec 21, 2013 2:35 pm
With respect for WhyNutUs' opinion, I'm with
JohnDoh on this one and hope this thread sparks some good tax-planning
ideas and discussion. Not to introduce a political element, but since I
cannot paraphrase as articulately as the original quote, this well-known
excerpt from U.S. Court of Appeals Judge Learned Hand (1872-1961) in
the case of Helvering v. Gregory (69F.2d 809) summarizes my belief:
"Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one's taxes. Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands."
"Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one's taxes. Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands."
- SteveKL
- Posts: 224
- Joined: 3 Sep 2012
Re: ACA Income Tax Planning Strategies
by Digital Dave » Sat Dec 21, 2013 2:47 pm
Hello all,
I am one of those that has saved and invested over the years to build a nice nest egg, by spending much less than I could. This has been my nature as an independent person that wants to pay his own way through life. When I lost my job 7 years ago, everything still went smoothly. My employer paid my health insurance for years, and I paid my own after leaving. No pensions, all my income was from my savings and investments.
As I said, I paid my own insurance costs, 100% after leaving work. Now the ACA comes along, that without subsidies would cost me a LOT more, including the co-pays, deductibles and some other pays that I forgot the name of. So I decided it was in my best interest to work for the most subsidies.
I am 63, and have been receiving Social Security starting at 62. I discovered that in 2012, 85% of my SS money was subject to federal income tax. I had realized a lot of gains, forgetting about this extra tax. Things were to change for 2013!
I cut back on my capital gains realizations to the level where just 50% of my SS money would be taxed. Fine. Then I learned the ugly truths about MAGI vs. AGI as it related to ACA. Late this year I suspended my SS money! I would delay this until I was 66 - 70.
Then I decided not to sell anything that would result in a taxable capital gain. There would still be dividends and gains by the funds passed on to me. Also no more Roth conversions! At the end of 2014, if I am below $23000, I'll then realize some gains. (I file as single).
The other part of my grand plan is that I signed up for the "Silver" plan. As I understand it, there are extra subsidies for singles with a MAGI of below about $29k. Being sick, this will cut down on these co-pays, deductibles, etc. and leave me with more to support myself down the road.
By refusing further SS payments, I might have cut off my nose as all the taxes saved wouldn't add up. But being cash heavy, I am spending down on a little more of that (which I am making 0% on anyway), while giving my SS payments in the future a boost. This is kind of a tax-free savings account, and might come in handy later. Of course, this depends on being still alive then, but if not, I won't know the difference anyway.
I hope that made sense. In other words, I'm gaming the tax system and ACA, legally. Happy holidays to all!
Dave
I am one of those that has saved and invested over the years to build a nice nest egg, by spending much less than I could. This has been my nature as an independent person that wants to pay his own way through life. When I lost my job 7 years ago, everything still went smoothly. My employer paid my health insurance for years, and I paid my own after leaving. No pensions, all my income was from my savings and investments.
As I said, I paid my own insurance costs, 100% after leaving work. Now the ACA comes along, that without subsidies would cost me a LOT more, including the co-pays, deductibles and some other pays that I forgot the name of. So I decided it was in my best interest to work for the most subsidies.
I am 63, and have been receiving Social Security starting at 62. I discovered that in 2012, 85% of my SS money was subject to federal income tax. I had realized a lot of gains, forgetting about this extra tax. Things were to change for 2013!
I cut back on my capital gains realizations to the level where just 50% of my SS money would be taxed. Fine. Then I learned the ugly truths about MAGI vs. AGI as it related to ACA. Late this year I suspended my SS money! I would delay this until I was 66 - 70.
Then I decided not to sell anything that would result in a taxable capital gain. There would still be dividends and gains by the funds passed on to me. Also no more Roth conversions! At the end of 2014, if I am below $23000, I'll then realize some gains. (I file as single).
The other part of my grand plan is that I signed up for the "Silver" plan. As I understand it, there are extra subsidies for singles with a MAGI of below about $29k. Being sick, this will cut down on these co-pays, deductibles, etc. and leave me with more to support myself down the road.
By refusing further SS payments, I might have cut off my nose as all the taxes saved wouldn't add up. But being cash heavy, I am spending down on a little more of that (which I am making 0% on anyway), while giving my SS payments in the future a boost. This is kind of a tax-free savings account, and might come in handy later. Of course, this depends on being still alive then, but if not, I won't know the difference anyway.
I hope that made sense. In other words, I'm gaming the tax system and ACA, legally. Happy holidays to all!
Dave
Investing in Mutual Funds, ETF's, P2P Lending and Forever Stamps
- Digital Dave
- Posts: 6
- Joined: 10 Mar 2007
- Location: Western New York
Re: ACA Income Tax Planning Strategies
by tfb » Sat Dec 21, 2013 4:38 pm JohnDoh wrote:As discussed in this NYT article "New Health Law Frustrates Many in Middle Class" and illustrated in the incorporated charts, there can be a sharp cost to exceeding the ACA premium credit threshold by "a small amount".
Amazingly they don't mention anything the affected can do to get themselves out of that situation. The media just want to fan the emotions. The lead couple exceed the income cutoff by $6,000. Increase 401k or IRA contributions by $6,000. Problem goes away, but the reporter won't have a story.
JohnDoh wrote:Are there other major strategies?
Income bunching. If you are over, get way over (convert to Roth, realize cap gains, stop contributing to 401k after getting the match, ...). Then use the money to supplement income for the following years (max out all pre-tax savings, as you point out, up to $67k per couple!).
Harry aka TFB, taking a break from the forums.
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tfb
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Re: ACA Income Tax Planning Strategies
by JohnDoh » Sat Dec 21, 2013 5:26 pm
Thanks for all the input so far.
How "way over"? Presumably one wouldn't want to go into the next tax bracket (e.g. 15%->25%). If this is so, then "below-the-line", itemized-deduction-bunching and income-bunching should be synchronized. I.e. in the years when (M)AGI is over the ACA subsidy / tax credit cutoff (not "threshold" as I incorrectly stated in my OP), one should maximize Schedule A itemized deductions (including health insurance premiums and elective / schedulable health expenses) and then bunch above-the-line income to the top of the current tax bracket. This is similar to advice for IRA->Roth conversions. But should one bunch more income if one could?
In any case, we end up with a strategy of alternating years:
SUBSIDY YEARS:
a) maximize above-the-line (M)AGI deductions to qualify for maximum ACA premium subsidy / tax-credit; AND,
b) minimize below-the-line Schedule A itemized deductions and take standard deduction
NON-SUBSIDY YEARS:
a) maximize below-the-line Schedule A itemized deductions; AND,
b) optimize above-the-line (M)AGI deductions such that taxable income (TI) is at the tax bracket ceiling (2014: $36,000 Single / $73,800 MFJ)
Does this sound correct?
tfb wrote:
JohnDoh wrote:Are there other major strategies?
Income bunching. If you are over, get way over (convert to Roth, realize cap gains, stop contributing to 401k after getting the match, ...). Then use the money to supplement income for the following years (max out all pre-tax savings, as you point out, up to $67k per couple!).
How "way over"? Presumably one wouldn't want to go into the next tax bracket (e.g. 15%->25%). If this is so, then "below-the-line", itemized-deduction-bunching and income-bunching should be synchronized. I.e. in the years when (M)AGI is over the ACA subsidy / tax credit cutoff (not "threshold" as I incorrectly stated in my OP), one should maximize Schedule A itemized deductions (including health insurance premiums and elective / schedulable health expenses) and then bunch above-the-line income to the top of the current tax bracket. This is similar to advice for IRA->Roth conversions. But should one bunch more income if one could?
In any case, we end up with a strategy of alternating years:
SUBSIDY YEARS:
a) maximize above-the-line (M)AGI deductions to qualify for maximum ACA premium subsidy / tax-credit; AND,
b) minimize below-the-line Schedule A itemized deductions and take standard deduction
NON-SUBSIDY YEARS:
a) maximize below-the-line Schedule A itemized deductions; AND,
b) optimize above-the-line (M)AGI deductions such that taxable income (TI) is at the tax bracket ceiling (2014: $36,000 Single / $73,800 MFJ)
Does this sound correct?
- JohnDoh
- Posts: 5
- Joined: 30 Nov 2013
Re: ACA Income Tax Planning Strategies
by SteveKL » Sat Dec 21, 2013 5:35 pm JohnDoh wrote:In any case, we end up with a strategy of alternating years:
SUBSIDY YEARS: b) minimize below-the-line Schedule A itemized deductions and take standard deduction
NON-SUBSIDY YEARS: a) maximize below-the-line Schedule A itemized deduction
This could dovetail nicely with the practice of bunching charitable donations and property tax payments together in alternating years (what the OP calls non-subsidy years), as discussed in these recent threads on that strategy:
viewtopic.php?f=2&t=127933
viewtopic.php?f=2&t=126963
- SteveKL
- Posts: 224
- Joined: 3 Sep 2012
Re: ACA Income Tax Planning Strategies
by JohnDoh » Sat Dec 21, 2013 6:20 pm SteveKL wrote:
JohnDoh wrote:In any case, we end up with a strategy of alternating years:
SUBSIDY YEARS: b) minimize below-the-line Schedule A itemized deductions and take standard deduction
NON-SUBSIDY YEARS: a) maximize below-the-line Schedule A itemized deduction
This could dovetail nicely with the practice of bunching charitable donations and property tax payments together in alternating years (what the OP calls non-subsidy years), as discussed in these recent threads on that strategy:
viewtopic.php?f=2&t=127933
viewtopic.php?f=2&t=126963
Yes, though I think one would try the bunching below-the-line Schedule A itemized deductions strategy in any case -- i.e. regardless of whether one was bunching above-the-line (M)AGI deductions. In other words, even if one qualifies for a ACA premium subsidy / tax-credit every year, one would still try to bunch itemized deductions -- although the value of the itemized deduction is reduced because (M)AGI is already reduced and therefore one's tax rate and liability is already reduced. But every bit helps.
- JohnDoh
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Re: ACA Income Tax Planning Strategies
by Mick » Sat Dec 21, 2013 6:22 pm
We have definitely made some changes to maximize
our ACA Subsidy. I am 63 so need to plan two more years for both of us
and seven more for my spouse. We have taken several steps this year
including Roth conversion to next bracket providing an extra cushion of
money should we need it. We will also be pulling cash out of our
taxable investments to cover known immediate expenses next year (like
HSA contribution and others) to take any profit this year. We also
elected an HDHP for our coverage with the max HSA contribution moves us
from 9.5% of income to about 8.5% and also reduces the income the
percent applies to. This will mean we will be able to deduct any
medical expenses over about 1.5% of a low income. We will keep the HSA
as a backdoor IRA as long as we can deduct medical expenses and
eventually use it when we are both on medicare.
So doing a lot of planning, both taxes and for subsidy. I can thank this forum for that. If I had went on the way we were we might have just missed the subsidy line. This approach will save us over $10,000 with the subsidy plus some taxes on the HSA contribution. We currently have no insurance as spouse was denied coverage and I could get it for $1200 but it excluded any heart or cancer related issues. Seemed pointless to pay that much a month for what was left.
So doing a lot of planning, both taxes and for subsidy. I can thank this forum for that. If I had went on the way we were we might have just missed the subsidy line. This approach will save us over $10,000 with the subsidy plus some taxes on the HSA contribution. We currently have no insurance as spouse was denied coverage and I could get it for $1200 but it excluded any heart or cancer related issues. Seemed pointless to pay that much a month for what was left.
- Mick
- Posts: 38
- Joined: 2 Aug 2013
Re: ACA Income Tax Planning Strategies
by Brandnew » Sat Dec 21, 2013 6:54 pm
Great topic! My wife and I have recently
retired (not old enough for medicare). We paid for our own 2013 health
insurance totaling $650 a month for a HDHP HSA plan. Our insurance
company said we didn't have to do anything for 2014 ... other than pay
$1140 a month ... Ouch. Since we have little in income coming in ...
signing up for bronze HSA insurance through the state exchange gave us a
$1115 monthly credit with two policies total $982 ... meaning, no
charge to us. Now, I don't feel so bad when I pay out of pocket for
minor doctor visits.
Strategy for now is to make sure I have enough cash on hand to live on/fund HSA contributions and, if needed, sell a few more equities this year.
Strategy for now is to make sure I have enough cash on hand to live on/fund HSA contributions and, if needed, sell a few more equities this year.
- Brandnew
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- Joined: 2 Jul 2013
Re: ACA Income Tax Planning Strategies
by stratton » Sat Dec 21, 2013 7:00 pm
One really obvious way is to look into paying
off the mortgage so as not to generate income. You lose the mortgage
interest write-off, but you can reduce income.
Paul
Paul
...and then Buffy staked Edward. The end.
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stratton
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Re: ACA Income Tax Planning Strategies
by SteveKL » Sat Dec 21, 2013 7:19 pm stratton wrote:One really obvious way is to look into paying off the mortgage so as not to generate income. You lose the mortgage interest write-off, but you can reduce income.
Paul, what do you mean here? How does having a mortgage relate to receiving income? I went back through the other posts in case you were replying to someone's specific question, but didn't see it. Thanks!
- SteveKL
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- Joined: 3 Sep 2012
Re: ACA Income Tax Planning Strategies
by stratton » Sat Dec 21, 2013 7:23 pm
I wasn't clear here.
If you're getting income from investments or even a job you can now not generate it or put a larger percentage into retirement savings if income isn't needed to pay for the mortgage.
The idea is to cut required income by reducing your payout.
Paul
If you're getting income from investments or even a job you can now not generate it or put a larger percentage into retirement savings if income isn't needed to pay for the mortgage.
The idea is to cut required income by reducing your payout.
Paul
...and then Buffy staked Edward. The end.
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Re: ACA Income Tax Planning Strategies
by obgyn65 » Sat Dec 21, 2013 7:53 pm
I have started to buy deferred annuities to defer income until I reach 62. I am 48.
"The two most important days in someone's life are the day that they are born and the day they discover why." -John Maxwell
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Re: ACA Income Tax Planning Strategies
by SteveKL » Sat Dec 21, 2013 7:54 pm stratton wrote:The idea is to cut required income by reducing your payout.
Ah, so. I have thought of that, as well. No matter how thrifty somebody is with their other expenses, if you have a mortgage then the options are either to generate current-year income (active or passive) to make the payment, or to use already-taxed money for that purpose.
If one were trying to get permanently into an income range that could qualify for an ACA subsidy, it seems the only solution would be to have a paid-off mortgage. If using the alternate-year method it could be possible to set aside a year's worth of payments in the higher-income "non-subsidy" years, then use those funds to make payments during the "subsidy year".
- SteveKL
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- Joined: 3 Sep 2012
Re: ACA Income Tax Planning Strategies
by Mick » Sun Dec 22, 2013 8:08 am stratton wrote:One really obvious way is to look into paying off the mortgage so as not to generate income. You lose the mortgage interest write-off, but you can reduce income.
Paul
Actually we just did about the opposite. Could have paid off the mortgage but it ate up a lot of our taxable savings. Would then have had to use our IRA for some expenses causing an increase in income and decrease in subsidy. By having mortgage we will be able to use the taxable savings until we start SS. Over the next 7 years we come out much better with this approach. Thus a Penfed 5/5 at 2.625% refi made sense over a payoff.
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