Monday, December 30, 2013

Weird Obamacare Strategies and Incentives - 6

This is the Sixth in a series of posts that have me a bit conflicted.  They could be interpreted as political, and, as advice, some of it may be considered unethical, but the point of the posts is to point out things in the law that provide negative incentives, and, at the same time, point out actions that can have big negative consequences on someone receiving a Premium Tax Credit (hereafter referred to as a subsidy.)  They are primarily designed to ensure that people don't make huge mistakes with huge consequences.  They should not be interpreted as me suggesting that you manipulate the rules in any illegal or unethical way.  If you continue reading these posts you will understand what I mean.

This post is for business owners and/or rental property owners with depreciable assets.  Most business owners understand that when you purchase something with a life of longer than one year, you must generally depreciate it over a number of years, rather than take the expense all at once.  There are exceptions, though, that allow you to take all or some of it in the current year.  One of these is a Section 179 deduction, which allows you to take up to the entire amount (subject to some limitations and restrictions).  The other is bonus depreciation (a "temporary" measure designed to stimulate business investment) that allows you to take half of the value in the current year, and then depreciate the rest over the life of the asset.

In the past, the decision on how much to take in the current year, and how much to depreciate, was one of the more complicated parts of a tax return.  The Affordable Care Act adds another, very difficult, dimension.  My advice to most of my clients was, absent a specific business reason based on expected earnings, or an immediate and tangible tax benefit (such as qualifying for Earned Income Credit or an Education Credit) assets should be depreciated.  The rationale is that you never really know what future earnings will be like, depreciation smooths out the fluctuations in taxes, and it simplifies the problems associated with early disposition of an asset.  Add Premium Tax Credit (subsidies) to the calculation.

The big problem with this is that you estimate your subsidy based on one tax return, and then reconcile it with the tax return two years in the future!  So taking the full amount in one year gets you a big subsidy, that you then have to pay back in a future year (though long term you will end up having the opposite happen - small subsidy but then big payback).  This has all the potential to completely screw up your budget and taxes, as your healthcare premium goes up and down year over year as you place assets in service.

Let me illustrate with a fictional family in 2013.  Again I will use Rhode Island, since their website is the most user friendly.  This is a married couple, with one child who had net earnings from a business of $50,000 before depreciation is taken into account (the only source of household income).  The business also placed $10,000 of assets in service that would normally be depreciated over 5 years (I'm using the most common class life).  This means their net income subject to taxes can be $40,000 (full section 179 deduction), $45,500 (50% bonus depreciation and the first year of depreciation for the rest) or $49,000 (first year of 5 year depreciation).  Theoretically they could have any number between $40,000 and $49,000 since you can take any portion of section 179 you want, but these are the most common amounts.

Note that the $40,000 result leaves no deduction for the future, the $45,500 result gives deductions of $1000 for the next 4 years, and $500 in the fifth year, and the $49,000 result gives $2000 deduction for the next 4 years and $1000 in the fifth year.  Basically, if you take it up front, you lose it in the future.

Here are the Rhode Island, MONTHLY, premium subsidies for those amounts:

$40,000 - $764.52
$45,500 - $697.50
$49,000 - $650.37

Those are the amounts, PER MONTH, that the government will pay for your family's insurance, so the difference between full deduction and regular depreciation is $114.15 per month, or $1369.80 per year.

But this is your 2013 tax return.  These numbers will be used to determine your subsidy in 2015 which will be reconciled on your 2015 tax return.  Who knows if you'll have a $10,000 asset to deduct in 2015!  You could end up paying the whole difference back!  Also, if you take the $40,000 number, you won't get the $2000 depreciation in 2014, so that will effect THAT subsidy.  Kinda sucks to be a small business owner in this world.

So what should you do?  I have no fricken clue.  I expect long conversations with my clients based on their specific situations.  I HOPE to be able to give them some good, solid advice on what to do, but it is simply too complicated to give blanket advice.

The best I can say is this: Be aware that this affects your decision.  Run numbers for lots of income situations, trying to anticipate your future earnings and deductions.  Keep the exchange informed of changes in family size and income.  If you can afford it, take the smallest subsidy possible, knowing you will get the full amount back when you file your taxes.

Please check my numbers and tell me if you don't agree.
Free advice at taxadvisor@email.com

6 comments:

  1. I have a simple question for a SuperTaxGenius: All over the internet, with enough research, I can see that self-employment/business depreciation is allowable in calculating MAGI for Obamacare subsidy eligibility.

    But is it true that depreciation of rental properties is allowable to reduce MAGI for Obamacare subsidy eligibility? Are we sure? Is there anywhere I can read this in black and white before I screw up?

    My entire income is from residential rentals. Should I perhaps claim self-employment income and business depreciation instead of rental income? It's on a Schedule E. I own a single member LLC but file as an individual. Sorry, that wound up getting more complicated!

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  2. First answer, with nor research: NO! Do not shift to self employment on rentals - the self employment tax will kill you! My gut tells me also that the Schedule E income carrying to the 1040 via 8582 is the right number for MAGI with rentals. The 8582 will properly classify any passive loss limits and the result "should" be the correct amount.

    As I said - this is gut, no research, so standby for a better answer when I find it.

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  3. This section from the irs.gov Premium Tax Credit FAQ gives a little more confidence - I will continue looking for more authoritative info:

    "Modified adjusted gross income is the adjusted gross income on your federal income tax return plus any excluded foreign income, nontaxable Social Security benefits (including tier 1 railroad retirement benefits), and tax-exempt interest received or accrued during the taxable year. It does not include Supplemental Security Income (SSI)."

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  4. From the Internal Revenue Bulletin:

    (2) Modified adjusted gross income. Modified adjusted gross income means adjusted gross income (within the meaning of section 62) increased by—

    (i) Amounts excluded from gross income under section 911;

    (ii) Tax-exempt interest the taxpayer receives or accrues during the taxable year; and

    (iii) Social security benefits (within the meaning of section 86(d)) not included in gross income under section 86.

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  5. The Internal revenue Code comports with the above - so I think we have our answer.

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  6. Here's an idea for #7:
    I retired early with little income other than some rental properties. Depreciation puts my income (AGI and MAGI) below the poverty line and thus ineligible for a subsidy. I live in a state that did not expand medicaid coverage so I'm not eligible for that. But, if I don't claim all eligible depreciation, I can get my income to a level eligible for a subsidy. Since my AGI is so low, I no longer pay federal income tax.

    Would love your thoughts on not taking all of allowable depreciation expenses. I recognize that that will not change my basis when I sell as that is calculated on "allowed" depreciation.

    ReplyDelete