Low Income Earners and the New Health Insurance Penalty

I don't make too much money, does the new health insurance rule apply to me?

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"If you happen to be under the minimum filing requirement, which would ostensibly mean you wouldn't have to file, how do they know whether your health care qualifies under the affordable care act part of the tax assessment? It seems to say that you are not required to make any payments so you don't have to worry about it, but it seems weird to not say anything."

That's an interesting question sent to me by a reader.

This is a good question and deserves a solid answer.

If a person's income is less than the minimum filing requirement, then that person is exempt from the shared responsibility payment. The IRS won't penalize such a person for not having health insurance. In fact, we could say that such a person isn't required to have health insurance. If such a person does file a tax return, then the person can indicate on Form 8965 that they qualify for an exemption from the shared responsibility payment. And that form gets attached to and sent to the IRS along with the rest of their tax return. Since the person isn't required to have health insurance coverage for the year, the IRS doesn't care whether their health insurance qualifies as minimum essential coverage under the Affordable Care Act.

Let’s dig deeper and see what’s really going on here.

"Beginning in 2014," the IRS says, "individuals must have health care coverage, qualify for a health coverage exemption, or make a shared responsibility payment with their tax return."[1]

So far, this idea is easy enough to grasp. People are required to have health insurance. In some situations, a person may also qualify for an exemption. An exemption in this context means that a person isn't required to have health insurance and won't be penalized for not having health insurance. If a person doesn't have health insurance and doesn't qualify for an exemption, then in that situation the person is required to pay a penalty, called the shared responsibility payment.

The question then naturally arises, well, what about people who earn income below the annual filing requirement threshold? If they aren't required to file a tax return, are they still required to have health insurance? And if they don't have health insurance, are they required to make the shared responsibility payment? And if they are required to have insurance, but they aren't required to file a tax return, just how will the IRS know whether their health insurance meets the definition of minimum essential coverage?

These questions, it seems to me, are what the reader is asking. So, let's give this some serious thought. Where do we begin?

Let's start here:

"If you are not required to file a tax return," the IRS says, "your tax household is exempt from the shared responsibility payment and you do not need to file a tax return to claim the coverage exemption. However, if you are not required to file a tax return but choose to file anyway, claim the coverage exemption on line 7a or 7b of Form 8965."[2]

What is this instruction from the IRS saying?

First, if a person is not required to file a tax return, then that person is exempt from the shared responsibility payment. Let's draw out what this means.

If a person is exempt from the shared responsibility payment, then that person won't be penalized if they don't have health insurance coverage during the year. In other words, that person is not required to have health insurance coverage for the year. If they do, great. If they don't, no problem. Bottom line: they won't have to pay a penalty for not having health insurance.

Now let's say a person isn't required to file a tax return, but they file a tax return anyway. Perhaps they had a job and some tax was withheld. And they are filing a tax return to get a refund of their taxes from the IRS. In this situation, the person has two options.

(1) If this person had health insurance for all 12 months of the year, then the person could check the box on the appropriate line of the tax return to indicate they had full year coverage.

(This is found on Line 61 of Form 1040, Line 38 of Form 1040A, and Line 11 of Form 1040EZ.) This signals to the IRS that the person did have health insurance, and thus the shared responsibility payment would not apply.

Or (2), if the person did not have health insurance coverage for the full year, the person can tells the IRS that the shared responsibility payment does not apply to their situation. This is done by filling out Form 8965 and checking the  yes box either for Line 7a or for Line 7b (whichever one fits their circumstances). Doing this signals to the IRS that the person did not have health insurance, but they qualify for an exemption, and thus the shared responsibility payment would not apply.

Here's the reason these procedures are important. The IRS computers may (or may not) be set up to analyze your particular situation. In other words, the IRS might not know – just by looking at your tax return – whether you are required to make the shared responsibility payment. And we don't want the IRS and their computers guessing about your situation. Because when the IRS makes guesses, it usually means you are going to pay more tax. So we want to stay protected by telling the IRS exactly what's going on.

The checkbox on Form 1040 (or 1040A or 1040EZ) means that you did have health insurance for the entire year. Checking this box means the shared responsibility payment does not apply in your situation because you were covered by health insurance.

The checkboxes on line 7a or 7b of Form 8965 means that you did not have health insurance for the entire year, and that the shared responsibility payment does not apply to your situation. Checking one of these boxes tells the IRS, "Hey, my income was low enough that I am not supposed to be penalized."

What are these check boxes for Lines 7a and 7b on Form 8965 mean?

Both of these compare income to a filing threshold amount. Line 7a measures household income, which is the modified adjusted gross income for everyone in the person's household for tax purposes. A household for tax purposes means the taxpayer, the taxpayer's spouse (if married and filing jointly), and all dependents. For each person in the tax household, we ask if that person is required to file a tax return. We then add up add up the modified adjusted gross income for each person in the household that is required to file a tax return. And that's household income. Then, compare this number to the filing threshold based on the taxpayer's filing status. If household income is below the threshold, then the person qualifies for the exemption from the shared responsibility payment (and thus does not need to have health insurance coverage).

Line 7b, by contrast, measures gross income. "Gross income," the IRS writes in Publication 17, "includes all income you receive in the form of money, goods, property, and services that is not exempt from tax. It also includes income from sources outside the United States or from the sale of your main home (even if you can exclude all or part of it)."[3] Compare the person's gross income to the filing threshold based on the taxpayer's filing status. If gross income is below the threshold, then the person qualifies for the exemption from the shared responsibility payment (and thus does not need to have health insurance coverage).

The underlying laws say that what we are really looking at is whether household income is less than the filing requirement threshold.[4]

Notes.

  1. IRS, Instructions for Form 1040 (2014), instructions for Line 61, page 50. PDF.
  2. IRS, Instructions for Form 8965 (2014), page 1, column 2. PDF.
  3. IRS, Your Federal Income Tax (2014), Publication 17, page 5. PDF
  4. Internal Revenue Code section 5000A(e)(2) and Treasury Regulations 1.5000A-3(f).