So you want to understand how the premium tax credits work? You’ve come to the right place. In this article, I discuss:
- What the premium tax credit is
- How the premium tax credit works
- Who’s eligible for a premium tax credit
- How to calculate your premium tax credit
- How your premium tax credit is reconciled on your tax return every year
If you find this article helpful or have suggestions on making it easier to understand, send me an email (rick@leguphealth.com) or message me on Twitter (@RickLindquist).
What the premium tax credit is
First, let’s define a tax credit.
A tax credit is an amount of money that you can subtract from the taxes you owe the government. A tax credit is different from a tax deduction. Tax deductions reduce your taxable income while tax credits reduce the tax you owe.
Second, let’s define a premium.
A premium is the cost of a health insurance policy.
Now, let’s put them together.
The premium tax credit is a tax credit that offsets your annual health insurance premiums. It’s a way for the government to pay for some or all of your private health insurance costs.
The premium tax credit is unique in two important ways.
First, the premium tax credit is refundable. Refundable means you can receive the tax credit as a full dollar-for-dollar refund even if you don’t owe any taxes at the end of the year.
Second, the premium tax credit is advanceable. Advanceable means you can receive an estimated tax credit before you file your tax return. Most people don’t realize this, but the primary role of your state’s Health Insurance Marketplace (“Marketplace”) is to estimate and advance these premium tax credits each month.
How the premium tax credit works
When you enroll in Marketplace coverage, you choose when you receive your premium tax credit. There are two options. You can choose to receive an estimated premium tax credit in advance. Or, you can wait to receive it when you file your tax return the following year.
Suppose you choose to receive it in advance. In that case, the Marketplace will send one-twelfth (1/12) of your estimated annual tax credit to the insurance company each month. This way, you only have to pay the difference between your monthly premium and the monthly tax credit amount.
On the other hand, suppose you choose to wait until tax time to receive your credit. In this case, you’ll pay the entire premium each month and receive your premium tax credit as a refund when you file your tax return the following year.
Note: The primary reason your state’s Marketplace exists is to estimate and facilitate your premium tax credit.
Who’s eligible for a premium tax credit
You’ve probably noticed I’ve been using the term household to refer to you or your family. The Marketplace and the Internal Revenue Services (IRS) deal with you in the context of your household.
If you’re single and file your taxes as an individual, you’re a household of one. If you have a family of four and file a single tax return for you, your spouse, your two dependents, you’re considered a household of four.
Another term to understand is the federal poverty level (FPL). The federal poverty level is set each year by Health and Human Services (HHS). The government uses it to determine your household’s eligibility for government assistance programs like Medicaid and premium tax credits. Notice that the federal poverty level increases with household size.
Before 2021, premium tax credits were only available to households with annual income below 400 percent of (or four times) the federal poverty level for their household size.[1] For 2021 and 2022, the American Rescue Plan (ARP) suspended the income eligibility requirement. And the Inflation Reduction Act extended that suspension through 2025.
Note: Policy advocates refer to this issue as the premium tax credit or “subsidy” cliff, and I’m in favor of removing it permanently before the temporary suspension expires on January 1, 2026.
To be eligible for premium tax credits, you must meet several criteria:
- You must purchase coverage through your state’s Marketplace. Suppose you buy coverage directly from an insurance company outside of the Marketplace. In that case, you are not eligible for a premium tax credit.
- You must not be eligible for affordable coverage through an employer.[2] In 2023, your employer coverage is affordable as long as you’re not required to pay more than 9.12 percent of your income to cover yourself. The affordability provision applies to group coverage provided by an employer via a group plan. It also applies to individual and family coverage reimbursed by an employer via special health reimbursement arrangements (HRAs).
- You must not be eligible for coverage through the government. Government coverage includes health insurance programs Medicaid, Medicare, CHIP, or TRICARE.
- You must file your own tax return. Someone else cannot claim you as a dependent on another tax return. And if you’re married, you and your spouse must file a joint tax return. You can’t file separate returns.[3]
- You must be a lawfully present and legal resident of the United States. If you're an illegal resident or in jail, you’re not eligible for premium tax credits.
How to calculate your premium tax credit
Full disclaimer. You may have to read this section a few times before it will make sense. The premium tax credit calculation is complex. I’m going to walk through the details. But, the easiest way to estimate your premium tax credit is to use a special-purpose calculator. It’s even better to use a quoting tool, which lets you see how your credit changes the cost of your available health insurance options.
Note: I highly recommend using a quoting tool to understand this concept. A quoting tool will allow you to adjust the inputs for household size and income to see how changes affect your premium tax credit.
The premium tax credit caps your household’s annual out-of-pocket health insurance costs as a percentage of your household’s income based on a percent of income cap. For 2021 through 2025, the percent of income cap ranges from 0 percent to 8.5 percent, depending on your household income.
Before I walk you through how to determine your household’s percent of income cap, you need to understand the concept of a benchmark plan. Since you have many health insurance plan options available in your state’s Marketplace, the IRS must pick one of them to “benchmark” against your income. By law, the benchmark plan is the “second-lowest-cost silver plan” available in your area.
Note: Most of the time, the benchmark plan is a single health insurance plan. However, in some cases, such as when your dependent child has moved away to another rating area for school, the Marketplace will combine multiple silver plans to create a benchmark.
To calculate your premium tax credit, you first need to determine your household’s percent of income cap. Your percent of income cap depends on where your household income falls relative to the federal poverty level. If your household’s annual income is greater than or equal to 400 percent of the poverty level, your percent of income cap is 8.5 percent. Otherwise, your percent of income cap varies based on the income bands in the chart below.
The federal poverty level is set each year by Health and Human Services (HHS). The chart below lists the latest federal poverty levels for the 48 contiguous states and the District of Columbia. Hawaii and Alaska have different numbers.
Using the two charts above, here are five examples:
- A household of 1 with $65,000 in income would have a percent of income cap of 8.5% (That’s an annual dollar cap of $5,525.)
- A household of 2 with $49,300 in income would have a percent of income cap of 4% (That’s an annual dollar cap of $1,972.)
- A household of 3 with $74,580 in income would have a percent of income cap of 6% (That’s an annual dollar cap of $4,475.)
- A household of 4 with $45,000 or less in income would have a percent of income cap of 0% (That’s an annual dollar cap of $0.)
- A household of 5 with $500,000 in income would have a percent of income cap of 8.5% (That’s an annual dollar cap of $42,500.)
The number in parentheses is the most each household would need to pay for their benchmark plan. I call this number the annual dollar cap.
If your benchmark plan’s annual premium is less than or equal to your annual dollar cap, your premium tax credit is $0. Otherwise, your maximum premium tax credit is equal to the benchmark plan’s annual premiums minus the annual dollar cap.
Using the same household examples from above, here are five sample premium tax credits:
- If Household 1’s annual benchmark plan premiums total $6,000, the maximum premium tax credit is $475 ($6,000 - $5,525)
- If Household 2’s annual benchmark plan premiums total $10,000, the maximum premium tax credit is $8,028 ($10,000 - $1,972)
- If Household 3’s annual benchmark plan premiums total $15,000, the maximum premium tax credit is $10,525 ($15,000 - $4,475)
- If Household 4’s annual benchmark plan premiums total $20,000, the maximum premium tax credit is $20,000 ($20,000 - $0)
- If Household 5’s annual benchmark plan premiums total $25,000, the maximum premium tax credit is $0 (Since $25,000 is less than $42,500, the credit is $0)
Your maximum premium tax credit is calculated based on your benchmark plan. But, you don’t have to buy the benchmark plan. You can use your premium tax credit to purchase any Marketplace plan available in your area.
Suppose you choose a plan with annual premiums greater than or equal to your maximum premium tax credit. In that case, you’ll receive your maximum premium tax credit and pay any extra costs out-of-pocket.
Suppose you choose a plan that costs less than your maximum premium tax credit. In that case, you will pay $0 out of pocket, and your premium tax credit will equal the annual premium for that plan. When you buy a plan that costs less than the maximum premium tax credit, you do not receive the difference as a refund. You can only receive “credit” for the dollars you spend.
How your premium tax credit is reconciled on your tax return every year
Let’s assume you chose to receive your estimated premium tax credit in advance. In that case, it’s crucial to understand how the actual premium tax credit will get reconciled with the estimate on your tax return.
Note: You don’t have to receive your premium tax credit in advance, but most people choose to.
When you receive the tax credit in advance, it’s an estimate based on an annual income estimate you provide to the Marketplace as part of your application. The IRS then reconciles your estimated premium tax credit based on your actual income when you file your tax return the following year.
Suppose you end up with less income than you estimated and received too little premium tax credit in advance. In that case, you’ll receive more premium tax credit in the form of a refund.
If you end up with more income than you estimated and you received too much premium tax credit in advance, you’ll have to pay some of it back in the form of a tax. The IRS caps the amount you have to pay back if your income is below 400 percent of your household’s federal poverty level.[4] But suppose your income is above or equal to 400 percent of the poverty level. In that case, you will have to repay all of the excess credits you received in advance.
Each year, the Marketplace generates a “Health Insurance Marketplace Statement” called a 1095-A for you to use when you file your tax return. The Marketplace also sends a copy to the IRS. Think of the 1095-A as a special kind of W-2 or 1099. It’s a way for the Marketplace to report information about your health insurance plan and any premium tax credits you receive to the IRS for tax purposes.
Your 1095-A will include personal identification information for you and everyone covered on your health insurance plan. It also lists the information the IRS needs to reconcile your premium tax credit, including the:
- Monthly premiums for the health insurance plan you enrolled in
- Monthly premiums for the second-lowest-cost silver plan (i.e., the “benchmark plan”).
- Monthly premium tax credits you received in advance
When you file your tax return, you’ll use your 1095-A to complete Form 8962. Form 8962 calculates your actual premium tax credit and reconciles it with any advance payments you received. Don’t worry. Your accountant and most online tax filing services like TurboTax will walk you through this.
Note: If you’re a LegUp Health client, you’ll be able to download your Form 1095-A online each year. You’ll also receive a copy via mail or email.
If you elect to receive an estimated premium tax credit in advance, be sure to track whether your actual income is tracking higher than your estimated income. If your income ends up being higher, you’ll owe more taxes at the end of the year. Don’t allow yourself to be surprised by this. Suppose you have a significant change in income. In that case, it’s a good idea to update your information with the Marketplace so it can adjust your estimated premium tax credit accordingly. The same goes for any changes in your household’s size.
Frequently asked questions (FAQs)
How long has the premium tax credit been available?
The credit has been available since 2014. In 2010, the Affordable Care Act (or “Obamacare”) implemented the credit to cap the cost of health insurance for low and middle-income Americans.
What is the easiest way to see if I’m eligible for a premium tax credit?
The easiest way to see if you’re eligible for a premium tax credit is to create a “soft quote” for Marketplace coverage. You can also use a special-purpose tool like our premium tax credit calculator. Adjust your income higher and lower to see how your premium tax credit changes.
Can I use my premium tax credit on any health insurance plan?
You can use your premium tax credit to buy any of the bronze, silver, gold, and platinum plans offered through your state’s Health Insurance Marketplace. You can not use premium tax credits to buy “catastrophic” plans or plans offered outside your state’s Marketplace (i.e., off-Marketplace plans).
Do I have to take my premium tax credit in advance?
No. Receiving the premium tax in advance is optional. You can also choose to take only a portion of your premium tax credit in advance.
How will the Marketplace determine my household’s benchmark plan(s)?
Your benchmark plan is the “second-lowest-cost silver plan” available in your area. Most of the time, it’s a single plan. However, in some cases, such as when your dependent child has moved away to another rating area for school, the Marketplace will combine multiple plans to create a benchmark.
What happens if my household size or income changes during the year?
If you elect to receive an estimated premium tax credit in advance, be sure to track whether your actual income is tracking higher than your estimated income. If your income ends up being higher, you’ll owe more taxes at the end of the year. Don’t allow yourself to be surprised by this. Suppose your income or household size changes. In that case, it’s a good idea to update your information with the Marketplace so it can adjust your estimated premium tax credit.
Note: LegUp Health clients can report these changes through the online portal and get help when needed.
If I buy health insurance directly from an insurance company outside of the Marketplace, am I eligible for the premium tax credit?
No. Premium tax credits are only available for plans available on your state’s Marketplace (“on-Marketplace plans”). Off-Marketplace plans are not eligible.
Am I eligible for premium tax credits if my employer offers a group health insurance plan?
If your employer’s group plan coverage is affordable, you’re not eligible for a premium tax credit.
Am I eligible for premium tax credits if my employer offers a health reimbursement arrangement (HRA)?
If your employer’s HRA is affordable, you’re not eligible for a premium tax credit.
Am I eligible for premium tax credits if my employer offers a taxable benefit allowance or stipend?
Yes. Stipends from your employer do not affect your premium tax credit eligibility. However, stipends increase your household income, which may affect the size of your premium tax credit.
Notes
[1] When I write “income,” I’m referring to modified adjusted gross income (MAGI). The IRS and your state’s Marketplace use your household’s MAGI when determining your premium tax credit amount.
[2] The employer coverage must also provide minimum value. It must have an actuarial value of 60 percent or more.
[3] There are exceptions to this rule.
[4] This cap is set annually based on the consumer price index.
