For ACA Eligibility, Are Promissory Note Principal Payments Included in My 2019 MAGI?

[Mo Money]

This question is for those who have some background with the ACA and with federal taxation (rare birds indeed!):

When I early-retired, my ownership in interest in my former law firm was purchased by that firm pursuant to an LLC agreement. The firm is paying the purchase price in 60 monthly installment payments using a 5-year promissory note. Those monthly payments include interest on the outstanding note balance. The firm is roughly 2/3 of the way through the payments on the note.

For reasons that remain a mystery to me, my able tax accountant instructed me to pay all of the interest on the 5-year note's principal when I filed my federal tax return shortly after I retired. I still annually pay the tax on the note interest I earn. But I owe no more tax on the note principal.

Yesterday, I learned that my privately purchased health insurance is going up about 12% in 2019.

So for the first time, I check out healthcare.gov last evening, now that 2019 open enrollment has begun. I used my 2017 federal tax return to provide a rough guide as to my 2019 MAGI, which is what Healthcare.gov apparently uses to determine eligibility. Specifically, I used my 2017 Adjusted Gross Income from Line 37. Using that number, I am eligible for a subsidy. Yay!

But then I remembered that I am getting substantial monthly note principal payments from my law firm. As stated above, I've paid the tax on the principal years ago. But are those monthly note principal payments that are made in 2019, included in 2019 MAGI for ACA purposes? Remember, all federal tax is already pre-paid on those 2019 principal payments to me.

Also, early on in the Healthcare.gov sign-in process, the site seemed to give me the option to get some sort of tax credit or refund in lieu of taking the subsidy right now. The option seemed to be recommended if my MAGI might vary substantially in 2019 from the MAGI number I provided. Is this a safe option for me to take if I am unsure of whether the note's monthly principal payments are included in MAGI?

For those who may want to say "LMGTFY," I did try to Google this, but no clear guidance. Except from Healthcare.gov, which stated, so helpfully, that MAGI is "not a line on your tax return."

My sincere thanks in advance for any guidance!

 

[gauss]

My understanding is that a "return of capital" is generally not taxable. But there may be capital gains taxes due? Would need to dig into this one further.

-gauss

 

[calmloki]

IF this is applicable: We've sold a number of rental properties. Normally our tax person has us pay the tax for the profit on sale, even if we are going to be taking payments for years to come. Think the reason given was "do you expect your income and taxes to be going up or down in the future?" On the places making payments over time we pay tax on the interest income, but not principal portion payments. On one place we were rubbing up against increased taxes or increased Medicare premiums so it worked out that the gal is paying her portion of the tax on both principal and interest received while I prepaid principal and will be only paying on interest in years to come.
Fun wrinkle: if the buyer making payments defaults and you take the property back but prepaid the principal you have a new basis equal to the sale price.

 

[Onward]

Typically return of capital is not taxable, but reduces your basis. That reduction affects your capital gain when you sell, but not until then.

I suspect return of capital doesn't count as income for ACA purposes, but you'll have to find the exact formula they use.

It's something like AGI + tax-free bond interest, isn't it?

 

[gauss]

Do you know if your LLC is treated by the IRS as a partnership (default) or has the LLC opted to be treated as a corporation by filing? If the answer is partnership, IRS Publication 541 Partnerships would be a source of further information.

Did you pay all of your capital gains taxes due in the year when you sold your interest in the LLC? Your description suggests that this is indeed the case.

-gauss

 

[Dtail]

Typically return of capital is not taxable, but reduces your basis. That reduction affects your capital gain when you sell, but not until then.

I suspect return of capital doesn't count as income for ACA purposes, but you'll have to find the exact formula they use.

It's something like AGI + tax-free bond interest, isn't it?

Below is the general formula.

http://laborcenter.berkeley.edu/pdf/2013/MAGI_summary13.pdf

 

[gauss]

Typically return of capital is not taxable, but reduces your basis. That reduction affects your capital gain when you sell, but not until then.

I suspect return of capital doesn't count as income for ACA purposes, but you'll have to find the exact formula they use.

It's something like AGI + tax-free bond interest, isn't it?

Its a bit more complicated, but I agree that for ACA purposes, "return of capital" would not be included for AGA MAGI purposes, but any taxable capital gains or interest income, of course, would.

OP do you receive a form K1 each year for the LLC activities?

If so, I believe the annual K1's should tell the whole story (with the possible exception of your adjusted cost basis for any capital gains.)

 

[Mo Money]

gauss: I do not receive a K-1 for the law firm any more, since my membership interest is deemed to be bought out via the promissory note. My federal return number (AGI, line 37) includes interest and capital gains. Thanks for your help on this.

Ultimately, I will get my accountant's blessing on the ER.org input, but I really value what you folks have to say!

PS: Any thoughts on whether I could cover my a*s by opting for the option given on Healthcare.gov to get a tax credit/refund later, to mitigate the risk that my 2019 MAGI is higher than expected?

 

[gauss]

PS: Any thoughts on whether I could cover my a*s by opting for the option given on Healthcare.gov to get a tax credit/refund later, to mitigate the risk that my 2019 MAGI is higher than expected?

Either way you will be "settling up" with form 8962 on your tax return at the end of the year.

I look at it as a cash flow issues vs the hassle in applying for the up front credits.

-gauss

 

[pb4uski]

Here is what I suspect happened. In the year that you sold your LLC shares you recognized the sale and paid taxes on any gain between the sales proceeds and your basis in the shares. Subsequently, you report annually interest income on the payments from the note.

So no, any principal that you receive is not included in tax return AGI so it is not included in MAGI. Pretty sure, but double check with your tax preparer.

 

[Mo Money]

Thanks gauss, pb4uski and the others who responded.

I will check with my accountant, but I suspect that the promissory note payments I'm getting are a return of capital, and that those payments don't get included in my MAGI for 2019.

I will do the best calculating I can for predicting 2019's interest and dividend income, but I am using my latest (2017) federal tax return as a rough gauge of my 2019 AGI (found at line 37). Does this make sense to you as a good starting point?

Even with a $3K capital loss carryforward for 2019, I will be dancing right on the edge of the so-called cliff. If I fall off the cliff, the worst-case scenario is that I have to pay back the premium tax credits, right? So what's the risk in doing my best to get the 2019 premium tax credit? I might as well try, and if I fall off, I'm merely going to be directed to pay the full cost of the plan I wanted to buy anyway. Agree?

Thanks again; this is the first time I've tried to get ACA coverage.

 

[gauss]

If you get a High Deductible , HSA qualified health insurance policy, you could make an HSA contribution for the year that could subtract several thousand dollars from your ACA MAGI.

-gauss

 

[SecondCor521]

Thanks gauss, pb4uski and the others who responded.

I will check with my accountant, but I suspect that the promissory note payments I'm getting are a return of capital, and that those payments don't get included in my MAGI for 2019.

I will do the best calculating I can for predicting 2019's interest and dividend income, but I am using my latest (2017) federal tax return as a rough gauge of my 2019 AGI (found at line 37). Does this make sense to you as a good starting point?

Even with a $3K capital loss carryforward for 2019, I will be dancing right on the edge of the so-called cliff. If I fall off the cliff, the worst-case scenario is that I have to pay back the premium tax credits, right? So what's the risk in doing my best to get the 2019 premium tax credit? I might as well try, and if I fall off, I'm merely going to be directed to pay the full cost of the plan I wanted to buy anyway. Agree?

Thanks again; this is the first time I've tried to get ACA coverage.

I think @pb4uski's analysis in post #10 is spot on.

As for estimating your 2019, you just, uh, estimate it. If your situation in 2019 will be similar to your situation in 2017, then sure, your 2017 line 37 is a good estimate. If your financial situation has changed, the ACA folks might want you to make appropriate adjustments to your estimate.

I'll add that for me my line 37 is my ACA MAGI. There are some adjustments to line 37 that you should make to get to your ACA MAGI, but they don't apply to me. I'm not sure how common those adjustments are.

As far as the cliff goes, your understanding is correct. If you get the advanced premium tax credit (APTC), then the government just pays that APTC to your insurance company every month, with you paying any amount that isn't covered by the credit. If it turns out that you fall over the cliff, you'll just have to repay the government for the total APTC when you file your taxes in April 2020. As far as I know, there are no penalties or interest if you have to repay. The only possible downside I could see is that the amount you would have to repay might be a fairly large number - it could be low five figures - and depending on your setup that might be a cash flow crunch. You'd want to be ready for that.

If you think you might be over the cliff, there are usually things you can do in December 2019 to get your MAGI under the cliff number. Basically anything that reduces line 37 will probably work - HSA's as @gauss mentioned, IRA contributions (if you have earned income), capital losses in excess of gains, etc.

 

[Mo Money]

gauss and SecondCor521: Thanks so much for the input.