Minor note on ACA subsidies and marginal rates

[SecondCor521]

Hi all.

Nitpicky discussion below. You probably have enough money to ignore it.

TLDR: You can't accurately assess ACA subsidy loss impact as a marginal rate by looking at the applicable figure number, nor can you properly do so by varying AGI by $100 and looking at Form 8962. The process is a bit more involved.

We've talked before about how the way ACA subsidies work as a parallel tax system in the 133% to 400% FPL range.

We've also talked about how the marginal rate effect is higher than one would expect than looking at the ACA applicable figure, because the ACA applicable figure is multiplied by one's entire AGI, not just the additional portion above a certain number.

One thing that tripped me up this year a little bit and made me investigate it is that if you're trying to figure out marginal tax rate effects by varying income by $100, then there are some rounding things that might make the ACA subsidy loss look like up to a 26% marginal rate (in addition to whatever federal and state marginal rates you might be paying).

What was happening to me is that varying income by $100 might or might not change the percentage of FPL number on line 5. Note that this number is calculated by truncating, not rounding, so for example 258.9% of FPL ends up being 258% for the rest of the form.

Because of this truncation and the way the math works on the rest of the form, I was calculating 25% or 26% marginal rates. However, this is generally just a matter of bad luck and the fact that $100 in AGI difference may not be enough to affect the percentage of FPL number (or it affects it too much; a problem that I think could happen at the lower end of the income scale).

What I did then, to figure out my real marginal ACA rate, was to take the AGI I was considering, and figure it as a percentage of the FPL to one decimal place. Let's use 258.9% as an example. I then took 258% and 259% as my two points of reference (one FPL% on either side of my exact AGI target). I then multiplied that by my base FPL number on line 4 to reverse engineer my AGI. I then looked up the applicable figures for 258% and 259% in the tables, and multiplied that by my two reverse engineered AGIs to get my annual contribution amount. I then took the difference between my two annual contribution amounts and the difference between my two reverse engineered AGIs and did the simple math to get a rate that way.

 

[scrabbler1]

I have noticed this in the last few days after my last big year-end dividend distribution came in a few days ago. I have my monthly ones still outstanding, so I decided to play some what-if games with the amount. When I increased it in increments of $100, I saw my total tax bill rise by $26-$28. Ten dollars of it was due to the marginal tax rate (10%) on the added income. But the rest of it, as you pointed out, was due to the %-of-AGI on the added income as well as a slightly higher %-of-MAGI which applies to my entire MAGI. This means that even if the added income were qualified dividends or LTCG taxed at 0%, I'd still see a sizable increase in my total tax bill. (I saw this happen years ago when an increase in QD or LTCG increased my tax bill because I was still itemizing my medical expenses which included a %-of-AGI component.)

 

[RunningBum]

I have noticed this in the last few days after my last big year-end dividend distribution came in a few days ago. I have my monthly ones still outstanding, so I decided to play some what-if games with the amount. When I increased it in increments of $100, I saw my total tax bill rise by $26-$28. Ten dollars of it was due to the marginal tax rate (10%) on the added income. But the rest of it, as you pointed out, was due to the %-of-AGI on the added income as well as a slightly higher %-of-MAGI which applies to my entire MAGI. This means that even if the added income were qualified dividends or LTCG taxed at 0%, I'd still see a sizable increase in my total tax bill. (I saw this happen years ago when an increase in QD or LTCG increased my tax bill because I was still itemizing my medical expenses which included a %-of-AGI component.)

Are you also pushing $100 of QDivs/LTCGs into being taxed? Just wondering if it's all due to using a larger % of income number in form 8962.

Also, once you get over 300% FPL, the subsidy rate is steady. 9.78% for 2020. So for every $100 income when you are above 300% FPL, you are taxed at that income rate, and also lose $9.78 in subsidy. Plus the possibility of making $100 more QDivs taxable.

Below 300%, the effect is more, because you've changed the multiplier for your subsidy on all of your subsidy money.

 

[scrabbler1]

Are you also pushing $100 of QDivs/LTCGs into being taxed? Just wondering if it's all due to using a larger % of income number in form 8962.

Also, once you get over 300% FPL, the subsidy rate is steady. 9.78% for 2020. So for every $100 income when you are above 300% FPL, you are taxed at that income rate, and also lose $9.78 in subsidy. Plus the possibility of making $100 more QDivs taxable.

Below 300%, the effect is more, because you've changed the multiplier for your subsidy on all of your subsidy money.

My spreadsheet is a skeleton version of my income tax form, so it separates the income taxes from the ACA subsidy, allowing me to identify each effect on its own.

When I add $100 to the QD amount, the ACA subsidy drops by the same amount (MAGI still went up) but the income tax is unchanged (0%). My FPL is under 300%, so I do have that added effect on the ACA subsidy due to being bumped up into a slightly higher %-of-FPL bracket.

Yes, I could also see some QD and LTCG getting pushed into being taxed at 15% instead of 0%. At least I avoided that added effect. (Whew!)

 

[sengsational]

521, I like the way the OP started out, hehehe!


I'm more practical and less academic when it comes to doing marginal rate analysis; I chunk it $1,000 at a time, and round the decimal. But, like anything in life, if the analysis interests you, then it's worth doing.

 

[FANOFJESUS]

I think the sweet spot so to speak is around 150% FPL I notice mine has doubled from two or three years ago for about the same income. Even with help from the government. That shocked me. I learned that health care and stable do not go together. Of course it will not get to crazy unless I fall off the ACA cliff. I have heard stories of people that went a few hundred over the ACA limit. That's went it really get crazy.

 

[SecondCor521]

TLDR: Be careful only changing your income by $100 to do marginal rate analyses - they may not accurately reflect ACA subsidy losses due to the way the rounding works on Form 8962.

I think scrabbler1 is talking about the standard effect of the increase in the applicable figure being multiplied by the entire AGI, which can result in additional ACA subsidy losses of about 15%. That's different than what I'm talking about.

What I'm talking about can be a ~25% ACA subsidy loss across small bands of income simply due to rounding on the form.

Here, I'll cook up an example on Form 8962.

Family size of 1 in the lower 48 making $31,349 in 2020. Line 8a turns out to be $2,599.

Same situation with $1 more income: $31,350. Line 8a turns out to be $2,608.

One dollar more of income, because of rounding in the calculation of line 5, results in $9 of subsidy loss. A 900% tax rate.

The above is probably close to the worst case, and it does average out over larger changes in AGI. But it bit me when I was trying to do marginal rate analyses on my own case and made the assumption that a $100 change in AGI would be enough to smooth over these little jagged edges. It's not.