Author Topic: Interesting Post-FIRE Tax Observation (ACA PTC and nonrefundable tax credits)  (Read 800 times)

Mr. Green

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2018 was the first year our family income resembled post-FIRE numbers on our tax returns. My wife worked half the year before FIRE'ing but we maxed out her 401k contribution and put some money in an IRA so our MAGI for ACA purposes still came in at 153% of the Federal Poverty Level. We also claim my dad as a dependent, since I support half of his expenses. We claim a $500 dependent credit for him, but because it is nonrefundable we aren't able to really take advantage of it because the tax on our income this year only amounts to $64, thanks to most of our income being qualified dividends after our $24,000 standard deduction.

I project our income ahead of time with a spreadsheet so I don't get any surprises come tax time. Our actual income this year was a little higher than I estimated, so our actual ACA Premium Tax Credit (PTC) was a little lower than what we received during the year, meaning I would need to repay $67 of that. The PTC repayment just gets lumped in with the rest of your tax, bringing our total tax owed to $131. However, because we are claiming the dependent tax credit for my dad we still owe $0 in tax, and we're leaving $369 of that credit on the table since it's nonrefundable.

In future years, if I were to estimate my PTC about $500 high, at the end of the year that overage that I would need to repay and the dependent tax credit we receive will cancel each other out, instead of leaving up to $500 of nonrefundable money on the table. I may or may not be able to do much with this for 2019 since I've already declared my estimated income during open enrollment, but it's an interesting observation that will be valuable in the future.

Of course, we'll still have to pay attention to the ACA brackets. If we're already maxing out a bracket and don't want to go any higher due to the loss of a Cost Sharing Reduction subsidy this may be of limited value, but it's worth noting.

walkwalkwalk

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At under 200% of the Federal poverty level, the maximum repayment is $600, so shoot for that or higher since it is the max. If you really have a clear idea what your income would be then your plan would be better at maximizing/not lying to the Marketplace.

secondcor521

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If your IRA contribution was for tax year 2018 and it was to a deductible IRA, you could recharacterize that contribution to a Roth IRA contribution.  If it was large enough, you could even do a partial recharacterization of the exact amount to raise your taxes owed and soak up the $369 of unused other dependent credit for your Dad.  As long as you recharacterize before you file, you should be good.

(The tax bill did away with recharacterizations, but that was only for conversions, not contributions.)

In future years, if you're tracking this stuff in December, you could also do a conversion of assets from a traditional IRA to a Roth IRA to tweak your taxes owed and absorb your non-refundable credits.  That's what I did.  I have $1K in other dependent credits for my two over-17-but-still-dependent kids, and I did a Roth conversion so that my taxes owed were $1,003.  My net tax should be $3, and then I'll get my PTC refund (in my case I overestimated my income) above and beyond that.

Mr. Green

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If your IRA contribution was for tax year 2018 and it was to a deductible IRA, you could recharacterize that contribution to a Roth IRA contribution.  If it was large enough, you could even do a partial recharacterization of the exact amount to raise your taxes owed and soak up the $369 of unused other dependent credit for your Dad.  As long as you recharacterize before you file, you should be good.

(The tax bill did away with recharacterizations, but that was only for conversions, not contributions.)

In future years, if you're tracking this stuff in December, you could also do a conversion of assets from a traditional IRA to a Roth IRA to tweak your taxes owed and absorb your non-refundable credits.  That's what I did.  I have $1K in other dependent credits for my two over-17-but-still-dependent kids, and I did a Roth conversion so that my taxes owed were $1,003.  My net tax should be $3, and then I'll get my PTC refund (in my case I overestimated my income) above and beyond that.
Thanks for pointing out the recharacterization! I wouldn't have even considered it and let the extra ~$350 in credit go. Now I see that I have nothing to lose in recharacterizing. I'll be able to move about $2,400 of the $3,000 in order to Max out the credit. Though I had to consider both the tax on the extra income and the loss of PTC as my income rises. If anything, I like doing anything with taxes at least once because it gives me a record to look back on if I ever find I need to do it again.

Padonak

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What happens if you spend money on health care during the year in addition to paying health insurance contributions. Do you get reimbursed for healthcare expenses or contributions only if you income is let's say <150% FPL.

seattlecyclone

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That is indeed an interesting little quirk of the rules!

DavidAnnArbor

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Keep in mind you might have to pay a state income tax on that extra income.

Mr. Green

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Keep in mind you might have to pay a state income tax on that extra income.
We will have to pay state income tax, which is pretty reasonable at 5.5%.

What happens if you spend money on health care during the year in addition to paying health insurance contributions. Do you get reimbursed for healthcare expenses or contributions only if you income is let's say <150% FPL.
You don't get reimbursed for expenses. That's also a challenging facet to creating your own income via Roth conversions because you can choose a lower income, which means lower deductibles and OOP maximums on your insurance plan, but then at the end of the year maybe you realize it's worth it for your income to be higher. Or it could go the other way. It takes some thought.

secondcor521

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Keep in mind you might have to pay a state income tax on that extra income.

And for those of us with kids in college, it raises the family EFC.  In the ranges the OP talks about, the family EFC tax would be about 5%-7%, and the loss of PTC is probably in a similar range.

Still worth it in my opinion to get a few thousand dollars more in a Roth federal-income-tax-free, especially if OP is on the younger side and can let that money compound tax-free for a decade or two.

Mr. Green

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That is indeed an interesting little quirk of the rules!
Looking at our projected income for 2019, I now realize that the same quirk applies to other tax situations. I'm expecting to have a few thousand dollars in 1099 income this year and the nonrefundable dependent tax credit that I would potentially miss out on without any income will cover a healthy portion of the self-employment tax I need to pay. So if that's something I want to do, rather than increase income even further, it's less money I have to send in when I earn that 1099 paycheck.

seattlecyclone

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Yep, it works when you have nonrefundable credits that would otherwise be wasted. Might as well add some more income that will bring your tax up just enough to use up that credit, whether through Roth conversions or capital gains or whatever else.

The interesting bit here is that when you overestimate your income for ACA purposes, that's a refundable credit that you get back regardless of your other taxes, but when you underestimate your income the result is a tax that can be offset by refundable credits.

walkwalkwalk

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That is indeed an interesting little quirk of the rules!
Looking at our projected income for 2019, I now realize that the same quirk applies to other tax situations. I'm expecting to have a few thousand dollars in 1099 income this year and the nonrefundable dependent tax credit that I would potentially miss out on without any income will cover a healthy portion of the self-employment tax I need to pay. So if that's something I want to do, rather than increase income even further, it's less money I have to send in when I earn that 1099 paycheck.
Nonrefundable credits can't offset self employment. Try increasing income another way.

DavidAnnArbor

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but when you underestimate your income the result is a tax that can be offset by refundable credits.

Moreover, you might not have to pay back the full premium tax credit.  There are limits to how much you are charged for underestimating your income, which end up being less than you would have paid for the actual health insurance premium.

secondcor521

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Nonrefundable credits can't offset self employment.

Why not?  Cite?  Looking at the new 1040 it sure looks like they can, but I'm not a tax expert.

walkwalkwalk

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I don't have a source but as some one else said on these forums, the line for nonrefundable comes before the line for self employment tax, ergo it cannot offset it. It has never been able to offset it in the past. I have multiple years experience in tax. Edit: I will try it in tax software tomorrow, but I dont believe it was changed by the new tax law.
« Last Edit: January 30, 2019, 07:59:26 PM by walkwalkwalk »

walkwalkwalk

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Nonrefundable credits can't offset self employment.

Why not?  Cite?  Looking at the new 1040 it sure looks like they can, but I'm not a tax expert.
Citation is personal experience. I work as a tax professional and just tried in the 2018 system, and I was correct.

secondcor521

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Nonrefundable credits can't offset self employment.

Why not?  Cite?  Looking at the new 1040 it sure looks like they can, but I'm not a tax expert.
Citation is personal experience. I work as a tax professional and just tried in the 2018 system, and I was correct.

OK, I'll respect your experience as a tax professional.  But I'd still like to understand why for my own edification.

So as an example, suppose I have a $5000 contractor gig that I file schedule C for and end up incurring some self employment tax.  No withholding, no estimated payments.  Suppose also that I have a 4-year-old dependent and qualify for the child tax credit.  Sure, some of the child tax credit is wasted in this scenario and you wouldn't be able to use the non-refundable part, but I wouldn't have to write a check to the IRS for the self employment tax, would I?  If so, can you explain why the credit doesn't offset the tax liability?

walkwalkwalk

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Nonrefundable credits can't offset self employment.

Why not?  Cite?  Looking at the new 1040 it sure looks like they can, but I'm not a tax expert.
Citation is personal experience. I work as a tax professional and just tried in the 2018 system, and I was correct.

OK, I'll respect your experience as a tax professional.  But I'd still like to understand why for my own edification.

So as an example, suppose I have a $5000 contractor gig that I file schedule C for and end up incurring some self employment tax.  No withholding, no estimated payments.  Suppose also that I have a 4-year-old dependent and qualify for the child tax credit.  Sure, some of the child tax credit is wasted in this scenario and you wouldn't be able to use the non-refundable part, but I wouldn't have to write a check to the IRS for the self employment tax, would I?  If so, can you explain why the credit doesn't offset the tax liability?
I'll start with, a lot of what the IRS does is arbitrary. However, I believe in this case they are making sure you pay in social security tax (self employment tax) since you would have done so if you were an employee making the same amount. Why the refundable credits offset it is anyone's guess. A lot of the refundable credits have to do with having children/low income, so they probably want to subsidize those people as a priority.

secondcor521

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Nonrefundable credits can't offset self employment.

Why not?  Cite?  Looking at the new 1040 it sure looks like they can, but I'm not a tax expert.
Citation is personal experience. I work as a tax professional and just tried in the 2018 system, and I was correct.

OK, I'll respect your experience as a tax professional.  But I'd still like to understand why for my own edification.

So as an example, suppose I have a $5000 contractor gig that I file schedule C for and end up incurring some self employment tax.  No withholding, no estimated payments.  Suppose also that I have a 4-year-old dependent and qualify for the child tax credit.  Sure, some of the child tax credit is wasted in this scenario and you wouldn't be able to use the non-refundable part, but I wouldn't have to write a check to the IRS for the self employment tax, would I?  If so, can you explain why the credit doesn't offset the tax liability?
I'll start with, a lot of what the IRS does is arbitrary. However, I believe in this case they are making sure you pay in social security tax (self employment tax) since you would have done so if you were an employee making the same amount. Why the refundable credits offset it is anyone's guess. A lot of the refundable credits have to do with having children/low income, so they probably want to subsidize those people as a priority.

Thanks.  My question of "why?" was more of a mechanical one.  What happens on the tax forms so that I end up writing a check to the IRS in the case I described?  I was looking for an answer like, "Oh, well if you look at Form 8937, the child tax credit is reduced to zero because there is no income tax liability, even though there may be a self-employment tax owed.  Thus the self-employment tax on Schedule 2 line 5 ends up falling through and creating a tax liability on Form 1040 line 18."  ( <- Totally made up answer just as an example - don't look at those forms/schedules/line numbers for reals.)

walkwalkwalk

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Nonrefundable credits can't offset self employment.

Why not?  Cite?  Looking at the new 1040 it sure looks like they can, but I'm not a tax expert.
Citation is personal experience. I work as a tax professional and just tried in the 2018 system, and I was correct.

OK, I'll respect your experience as a tax professional.  But I'd still like to understand why for my own edification.

So as an example, suppose I have a $5000 contractor gig that I file schedule C for and end up incurring some self employment tax.  No withholding, no estimated payments.  Suppose also that I have a 4-year-old dependent and qualify for the child tax credit.  Sure, some of the child tax credit is wasted in this scenario and you wouldn't be able to use the non-refundable part, but I wouldn't have to write a check to the IRS for the self employment tax, would I?  If so, can you explain why the credit doesn't offset the tax liability?
I'll start with, a lot of what the IRS does is arbitrary. However, I believe in this case they are making sure you pay in social security tax (self employment tax) since you would have done so if you were an employee making the same amount. Why the refundable credits offset it is anyone's guess. A lot of the refundable credits have to do with having children/low income, so they probably want to subsidize those people as a priority.

Thanks.  My question of "why?" was more of a mechanical one.  What happens on the tax forms so that I end up writing a check to the IRS in the case I described?  I was looking for an answer like, "Oh, well if you look at Form 8937, the child tax credit is reduced to zero because there is no income tax liability, even though there may be a self-employment tax owed.  Thus the self-employment tax on Schedule 2 line 5 ends up falling through and creating a tax liability on Form 1040 line 18."  ( <- Totally made up answer just as an example - don't look at those forms/schedules/line numbers for reals.)
In the old 1040 (2017 and earlier) the second page of the 1040 was split into sections that functioned together. As some one else on this site mentioned, the 1040 is meant to be prepared starting at line 1 and going down through the form. The new 1040 still does this, however, I believe it is less clear that the taxes function this way since you are flipping between schedules to try to come back to numbers going down the 1040.

secondcor521

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Nonrefundable credits can't offset self employment.

Why not?  Cite?  Looking at the new 1040 it sure looks like they can, but I'm not a tax expert.
Citation is personal experience. I work as a tax professional and just tried in the 2018 system, and I was correct.

OK, I'll respect your experience as a tax professional.  But I'd still like to understand why for my own edification.

So as an example, suppose I have a $5000 contractor gig that I file schedule C for and end up incurring some self employment tax.  No withholding, no estimated payments.  Suppose also that I have a 4-year-old dependent and qualify for the child tax credit.  Sure, some of the child tax credit is wasted in this scenario and you wouldn't be able to use the non-refundable part, but I wouldn't have to write a check to the IRS for the self employment tax, would I?  If so, can you explain why the credit doesn't offset the tax liability?
I'll start with, a lot of what the IRS does is arbitrary. However, I believe in this case they are making sure you pay in social security tax (self employment tax) since you would have done so if you were an employee making the same amount. Why the refundable credits offset it is anyone's guess. A lot of the refundable credits have to do with having children/low income, so they probably want to subsidize those people as a priority.

Thanks.  My question of "why?" was more of a mechanical one.  What happens on the tax forms so that I end up writing a check to the IRS in the case I described?  I was looking for an answer like, "Oh, well if you look at Form 8937, the child tax credit is reduced to zero because there is no income tax liability, even though there may be a self-employment tax owed.  Thus the self-employment tax on Schedule 2 line 5 ends up falling through and creating a tax liability on Form 1040 line 18."  ( <- Totally made up answer just as an example - don't look at those forms/schedules/line numbers for reals.)
In the old 1040 (2017 and earlier) the second page of the 1040 was split into sections that functioned together. As some one else on this site mentioned, the 1040 is meant to be prepared starting at line 1 and going down through the form. The new 1040 still does this, however, I believe it is less clear that the taxes function this way since you are flipping between schedules to try to come back to numbers going down the 1040.

Yup, I'm familiar with the form redesign.  I think I may have been the "someone else" you're referring to - I made a post that said essentially that a few days ago.

Still not an answer to my question, but I am not curious enough to go look at it myself.  I think maybe we're talking past each other.  I'm going to drop the topic.  OP can obviously investigate it himself if he wants to.

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I think I may have an example to share. This is where Im at with my taxes this year:

1.  64541 (wages)
6.  65754 (wages + SE income)
7.  58362 (AGI after HSA and IRA contrib)
8. -24000 (mfj deduction)
10. 34362 (taxable income)
11. 3796 (taxes owed includes 604 repayment for PTC)
12. 4240 (CTC and Savers Credit)
14. 184 (Self Emp Tax owed)
15. 184
16. 1223 (withholding)
18. 1223
19. 1039 (refund is withholding minus SE tax owed)

So, even though my CTC and Savers Credit exceed my taxable income tax plus the 604 PTC repayment,
I am not receiving any of that leftover credit. And the 184 I owe for SE is coming out of the witholding only.

secondcor521

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I think I may have an example to share. This is where Im at with my taxes this year:

1.  64541 (wages)
6.  65754 (wages + SE income)
7.  58362 (AGI after HSA and IRA contrib)
8. -24000 (mfj deduction)
10. 34362 (taxable income)
11. 3796 (taxes owed includes 604 repayment for PTC)
12. 4240 (CTC and Savers Credit)
14. 184 (Self Emp Tax owed)
15. 184
16. 1223 (withholding)
18. 1223
19. 1039 (refund is withholding minus SE tax owed)

So, even though my CTC and Savers Credit exceed my taxable income tax plus the 604 PTC repayment,
I am not receiving any of that leftover credit. And the 184 I owe for SE is coming out of the witholding only.

Thank you!  Your example looks correct to me and confirms what @walkwalkwalk was saying above, so you are both correct and I was uninformed.

The mechanical answer to my question then is that non-refundable credits can offset regular income tax down to zero (see line 13 of Form 1040), but self-employment (and other taxes on schedule 4) come after that, so they can't be offset.  Refundable credits can offset schedule 4 taxes, though - see line 17 - which may be helpful to the OP since part of the CTC is refundable I believe when the child is under 17.