Submerged state update: Obamacare's gift of the MAGI
[UPDATE, 10/24/13: Per "Freelancer" comment below, there are multiple definitions of MAGI in the tax code, and in the initial post I used the wrong one. Erroneous info marked below. If you got here by search and are simply looking for info about how to calculate MAGI in the ACA, go to Freelancer's post or to this summary sheet of what income to include/exclude]
[UPDATE 2, 12/23/13: Now that actual plans, prices and subsidies can be viewed, I have a series of posts exploring various income/subsidy scenarios. Last in series here. ]
Covered California, the state entity enthusiastically administering the state's health care exchanges, offers not only posted price estimates for the different plans offered in the exchanges, sorted by age and income, but also a personal cost calculator, in which you punch in the number of people in your household, their ages, and your family income to get an estimate of both the cost of a mid-level silver plan and your subsidy.
One fact worth mulling is that the income on which the subsidy is based is the Modified Adjusted Gross Income (MAGI) based on IRS filings. That's a reminder that the premium subsidy is another tax cut (offset in large part by increased taxes on the wealthy, employers, medical device makers and others). The ACA's premium support is one more benefit credited negatively, by lowering the tax bill, the social service mechanism of choice for a tax-averse polity. Bowing to preferred conservative methods, we've added another subaqueous pillar to the Submerged State.
The "m" in MAGI is important, however, as it modifies the adjusted gross income (AGI) we're all familiar with on our tax forms by adding important deductions back into the total -- e.g., student loan interest, tuition, IRA contributions, and the deduction for half the self-employment tax. The "m" in some measure avoids piling subsidy on subsidy, or augmenting one incentive with another.
The use of MAGI rather than AGI is bad news for the self employed, who I assume make up a large proportion of those who make enough money to qualify for premium subsidies but who lack access to employer-provided health insurance. But it could be worse.
On the down side, loss of the self-employment tax deduction in the income calculation could hurt. We self-employed pay both halves of the Social Security and Medicare taxes, a whopping 15.3% that employees and employers otherwise split. We then get to deduct half of that tax from our AGI -- but not our MAGI.
If you make $40k as an independent contractor, you pay about $6k in self-employment tax and take about $3k off your AGI. For ACA subsidy purposes, let's say you're 40 and single and make that $40k. According to a Kaiser Family Foundation calculator (which provides a little more info and gets slightly different results from Covered California), your income is slightly under the 400% FPL (federal poverty level) that's the cutoff for subsidy eligibility, and you are eligible for an insurance subsidy of just $57. If the AGI were used, however, you would post an income of $37k and be eligible for a subsidy of $342. If you were married with two kids, and total household income were $75k, knocking that down to $72k would be worth that same extra $285 in subsidy. [UPDATE: Per comments below, the self-employment tax deduction does in fact come off your MAGI as defined in the ACA. So the subsidy reductions sketched out above are in fact available. See Freelancer comment below for the add-backs in MAGI as defined in the ACA.]
The good news for the self-employed is that MAGI does not strip out contributions to an individual 401k (nor to employer-sponsored 401ks for employees). Current law allows for large contributions to individual 401ks: 20% of net income plus $17.5k if you're under 50 and $23k if you're over. Those contributions come straight off the AGI -- and the MAGI. For a self-employed person, that's an important offset to the self-employment tax, to the extent that you can afford to pony up. Now the ACA adds a little booster to that incentive.
Let's say you're 45, married with two children and self-employed, earning $60k and with a household MAGI of $94,000, 394% of FPL. According to the Kaiser calculator, your insurance premium subsidy could be $3,978, lowering your family premium from $12,908 to $8,930 for a mid-range "silver" plan. You can legally contribute $29.5k into an individual 401k, reducing the household's AGI by the same amount. That's obviously an enormous bite, so let's say that you habitually manage $12k and that that contribution is figured into the $94k MAGI quoted above.
Now, let's say you swallow hard and pony up another $6k, reducing MAGI to $88k. The family subsidy (in Kaiser's estimate) rises to $4,548, or by $570. You get approximately 10% of your 401k contribution back as a new subsidy. That's on top of the prior total tax bill reduction yielded by the contribution, which for a couple in this bracket is 25%, or $4,500.
The self-employed also always have an incentive to maximize their expense reporting and so reduce their net income. The ACA adds a similar incentive booster to those seeking subsidized insurance on the exchanges.
Let's face it, our Byzantine tax code just got more convoluted. But that's the cost of improving the safety net in a country in the grip of small-state and free market ideology.