Occasionally, our clients are fortunate enough from a tax-planning standpoint to take advantage of the 0% long-term capital gain tax bracket. The 0% long-term capital gain bracket was created in 2003 under President Bush’s Jobs Growth and Tax Relief Reconciliation Act and was later made permanent under the American Taxpayer Relief Act of 2012. This legislation can produce significant tax savings for individuals with taxable income below the 15% ordinary income tax bracket. While the mechanics of the 0% tax calculation can be a bit overwhelming, the main point to remember is that married couples must have less than $75,900 of taxable income or individuals with less than $37,950 of taxable income in 2017; there may be an opportunity to harvest some long-term capital gains and pay $0 additional federal tax. Keep in mind, the additional income created by harvesting gains may increase a taxpayer’s state tax liability, but more often than not, the opportunity is still too good to pass up.
There have been plenty of articles written since 2003 about the 0% capital gain bracket, and rightfully so, it’s a good deal for taxpayers if properly utilized; however, the purpose of this article is not to reiterate the benefits. Instead, I’d like to highlight a potential pitfall that may be waiting for those low-income tax payers who are also eligible for a premium tax credit under the Affordable Care Act of 2010.
Most taxpayers who are not covered by a group health insurance plan, and not yet eligible for Medicare, are enrolled in a Marketplace plan. Marketplace plans are private health insurance plans that must meet the requirements set forth by the Department of Health and Human Services, which ensures a reasonable level of health insurance for all individuals. Under the Affordable Care Act, low-income taxpayers may also be eligible for significant premium tax credits to help offset or potentially eliminate all premiums due for the aforementioned health insurance coverage. The amount of a taxpayer’s premium tax credit is determined by the taxpayer’s family size and combined income for the year, relative to the federal poverty line. If the taxpayer’s income falls between 100% and 400% of the federal poverty line for the year, they will receive at least some premium tax credit.
Here are the most common federal poverty thresholds:
- $12,060 (100%) up to $48,240 (400%) for one individual
- $16,240 (100%) up to $64,960 (400%) for a family of two
- $24,600 (100%) up to $98,400 (400%) for a family of four
You may be asking yourself at this point, where is the pitfall? Let’s take a look at the following example:
Assume we have a married couple under the age of 65 who recently retired and has not yet commenced their Social Security or retirement pension benefits. Their previous employers did not provide any type of retiree health insurance, so they are enrolled in a Marketplace plan and receiving a sizable premium tax credit (we’ve encountered situations where the premium tax credits are in excess of $10,000 per year.) Like most enrollees in a Marketplace plan, they were given the option of estimating their premium tax credit and having it applied monthly to reduce their premiums, which they elected. The fortunate couple is in a position where they are not paying any premiums for the coverage they selected from the Marketplace; most would agree this is a good deal.
Here comes the pitfall. Like most of us, the aforementioned couple wants to take full advantage of any opportunities they have to minimize the taxes they pay. Why not harvest some capital gains while they are in the lowest bracket and pay 0% in additional taxes as outlined above? If they do, the couple could be in for a very unexpected and unpleasant surprise when they go to file their taxes in April. Any capital gains they harvest at year-end will push their total income above the federal poverty line and would forfeit some or all of their premium tax credit, which ultimately causes a very large and unintended tax bill. This is a situation where two great tax-planning strategies cannot coexist. In-depth analysis needs to be completed to determine which of the strategies is most beneficial for the couple.
The example above is unique and may not apply to everyone, but the manner in which the planning opportunities crossed paths is quite common. This is why we take a comprehensive approach to our financial planning, ensuring our clients are well educated and fully aware of the options they have for achieving their lifestyle and legacy choices.