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When is a health insurance rebate taxable?
You receive a rebate from your health insurance company – great news, right? The sticky wicket is the possible tax consequences.
The Affordable Care Act requires health insurance companies to disclose the amount of premium dollars they actually spend on health care and the amount they spend on administration, such as salaries and marketing.
If an insurance company spends less than 80 percent of premiums on medical care it must rebate the portion of premium dollars that exceeded this limit. This rule is commonly known as the Medical Loss Ratio (MLR) or the 80/20 rule. For the large group market, which is typically insurance provided through large employers, spending less than 85 percent requires rebates.
On June 1, 2012, insurance companies submitted their annual MLR reports for coverage provided during 2011 to the Department of Health and Human Services (HHS). Based on this data, HHS has announced that insurance companies that did not meet the 80/20 rule will be issuing more than $1.1 billion in rebates to nearly 12.8 million insured policyholders.
These Americans may see rebates ranging up to approximately $800, with the average being about $150. However, the choice may depend on their employers, if applicable.
Rebates must be paid by Aug. 1 each year, using one of four methods:
1 A rebate check 2 A lump-sum reimbursement to the same account that was used to pay the premium if it was paid by credit card or debit card 3 A direct reduction in future premiums 4 A rebate to an employer using one of these methods, with the employer applying the rebate in a manner that benefits its employeesIf you receive a rebate, whether that rebate represents taxable income to you or not depends on a number of factors. The tax principle involved is called the tax benefit rule. The notion behind the tax benefit rule is that, if you received a tax reduction for money you spent in 2011 and you get some of that money back in 2012, the IRS wants to recover some of the tax benefit you received last year.
Self-employed – If you claimed the premium as a page 1 deduction on your 2011 return because you were self-employed, the rebate will be taxable.
Itemized vs. standard deduction – If you have an individual policy or you paid premiums on an employer-provided policy with after-tax dollars, the tax status of any rebate will depend on whether you deducted the premiums on your 2011 return:
If you claimed the standard deduction rather than itemizing, the rebate will be tax-free.
If you itemized and did not claim a medical deduction because your qualifying expenses, including you medical insurance premium, did not exceed 7.5 percent of your adjusted gross income, your rebate will be tax-free.
If you deducted any medical expenses, all or part of the rebate will be taxed. The taxable amount depends on how much your total itemized deductions exceeded the standard deduction for your filing status.
Group plans – If you get your health insurance at work and your employer has a program that lets you pay your healthcare premium with pretax dollars, the rebate will be taxable.
Your employer may choose either to give you your share of the rebate in cash or to use the rebate to reduce your health premium in 2012. The choice made by your employer will not affect the taxation of your rebate in 2012.
If you purchase medical insurance at work, you may not actually receive a check – even if you are entitled to a rebate. If your employer opts to reduce your future premium payments, your “rebate” will come in the form of higher take-home pay because a lower insurance premium will be withheld from your pay.
The technical information here is necessarily brief. No final conclusion on these topics should be drawn without further review and consultation. Please be advised that, based on current IRS rules and standards, the information contained herein is not intended to be used, nor can it be used, for the avoidance of any tax penalty assessed by the IRS.
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