Supreme Court Upholds Affordable Care Act Subsidies
Employee Benefits Update
Date: June 25, 2015
The Supreme Court of the United States today upheld the Fourth Circuit Court of Appeals’ decision in King v. Burwell by a 6-3 vote and held that taxpayers who enroll in health insurance coverage through any Exchange established under the Affordable Care Act (ACA) are eligible for tax credits, but used different reasoning to reach its result. The different path the Court took, though, will not impact the implementation of the ACA or affected health plans.
While this decision maintains the status quo, it is significant because it supports the ACA’s current infrastructure and avoids a number of problems that could have been created had the Supreme Court ruled another way.
What question was before the Supreme Court?
The Court was asked to determine whether the Internal Revenue Service (IRS) exceeded its authority in publishing a key portion of its 2012 regulations under the ACA. Those regulations provide that an advance refundable tax credit (sometimes referred to as a subsidy) is available to a taxpayer who enrolls in health insurance coverage through any Exchange (sometimes referred to as a Health Insurance Marketplace) established under the ACA, regardless of whether the Exchange was established by a State or the federal government.
The petitioners disagreed with the IRS’s interpretation, arguing that such subsidies should be available only to taxpayers who enrolled in coverage through an Exchange that was established by a State. They argued that the ACA does not authorize subsidies for taxpayers who enroll in coverage through Exchanges established by the federal government or through a partnership with the federal government.
The Fourth Circuit Court of Appeals upheld the IRS’s interpretation, finding that the ACA is ambiguous, and the Supreme Court today upheld the Fourth Circuit’s decision, though using different reasoning.
What does the ACA actually say?
Section 1311(b) of the ACA provides that “[e]ach State shall, not later than January 1, 2014, establish an American Health Benefit Exchange (referred to in this title as an ‘‘Exchange’’) for the State….”
- Although Section 1311 of the ACA provides that each State “shall” establish an exchange, federalism prohibits Congress from compelling States to take action.
Section 1321(c) of the ACA provides that if a State does not establish its own Exchange, “ the Secretary shall (directly or through agreement with a not-for-profit entity) establish and operate such Exchange within the State….”
Section 1401 of the ACA creates new Section 36B of the Internal Revenue Code (Code), which in turn creates the subsidy. Section 36B provides that the amount of the subsidy available to a taxpayer for a year is equal to the taxpayer’s “premium assistance credit amount” for the year. The premium assistance credit amount is determined based on the taxpayer’s number of “coverage months” occurring during the taxable year. A coverage month is one in which, among other requirements, the taxpayer is enrolled in coverage as of the first day of that month under “a qualified health plan described in subsection (b)(2)(A) that was enrolled in through an Exchange established by the State under section 1311 of the Patient Protection and Affordable Care Act….”
What did Congress mean?
That’s the million-dollar question. When referring to “an Exchange established by the State under section 1311,” in its definition of coverage month, did Congress intend to provide subsidies only to those taxpayers in states that established their own Exchanges?
The petitioners argued that the definition of coverage month intentionally referred only to Section 1311 (and not Section 1321) because Congress intended to create a carrot to encourage states to establish their own Exchanges.
The government argued that the phrase “an Exchange established by the State under section 1311,” was meant to include Exchanges established by the federal government as a surrogate for the State. Among other arguments, the government asserted that Congress would not have buried such a carrot in sub-clauses setting forth the technical formula for calculating the subsidy amount.
What is the significance of the subsidy?
The subsidy is significant for at least four reasons:
- First, it immediately lowers the cost of Exchange-based health insurance. The subsidy is structured as a tax credit that reduces the amount of federal income tax a taxpayer would otherwise owe for a year. However, it is also structured as an advance refundable tax credit, which means the taxpayer can receive the benefit of the credit before he files his tax return in the following year. When a taxpayer applies for health insurance coverage through an Exchange, he can also apply for a subsidy. The Exchange will estimate the amount of credit to which the taxpayer will likely be entitled and reduce his monthly health insurance premiums by a ratable portion of the credit. If the Exchange overestimates the amount of the credit, the taxpayer will owe the difference when he submits his tax return for the year. If the Exchange underestimates the amount of the credit, the taxpayer will be entitled to a refund.
- Second, because the subsidy reduces the cost of Exchange-based health insurance,itincreasesthenumberoftaxpayerssubjecttotheACA’s individual mandate,underwhichtheACA generally imposes a tax penalty on individuals not enrolled in health insurance coverage for the full year. However, certain individuals are exempt from this penalty – including those for whom health insurance coverage is not affordable. In certain cases, the availability of the subsidy would make coverage affordable and subject an individual to the individual mandate penalty when he would otherwise be exempt.
- The petitioners live in Virginia, which did not establish its own Exchange. They claimed that without the subsidy, they would be exempt from the individual mandate because their incomes are low enough to make health insurance unaffordable. They further claimed that that they do not wish to obtain health insurance, so the IRS’s interpretation of the ACA would subject them to a tax penalty.
- Third, the subsidy determines whether and to what extent an employer is subject to a tax penalty under the ACA’s employer mandate. An employer that does not offer affordable, minimum-value health insurance coverage to all of its full-time employees will be subject to a tax penalty if at least one of its full-time employees obtains a subsidy. In certain cases, the tax penalty amount is determined based on the number of full-time employees who obtain a subsidy.
- Fourth, the subsidy is part of the ACA’s larger design. To achieve its goal of providing broad access to health insurance coverage, the ACA requires insurance companies to accept applicants regardless of health condition. Insurance companies therefore want a large pool of people (including a large number of healthy people) over which to spread risk. If individuals do not obtain health insurance until a health condition necessitates the coverage, the insurance companies could be covering only people with high health care expenses, which could cause the cost of the coverage to be high. If insurance companies raise premiums to help pay for this high cost of coverage, more people might choose to forgo insurance until it becomes necessary. A decreasing risk pool and adverse selection could result in further premium increases, which could result in even fewer people purchasing insurance.
What is this decision’s significance?
Because the Supreme Court upheld the IRS’s interpretation of Section 36B of the Code, the ACA’s implementation should continue uninterrupted.
Now that this question has been resolved, the IRS and other regulatory agencies are free to focus their efforts on the remaining outstanding ACA issues, including implementing the new reporting requirements, developing nondiscrimination rules for insured health plans, issuing guidance on automatic enrollment requirements for large employers, and promulgating regulations on the Cadillac Tax.
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