Occasionally, our clients are fortunate 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 those individuals with taxable income below the 15% ordinary income tax bracket. While the mechanics of the 0% tax calculation can be a bit overwhelming, in order to qualify in 2017 married couples must have less than $75,900 of taxable income or individuals with less than $37,950 of taxable income. There may be an opportunity to harvest some long-term capital gains and pay $0 of 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 of the 0% capital gains rate, rather I’d like to highlight a potential pitfall that may be waiting for those low-income taxpayers 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 ensure at least some 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 that can offset or potentially eliminate all premiums due to the aforementioned health insurance coverage. The taxpayer’s premium tax credit amount is determined by the taxpayer’s family size and 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 assume we have a married couple that has recently retired and has not yet commenced Social Security or private pension benefits. Assuming their previous employer(s) do not provide any type of retiree health insurance, they are likely 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). Most enrollees in a Marketplace plan are given the option of estimating their premium tax credit and having it applied monthly to reduce their premiums. This same couple may be looking to take advantage of the 0% capital gains rate at year-end.
In this scenario, 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 harvested at year-end would push their total income above 400% of the federal poverty line, which would forfeit their entire premium tax credit, and cause a very large and very unintended tax bill.
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.