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Anne Powelson Anne Powelson
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Health insurance premium rebates: a cloud to the silver lining?

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Here's a story that might make you feel better if you weren't one of the 10,000 Mainers receiving a rebate under the Affordable Care Act. Turns out, in some cases the rebates will be taxable.

Why might these refunds be considered taxable? If you are refunded an expense you deducted in a prior year, then the refund can be taxable. This is most commonly seen in state tax refunds. If you deduct state income taxes on your federal return and receive a refund from the state, that refund may be taxable in the tax year it is received. The taxable amount is never in excess of the amount which provided you with a tax savings. As an example, an individual with only one deduction has $6,700 in state taxes withheld in 2011. On her federal tax return, she itemizes state taxes withheld as shown on her W-2. But in this example, she owes $0 to the state, so in 2012 she gets all $6,700 back. The $6,700 is not all taxable, only $1,000, which is the difference between what she'd itemized that year and the standard deduction for 2011: $5,700.

But back to health insurance premiums:

Those purchasing individual policies in Maine will not be receiving any rebates on insurance premiums. Providers of individual insurance in Maine received a waiver to the requirement to spend less than 20 percent on administrative costs. But purchasers of individual policies in other states would need to add the insurance rebates to their 2012 taxable income if they either received a tax advantage from itemizing their medical deductions or took the self-employment insurance premium deduction on the front page.

It is possible that employed people have deducted their health insurance premiums as well. There are three general cases:

1. Health insurance premiums paid with post-tax dollars and the rebate is given only to 2011 participants: If you paid for your health insurance premiums with post tax dollars and you itemized medical deductions, your rebated premiums would be taxable to the extent they helped you save money on your 2011 return. The taxable portion of your rebate must be reported on your tax return.

2. Health insurance premiums paid with post-tax dollars but the rebate is given to all participating in 2012 (regardless of 2011 participation): Because the rebate goes to all 2012 participants, it lowers 2012 premiums and is not considered a refund to 2011 expenses. You do not report the rebate separately, but it does reduce your deductible 2012 medical expenses.

3. Health insurance premiums paid with pre-tax dollars: If you paid for your health insurance premiums through pre-tax dollars, you will automatically pay taxes on your rebate. If the rebate is processed as a rate reduction, you'll pay less for health insurance premiums this year and have more taxable income. If you receive the rebate as cash, it will be considered wages, and taxes withheld accordingly. In either case, merely reporting your W-2 information will incorporate the rebate into your return.

More details and examples are available at IRS.gov; search for 'Medical Loss Ratio.'

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