This tax season's going to be cumbersome for freelancing clients and independent contractors and their accountant, thanks to additional paperwork stemming from the Affordable Care Act.
Last year was the first year in which individuals were required to carry health care insurance under the ACA. Readers may recall the rocky road that awaited freelancers, independent contractors and early retirees who purchased coverage on their own via the insurance exchanges during the first open-enrollment period in 2013. Subsequently, advisers guiding those clients had mixed results when helping those clients obtain coverage.
Adding a new wrinkle to kick off 2015, taxpayers will now have to note on their federal returns whether they had coverage in 2014, and they'll have to state whether they received tax credits to help foot the cost of the insurance.
Note that the subsidies are largely available to those with family income between 100% and 400% of the federal poverty level, so they're not generally applicable to advisers' typical wealth management client. Nevertheless, those who are self-employed or who freelance and have variable income could be eligible for those subsidies, and they're the ones facing a complex tax season.
The problem for these clients is that they used estimates of their taxable income in 2014 when they had applied for health insurance coverage and subsidies.
ESTIMATED VS. ACTUAL INCOME
“In many situations, people didn't know what that [income] was going to be, so they made their best guess,” said Ted Sarenski, a certified public accountant, personal financial specialist and CEO of Blue Ocean Strategic Capital. “Some people will have adjustments one way or another.”
When these clients file their taxes for 2014, they'll have to reconcile their actual income versus the estimate they had provided last year when they signed up for insurance coverage and subsidies. If these clients ended up earning more money than they had guessed in 2014, they'll be on the hook to return the subsidies to the federal government.
“It's going to be eye-opening for many taxpayers: they estimated their income; it's gone up and now they have to pay the money back,” said Jimmy Williamson, CPA and senior partner at MDA Professional Group.
It's pretty easy for taxpayers to underestimate the amount that they made in 2014. For instance, estimated household income is what's used in the calculation for coverage and subsidies. This means that dependents and the money they make are included.
“That's not information that we normally capture,” Mr. Williamson said. “Typically you're capturing income for a couple, and not the kids, especially if they have summer jobs. With the new rules, household and family income are more dynamic.”
Bonuses and raises throughout the year can also throw off annual income estimates, so filers who received them may end up paying back their health care coverage subsidies, Mr. Williamson added.
PENALTIES AND SUBSIDY REPAYMENTS
Going forward, accountants are having educational meetings with their staffers and preparing them to ask questions in advance of tax time. “It's another set of questions that we have to review with folks that they didn't have to in the past,” Mr. Sarenski said. “Did you get coverage on the exchange? What was the premium you paid for the year? What subsidies did you receive? We have to ask these questions.”
Accountants also will need to discuss whether clients have minimum essential coverage for the year, per the Affordable Care Act, or will they qualify for an exemption, noted Kristin Esposito, senior technical manager at the American Institute of Certified Public Accountants.
“Ideally, CPAs would be having this discussion with clients throughout the year to talk about these issues, and usually in December or January, tax preparers send out a tax return organizer to clients,” said Ms. Esposito. “2014 is a different year: There are many moving parts that need to come together. That's the challenge tax preparers will have.”