IRS Premium Tax Credit Final Rule Upheld

by Cecylia K. Hahn

On March 23, 2010, Congress enacted the Patient Protection and Affordable Care Act (“ACA”). Pub. L. No. 111 – 148, 124 Stat. 119 (2010). One provision in the voluminous ACA addresses premium tax credits to certain individuals who sign up for health insurance on an internet-based marketplace called an “Exchange.” See 42 U.S.C. §§ 18031, 18041. The provision authorizes a federal tax credit for many low-and middle-income individuals to offset the cost of insurance purchased on an Exchange established by a state. 26 U.S.C. §36B. Thus, the issue arises, what about exchanges established by or with the assistance of the federal government in the 34 states that declined to establish their own Exchange. Individuals interested in this issue may be those that would be wholly exempt from the individual mandate if not for the tax credit. Further, employers have an interest because their tax penalty is, to an extent, dependent upon an employee receiving a tax credit resulting from his or her joining an exchange.

The IRS addressed this issue on May 23, 2012 in a Final Rule implementing the ACA’s premium tax credit provision.   77 Fed. Reg. 30,377.  In its Final Rule, the IRS interpreted the ACA as authorizing the agency to grant tax credits to certain individuals who purchase insurance on either a state-run health insurance Exchange or a federally-facilitated Exchange.  The IRS rejected the limitation of the tax credit to individuals purchasing insurance on a state Exchange only, stating:

The statutory language of section 36B and other provisions of the [ACA] support the interpretation that credits are available to taxpayers who obtain coverage through a State Exchange, regional Exchange, subsidiary Exchange, and the Federally-facilitated Exchange. Moreover, the relevant legislative history does not demonstrate that Congress intended to limit the premium tax credit to State Exchanges. Accordingly, the final regulations maintain the rule in the proposed regulations because it is consistent with the language, purpose, and structure of section 36B and the [ACA] as a whole.

On January 15, 2014, Judge Paul L. Friedman, U.S. District Court for the District of Columbia, upheld the IRS final rule, which had been challenged by a group of individuals and employers residing in states that had declined to create an Exchange. The opinion appears here.  Judge Friedman agreed that “on its face, the plain language of 26 U.S.C. § 36B(b)-(c), viewed in isolation, appears to support” the argument that the tax credits only apply to individuals who purchase health care insurance on a state Exchange.  However, the overall law does not support this limited interpretation, and for the purpose of the ACA’s premium tax credit provision, the federal government may create an Exchange on behalf of a state.  Thus, Judge Friedman held “that the IRS Rule is consistent with the text, structure, and purpose of the [ACA]. Section 36B must be read as authorizing the IRS to deliver tax credits to individuals purchasing health insurance on federally-facilitated Exchanges.”

Within minutes of the decision, it was appealed to the United States Court of Appeals for the District of Columbia Circuit.  Challengers to the IRS Final Rule maintain that it is contrary to the law enacted by Congress and dilutes states’ decisions to refrain from creating an Exchange.  Individual plaintiffs are upset because without the credits they would be exempt from the individual mandate altogether.   The federal government responds that the ruling is appropriate because in this case the federal government may step in the shoes of the states, which have declined to create an Exchange, in order to create one on their behalf.  The D.C. Circuit will review Judge Friedman’s decision and may uphold, reverse, or send the decision back to the lower court with instructions.  At this point, no one can predict what the final determination will be as to whether individuals may receive a tax credit when purchasing health care insurance on a federally-facilitated Exchange.