Taxpayers File Suit Over IRS Rule on Health Care Act Tax Credits

Forbs reports:

“Just one day after the Internal Revenue Service additional Proposed Regulations to clarify governance issues related to the HealthCare Act, a group of taxpayers filed a lawsuit in federal court, hoping to put the brakes on the IRS’ right to enforce the Act. The case, Halbig et al v. Sebelius et al, (downloads as pdf) was filed Thursday in the District Of Columbia District Court by twelve plaintiffs, comprised of individuals and companies.

The plaintiffs, as identified in the lawsuit are Jacqueline Halbig; David Klemencic; Carrie Lowery; Sarah Rumpf; Innovare Health Advocates; GC Restaurants SA, LLC; Olde England’s Lion & Rose, Ltd.; Olde England’s Lion & Rose at Castle Hills, Ltd.; Olde England’s Lion & Rose Forum, LLC; Old England’s Lion & Rose at Sonterra, Ltd.; Olde England’s Lion & Rose at Westlake, LLC; and Community National Bank. They hail from Kansas, Missouri, Tennessee, Texas, Virginia and West Virginia, all states that have not yet set up exchanges under the new Health Care Act.

The defendants are Kathleen Sebelius, in her capacity as Secretary of the U.S. Department of Health and Human Services; Jacob Lew, in his capacity as Secretary of the U.S. Department of the Treasury; Steven Miller, in his capacity as the Acting Commissioner of the Internal Revenue Service; and their respective agencies (DHHS, Treasury and IRS).

Under the set of laws making up what we tend to call the Health Care Act (the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010, as amended by the Medicare and Medicaid Extenders Act of 2010, the Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011, and the Department of Defense and Full-Year Continuing Appropriations Act, 2011), certain employers must pay an excise tax penalty for a failure to provide “minimum coverage” for all covered employees (generally those that are full time). The penalty is intended to discourage employers from not offering full coverage. If the employer doesn’t offer full coverage, employees have to seek out their own coverage through one of the new state exchanges. In that event, the employee might be eligible for a health care tax credit assuming that they meet certain criteria, including income thresholds of between 100-400% of the federal poverty lines.

Got it so far?

But even though this piece of the Health Care Act is slated to go into effect in 2014, most states aren’t ready. In fact, two thirds of states are either not ready or not willing to establish their own insurance exchanges. This means they will likely rely on the federal exchanges.

And here’s where things get tricky. Congress wanted the states to participate in the exchanges so, as the law was written, refundable tax credits would be available to individuals who did not receive coverage from an employer and couldn’t otherwise afford to buy insurance. As more and more states opted out, it was necessary to switch to “plan B” – or those federal exchanges. When the Regs came out, there was a curious tweak: the credits were available to taxpayers who participated not just in state exchanges but also in federal exchanges. This is, the plaintiffs say, beyond the scope of the law.

If you’re scratching your head at this point, wondering why the plaintiffs would shy away from tax credits and subsidies, here’s your answer: the plaintiffs don’t want the tax credits. Without the credits, these individuals would have been exempt from the individual mandate penalty – the cost of insurance would have been considered unaffordable. But now, with the credit, the coverage is bumped into the “affordable” category making them subject to the rules requiring coverage – coverage that, in this case, the plaintiffs argue they don’t necessarily want.

The effect bumps up to employers, as well. Under the law, employers have to offer a minimum level of health care coverage to full time employees or face a penalty. The penalty only applies if the employees who don’t receive coverage under an employee plan are eligible for the credits. By extending the credits to the federal exchanges, employers become subject to the so-called “employer mandate”.

Those results, according to Yaakov Roth, one of the attorneys from Jones Day representing the plaintiffs, were not intended under the statute. Roth argues that IRS does not have the authority to extend the tax credits to those taxpayers located in states not operating state exchanges. As a result, the plaintiffs in the lawsuit are asking the court to prohibit the IRS from enforcing the Regulations as written.

All of that, of course, leads to the logical question: what if they win? If the plaintiffs effectively strike the IRS rule as overreaching, the IRS would not be able to extend credits to taxpayers in the thirty-three states which currently don’t have plans to implement state-exchanges. No tax credits and no employer penalties.

That result, however, means that even more taxpayers would fall outside of the net for coverage than the President had originally intended. In 2012, while the Supreme Court upheld most of the Health Care Act, as written, the Court did find fault with provisions that would have required states to rapidly expand Medicaid coverage lose existing federal dollars. That was a defeat – albeit a slight one – for the administration and ultimately limited the scope of health care coverage available to Americans.

Losing this battle would be another defeat for the administration since the success of the Health Care Act largely hinges on the individual mandate. Admittedly, if plaintiffs secured a win based on an overreaching interpretation of the statute by IRS, Congress could go back and fix the statute. Easy-peasy, right?

Only, maybe not so much. While opponents of the existing Health Care Act haven’t been able to overturn the rule, proponents may not have enough political steam to push meaningful, and if the plaintiffs are successful, necessary, tweaks through Congress. With political tides turning, that might not be so easy and time is running out. The enrollment period for healthcare coverage using those state and federal exchanges begins on October 1 with an eye towards a January 1, 2014, start date. Nearly seven million taxpayers are expected to sign up for the exchanges in the first year alone with an estimated six million taxpayers subject to a penalty for noncompliance; both of those numbers are likely to increase in subsequent years.