Tax Implications of the Affordable Care Act

The United States Court of Appeals for the D.C. Circuit and the Fourth Circuit have recently released directly conflicting opinions regarding the legality of an IRS tax credit provided to individuals from federal health care Exchanges under the Act.

Photo by Connor Tarter (Flickr).

Despite the best efforts of many politicians, the debate over “Obamacare” is not over.  On July 22, 2014 the United States Court of Appeals for the District of Columbia Circuit and the Fourth Circuit each issued drastically different opinions regarding tax subsidies given to individuals who buy health insurance using certain Affordable Care Act (“ACA”)Exchanges.

Through the ACA individuals may be eligible to receive tax credits by purchasing health insurance through Exchanges.  An Exchange, also called a Marketplace, is either a government or nonprofit entity who is in charge of screening individuals for healthcare plans.   These entities set up the applicable websites in order to allow individuals to fill out applications to qualify for health insurance under the ACA.  An individual can use an Exchange to preview plans in their area along with different prices which vary based on that individual’s income and household size.  Although the ACA cannot require states to create Exchanges, it attempts to encourage states to do so through a variety of incentives.  Thirty-four states have refused to establish these Exchanges and therefore, the federal government is required to create them on its own.

In order to encourage individuals to purchase health insurance, Congress enacted a provision of the Internal Revenue Code which provides tax credits for individuals who use an Exchange in order to purchase health insurance.  Under the ACA individuals were required to purchase health insurance in order to avoid the penalty of 1% of a household’s yearly income or $95 per person for a year, whichever is higher.  These Exchanges “also serve as the gateway to the refundable tax credits.”  The applicable provision, 26 U.S.C. § 36B(c)(2)(A)(i) provides that, “as of the first day of such month the taxpayer, the taxpayers spouse, or any dependent of the taxpayer is covered by a qualified health plan described in subsection (b)(2)(A) that was enrolled through an Exchange established by the State under section 1311 of the Patient Protection and Affordable Care act.”

On May 23, 2013 the Internal Revenue Service (IRS) issued a regulation which allowed these tax credits to be received by an individual who purchased insurance from a qualifying Exchange.  The IRS defined Exchange as including both state and federally created Exchanges.  This IRS regulation is the source of controversy in these two appellate cases.  The overarching issue consists of whether or not the IRS exceeded its authority by declaring that tax credits are available to individuals who enrolled through both state and federal Exchanges.

While ruling on this issue both courts relied on the Chevron Framework to determine whether the IRS exceeded its authority.

When courts are faced with the permissibility of a government agency’s interpretation of a statute, courts follow the “Chevron framework” set out in Chevron U.S.A, Inc. v. Natural Resources Defense Council, Inc.  The first step of the Chevron framework asks “whether Congress has directly spoken to the precise question at issue, for if it has, the court must give effect to its unambiguously expressed intent.”  If the court finds that the statute is plain on its face, and the “regulation responds to it” the regulation is permissible.  If the statute is ambiguous and is susceptible to different interpretations the court then applies step two, which “defers to the agency’s interpretation so long as it is based on a permissible construction of the statute.

The D.C. Circuit held in Halbig v. Burwell, that individuals who purchase insurance through a federally created Exchange are not eligible for these tax credits.

On this issue the D.C. Circuit found that “a federal Exchange is not an ‘Exchange established by the state’ and section 36B does not authorize the IRS to provide tax credits for insurance purchased on federal Exchanges.”  In the first step of the Chevron framework the D.C. Circuit initially analyzed the plain language of this statute in light of sections 1311 and 1321 of the Affordable Care Act.  The Court found that in order to be eligible for the tax credits three elements must be met: (1) an Exchange, (2) established by the state, and (3) established under section 1311.

Based on the fact that Congress specifically provided that “Exchanges established by the State” are eligible for the tax credits, rather than state and federal Exchanges, or just Exchanges, the Court found that there is nothing in the statute that indicates that federally created Exchanges were included in these tax benefits.  The court also specifically noted that reading the plain language of this statute and excluding federally created Exchanges from these tax credits did not render the other provisions of the Affordable Care Act absurd or superfluous.

After looking at the plain language of the statute, the court moved on to examine the legislative history of the Affordable Care Act due to disagreement in the court’s precedents.  The court found that one group of cases requires the court to stop their inquiry at the plain language of the statute, while others require the court to look into the legislative history of the statute.  Thus, because the court’s holding would be the same either way, the court examined the legislative history of this statute.  While looking through the legislative history the court limited its analysis to whether “the legislative history provides evidence that this literal meaning is ‘demonstrably at odds with the intentions’ of the ACA’s drafters.” The court answered this issue in the negative finding that there is no evidence that Congress actually “meant something other than what it literally said.”  Therefore, the D.C. Circuit found that the plain language of the statute prevails.

In direct contrast Fourth Circuit applied Chevron deference and upheld the IRS’s interpretation.

In King v. Burwell, the Fourth Circuit found that the Regulation passed by the IRS was a permissible construction of the statutory language. The court therefore found that individuals who purchase healthcare through federal Exchanges are eligible for the federal tax credits.

In this case the court examined the first of the Chevron factors and found that Congress has not “directly spoken to the precise question at issue.”  The Fourth Circuit found that it is not required to examine this provision in isolation; rather the court should look at it in the context of the whole Affordable Care Act.  Thus, the court found that reading 26 U.S.C. § 36B along with sections 1311 and 1321 of the ACA provide an interpretation that would allow the tax credits to apply to the federally created Exchanges, despite finding that the defendants have an “only slightly” stronger position.  The court also found that to exclude federal Exchanges from the tax credit would make certain reporting requirements under 26 U.S.C. 36B(f) useless.

By examining the language of the statute along with the lack of legislative history the court was able to move on to the second step of the Chevron analysis.  On this issue the court found that because Congress did not directly speak to the specific issue in this case the IRS’s interpretation of this statue was permissible.  A court will uphold an agency’s interpretation of a statute as long as that interpretation is not “arbitrary, capricious, or manifestly contrary to the statute.”  Therefore, in light of the broad policy goals of the ACA, ensuring all citizens have affordable healthcare, and because the Court was not able to determine whether Congress intended to make the tax credits available for both federal and state Exchanges, the court upheld the IRS’s interpretation.

The outcome of these cases will have substantial repercussions regarding the future of healthcare in this country.  If the tax credits are made available to individuals who purchased insurance under both state and federal Exchanges, there will be a huge increase in the number of people who are not exempted from the requirement of purchasing health insurance in the face of a penalty.  The Supreme Court of the United States will likely hear a case similar to these soon in order to give final answers to the important questions they raise.

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About Davis Puryear, Former Managing Editor (15 Articles)
Davis Puryear served as the Managing Editor of the Campbell Law Observer during the 2014-2015 school year. In 2012, Davis graduated from the University of South Carolina with degrees in Finance and Marketing. Davis has previously interned with Hutchens Law Firm of Fayetteville and the Cumberland County District Attorney's Office. He is from Fayetteville, North Carolina. Davis graduated from Campbell Law School in May 2015.
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