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On March 23, 2010, President Barack Obama signed into law the Patient Protection and Affordable Care Act (PPACA). 1 On June 28, 2012, the U.S. Supreme Court ruled in National Federation of Independent Business v. Sebelius that the individual mandate provisions of PPACA are constitutional. 2 Many Americans believed that this Supreme Court decision brought closure to the legal challenges to PPACA.
However, a second round of challenges is now moving through the federal courts that target the IRS's interpretation in the regulations that the premium assistance credit provided in Sec. 36B is available to insurance purchased on both state health insurance exchanges and federal health insurance exchanges. In November 2014, the Supreme Court agreed to hear one of the cases involving this issue.
PPACA includes an "employer mandate" requiring large employers to offer health insurance coverage, 3 an "individual mandate" requiring individuals and their dependents to maintain health insurance coverage, 4 and a refundable credit/subsidy 5 available to individuals to help make a health insurance purchase affordable. Sec. 36B, which provides the premium assistance credit, refers twice to qualifying insurance purchased on "an Exchange established by the State." 6 While the law provided a fallback option that allows the federal government to establish an exchange if a state did not, it did not specify that the system of mandates and refundable credits/subsidies would apply to federal exchanges.
A majority of states decided to allow the federal government to establish the exchange in their state. On May 23, 2012, the IRS promulgated final regulations, including Regs. Sec. 1.36B-1(k), providing that the system of mandates and refundable credits/subsidies applies to both state exchanges and exchanges established by the federal government. 7 At least four lawsuits were filed against the government, claiming that the IRS exceeded its authority by interpreting the law as applying to both federal and state exchanges. In addition to cases arising in the District of Columbia 8 and Virginia, 9 the states of Indiana and Oklahoma brought challenges. 10 The plaintiffs in these cases all claimed that under the Administrative Procedure Act (APA), 11 the IRS's interpretation of the law in Regs. Sec. 1.36B-1(k) is arbitrary and capricious and not "in accordance with law." 12
On July 22, 2014, two of these lawsuits were decided by federal appeals courts. In Halbig, 13 the D.C. Circuit vacated Regs. Sec. 1.36B-1(k) on the grounds that Sec. 36B "unambiguously forecloses the interpretation embodied" 14 in the regulation. Within hours, the Fourth Circuit in the Virginia case, King, 15 upheld the regulation, ruling that it is a "permissible construction of the statutory language" 16 entitled to deference under the Chevron doctrine (described below). On Sept. 30, 2014, in the case brought by the state of Oklahoma by its attorney general, the District Court for the Eastern District of Oklahoma vacated Regs. Sec. 1.36B-1(k). 17 The government appealed this decision to the Tenth Circuit. 18 Then, on Nov. 7, 2014, the U.S. Supreme Court granted a petition for certiorari by the losing plaintiffs in King. Appellants in the other cases have agreed to hold their appeals in abeyance pending a Supreme Court determination.Mandates and Refundable Credits
Beginning Jan. 1, 2014, the employer mandate penalties imposed under Sec. 4980H(a) and Sec. 4980H(b) were scheduled to go into effect. However, the IRS announced on July 10, 2013, that it would delay enforcement of the employer mandate penalties until Jan. 1, 2015. 19 Any final decision vacating Regs. Sec. 1.36B-1(k) would, according to the court in Halbig, effectively make the employer mandate penalties inapplicable in states using federal exchanges. 20
Sec. 4980H imposes a shared-responsibility assessable payment obligation on large employers, which are defined as employers with an average of at least 50 full-time (at least 30 hours per week) plus full-time-equivalent employees 21 during the preceding calendar year. It creates two separate and alternative penalties: (1) the Sec. 4980H(a) penalty for failing to offer all full-time employees the opportunity to enroll in minimum essential coverage under an eligible employer-sponsored plan and (2) the Sec. 4980H(b) penalty imposed when the employer offers its full-time employees the opportunity to enroll in an eligible employer-sponsored plan, but the coverage is unaffordable (described below) or does not provide minimum value. 22 Both penalties apply only if at least one full-time employee has been certified under Section 1411 of PPACA as having received subsidized coverage through an exchange, i.e., a premium tax credit under Sec. 36B or coverage for which a cost-sharing reduction under PPACA Section 1402 (described below) is allowed or paid.
The Sec. 4980H(a) penalty is calculated by multiplying the number of full-time employees (not including full-time equivalents), less a 30-employee reduction (80-employee reduction under transition relief for 2015 only), times the applicable payment amount of $166.67 per month (indexed for inflation after 2014).
Example 1: Company X has 100 full-time employees during each month of 2016, does not offer employer-sponsored health insurance, and has received a Section 1411 certification for 10 full-time employees. The Sec. 4980H(a) monthly penalty (unadjusted for inflation) would be $11,667 ([100 ‒ 30] × $166.67), amounting to an annual penalty of $140,000 ([100 ‒ 30] × $2,000).
The Sec. 4980H(b) penalty is calculated by multiplying the number of full-time employees certified under Section 1411 of PPACA as having obtained qualifying coverage through an exchange, times the applicable payment amount of $250 per month. (This dollar amount also is adjusted for inflation after 2014.) Sec. 4980H(b)(2) caps the Sec. 4980H(b) penalty by the amount that would have been due under the Sec. 4980H(a) calculation if the employer had failed to offer coverage to any of its full-time employees.
For 2014, coverage is unaffordable for any month if it requires an employee contribution of more than 9.5% of one-twelfth of the employee's household income. This percentage, which is adjusted yearly, is 9.56% for 2015. 23
Example 2: Company Y has 100 full-time employees during each month of 2016, offers employer-sponsored health insurance, and has received a Section 1411 certification that 10 full-time employees are eligible for subsidized coverage because the employer-sponsored plan is deemed to be unaffordable for them. The monthly penalty (without adjustment for inflation) would be $2,500 (10 × $250), amounting to an annual penalty of $30,000 ($2,500 × 12).
Of course, in this second example, the employer is also incurring the cost of maintaining an employer-sponsored health insurance plan that is deemed to be affordable for the other 90 full-time employees.
Sec. 4980H(c)(3)(A) defines the premium tax credit as the credit allowed under Sec. 36B. Further, eligibility for the reduced cost sharing is limited to individuals eligible for the Sec. 36B credit. 24 Section 1402 of PPACA provides for reduced cost sharing, which offers financial assistance for an individual's share of expenses covered by a health insurance policy issued through an exchange, i.e., deductibles and out-of-pocket expenses. Individuals with household incomes between 100% and 400% of the federal poverty line for the family size involved who are eligible for the Sec. 36B advance premium assistance credit and who enroll in a silver-level qualified health plan may be eligible for a subsidy to reduce their cost sharing. 25
Notably, Sec. 4980H(d)(3) specifically provides that either penalty is refundable if an applicable premium tax credit or cost-sharing reduction is subsequently disallowed.
The individual mandate penalty of Sec. 5000A is calculated on an annual basis as the lesser of the sum of the monthly penalty amounts or the national average premium cost of a qualified health plan with a bronze level of coverage. 26 The monthly penalty amount is one-twelfth of the greater of (1) a flat dollar amount, or (2) a percentage of the excess of household income 27 for the tax year over the individual's threshold income required for filing a tax return.
The flat dollar amount is the sum of applicable dollar amounts of $95 for 2014 for each individual in the taxpayer's shared-responsibility family without coverage (limited to 300% of the applicable dollar amount). The applicable dollar amount rises to $325 in 2015, $695 in 2016, and $695 indexed for inflation thereafter. The percentage-of-income rate starts with 1% in 2014 and rises to 2% in 2015 and 2.5% for 2016 and thereafter. It appears most individuals subject to this penalty would more likely owe the amount calculated under the percentage-of-income provision. 28
The individual mandate can be avoided under a number of exceptions and exemptions, including when an individual fails to purchase a health insurance policy because it was not affordable. A health insurance policy is deemed to be unaffordable for this purpose if the cost of the cheapest available policy reduced by the amount of the Sec. 36B credit exceeds 8% of the individual's household income. 29 The plaintiffs in Halbig and King included individuals who alleged that Regs. Sec. 1.36B-1(k) made health insurance affordable due to the availability of the Sec. 36B credit on a federal exchange and thus denied them the opportunity to avoid the individual mandate under the affordability exception.
The Sec. 36B credit is available to taxpayers with household income up to 400% of the federal poverty line, in tiers that determine the "applicable percentage." The credit was designed to reduce the cost of health insurance and encourage greater participation in the health insurance market by lower-income taxpayers. The credit amount equals the sum for the tax year of the monthly "premium assistance credit amounts," which are the lesser of (1) the monthly premiums for one or more health insurance policies purchased on an exchange that cover the taxpayer, spouse, and dependents, or (2) the excess of the adjusted monthly premium for such month for the second-lowest-cost "silver" plan, over an amount equal to one-twelfth of the applicable percentage of the taxpayer's household income for the tax year. 30 According to the statute, the Sec. 36B credit is available only to subsidize the cost of health insurance premiums paid under a health insurance exchange established by a state. 31Standing and the APA
An initial question considered by both federal appellate courts was whether any of the plaintiffs had standing to challenge Regs. Sec. 1.36B-1(k). Plaintiffs in the four lawsuits challenging Regs. Sec. 1.36B-1(k) have included two states, dozens of public-school districts, and multiple private employers, as well as individual taxpayers residing in states that did not create their own exchange. 32 The government in Halbig characterized one plaintiff's injury as "purely ideological" 33 and not justiciable. Each lawsuit was initiated under the APA, which permits judicial review of "final agency action for which there is no other adequate remedy in a court." 34
Both the Halbig and King courts found that at least one plaintiff in each case had such standing. Article III of the U.S. Constitution requires a litigant to demonstrate he or she has suffered (1) an injury in fact (2) fairly traceable to the alleged conduct of the defendant (3) that is likely to be redressed by the relief the plaintiff seeks. The Halbig majority found that David Klemencic, a West Virginia resident, had standing because the availability of the Sec. 36B credit reduced the cost of health insurance to below the 8% threshold for claiming an exemption from the individual mandate. 35 Under similar reasoning, the King court found that the four individual residents of Virginia also had standing.
The government in both cases next argued that the plaintiffs were not entitled to challenge Regs. Sec. 1.36B-1(k) under the APA. A cause of action challenging a final agency action such as the issuance of Treasury regulations is permitted under the APA when "there is no other adequate remedy in a court." 36 The government claimed that the plaintiffs had an adequate remedy in the form of a traditional tax refund suit. Both courts rejected these arguments, concluding that a traditional tax refund suit did not offer prospective relief available under the APA and that the monetary relief available in a tax refund suit was doubtful and limited and not of the same genre as an action under the APA.
The District Court for the Southern District of Indiana similarly found that the plaintiffs in that case, who are the state of Indiana and the various school districts in the state, had standing to challenge the provision because the availability of the premium tax credit for insurance purchased on the federal exchange in Indiana would cause them to be subject to an employer mandate penalty. 37The Statutory Language
Section 1311(b)(1) of PPACA provides that the states "shall" establish exchanges. 38 However, despite the language, the federal government could only encourage the states rather than command them to do so. As a fallback position, Section 1321(c)(1) of PPACA authorizes the federal government to establish and operate "such Exchange within the State." 39 The government argued that the statutory reference to "such Exchange" meant that the federal government was simply stepping into the shoes of the state and that there was no difference under the statutory system whether the exchange was actually established by the state or established by the federal government on behalf of the state.
The D.C. Circuit in Halbig reasoned that the statutory language requires (1) an exchange (2) established by the state (3) under Section 1311. The court rejected the government's argument because a federal exchange did not satisfy the second element—"established by the State." The court noted that Congress knew how to classify a nonstate entity as a state when it provided in PPACA that U.S. territories electing to establish exchanges "shall be treated as a State." 40
The Fourth Circuit in King observed that "a literal reading of the statute undoubtedly accords more closely" 41 with the position advocated by the plaintiffs. However, the court held that a contextual reading of the statutory language, including the reference to "such Exchange" in Section 1321 of PPACA authorizing the federal government to establish the exchange, gave the government the "stronger position, although only slightly." 42 The court concluded that the intent of Congress was not so clear and unambiguous as to foreclose any other interpretation.A Contextual Analysis
The government argued in the cases that at least two other provisions in PPACA indicated that Congress intended to extend the system of mandates/credits to exchanges established by the federal government. Sec. 36B(f)(1) requires all exchanges to make annual reports to Treasury that include six specific information items. Three of these items refer to the Sec. 36B credit. The government argued that it would be nonsensical to require federal exchanges to report credit information if no credit were available in the first instance. The plaintiffs responded that the Sec. 36B(f)(1) reporting was simply a comprehensive list of all required information and that some of the reporting still applied to federal exchanges.
The government also suggested that the definition of a qualified individual eligible to purchase a health insurance policy in the exchange supported its position. Section 1312 of PPACA limits access to the exchanges to "qualified individuals," defined as persons who reside "in the State that established the Exchange." The government argued that there would be no qualified individuals in states with federal exchanges if a federal exchange established under Section 1321 of PPACA were not viewed as the equivalent of a state exchange established under Section 1311 of PPACA, a result that the government asserted Congress could not have intended. The plaintiffs responded that the residency requirement of Section 1312 only limits enrollment in state exchanges, e.g., Illinois residents cannot use the Indiana exchange.
The Halbig court rejected the government's first argument because it found purpose in the comprehensive reporting even if the federal exchanges reported zero for the credit amounts. With regard to the qualified individual argument, the court concluded the government's reading of the "qualified individual" language of Section 1312 of PPACA was flawed because the law did not provide that only qualified individuals could buy insurance on the exchanges. The court stated that the exchanges in states with federal exchanges would have customers, just not customers who were "qualified individuals." Thus the court found no reason to reject Sec. 36B's plain statutory language, "established by the State." The King court found that on both issues, the government's argument was the "better of the two cases" but that neither of the apparent statutory conflicts made the intent of Congress clear.The Legislative History
Both the Halbig and King appellate courts concluded that the legislative history was not particularly illuminating regarding the intent of Congress. The Halbig court held that the "silence is unhelpful to the government" because the government had the burden to convince the court that there was some reason to depart from the plain meaning of the statutory language. However, the King court held that the absence of clarifying legislative history simply meant that, while the government had the better of the statutory construction arguments, neither party had made a compelling argument that the statute was unambiguous.The Chevron Analysis
The U.S. Supreme Court held in Mayo Foundation 43 that any challenge to a Treasury regulation must be measured by the standards established in Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc. 44 The first step of the Chevron two-part framework asks whether Congress has directly addressed the precise question at issue. The Halbig court held that Congress directly addressed the precise question when it used the statutory language "established by a State" in 42 U.S.C. Section 18031(d)(1). This court held that a "principle of legislative supremacy" guides the interpretation of a statute. A court's duty is to "ascertain the meaning of the words of the statute" and that "policy is made by elected, politically accountable representatives, not by appointed, life-tenured judges." 45 Since the Halbig court held that Congress had addressed the precise question at issue, the Chevron analysis was finished.
The King court concluded that Congress did not directly address the precise question of whether the system of mandates/credits would apply only to state exchanges. The King court proceeded to step two of the Chevron analysis, under which a court examines the regulation at issue to determine if it is arbitrary or capricious in substance or manifestly contrary to the statute; if it is not, the court should uphold the regulation. In other words, the court should determine in step two whether the regulation is based on a permissible construction of the statute.
In Chevron, the Supreme Court recognized that the power of an agency to administer a congressionally created program requires formulating policy and making rules to fill any gap Congress left, implicitly or explicitly. It acknowledged that formulating that policy might require more than ordinary knowledge about the matters subjected to agency regulations. The ultimate question of whether to apply Chevron deference is whether Congress would have expected courts to treat the regulation as either within or outside its delegation to the agency of gap-filling authority.
The King court found that widely available tax credits are essential to fulfilling PPACA's primary goals and Congress was aware of their importance when drafting the bill. The court further found that the IRS interpretation ensures this essential component on a sufficiently large scale. The court thus held that Regs. Sec. 1.36B-1(k) was a permissible construction of the statutory language, applied Chevron deference, and upheld the regulation.Supreme Court to Decide
Because of the split between the Fourth Circuit and D.C. Circuit, on Nov. 7, the U.S. Supreme Court granted a petition for certiorari to the plaintiffs in King. 46 The Supreme Court is expected to issue its decision by the end of its term in June.
Although the D.C. Circuit had granted the government's petition for an en banc rehearing of Halbig, it agreed to the government's request to hold the case in abeyance until the Supreme Court decides King. 47 Although the rehearing order for Halbig vacated the court's panel judgment, the panel opinion's rationale, logic, and analysis may still be considered by other courts. 48 Similarly, the Tenth Circuit on Nov. 19 placed in abeyance the plaintiffs' appeal in Oklahoma v. Burwell while King is under consideration in the Supreme Court. In addition, the state of Oklahoma petitioned the Supreme Court for certiorari. 49
A decision by the Supreme Court to vacate Regs. Sec. 1.36B-1(k) would "gut" 50 and "effectively destroy" 51 PPACA. Without the Sec. 36B premium assistance credit, the Sec. 4980H employer mandate, and the Sec. 5000A individual mandate, the "ultimate result would be an adverse-selection 'death spiral' in the individual insurance markets in States with federally-run Exchanges." 52 The federally run exchanges would have fewer buyers and even fewer sellers and "would not operate as Congress intended and may not operate at all." 53
This is a case of statutory construction. Congress and the president can correct the problem through a legislative compromise. Tax advisers should keep a watchful eye on this issue as it moves through the judicial branch and be attuned to the range of responses that might emerge from the political branches.
1 Patient Protection and Affordable Care Act, P.L. 111-148, as amended by the Health Care and Education Reconciliation Act, P.L. 111-152.
2 National Federation of Independent Business v. Sebelius, 132 S. Ct. 2566 (2012). However, the Court also held that the Medicaid expansion provisions were unconstitutional.
3 Sec. 4980H.
4 Sec. 5000A.
5 Sec. 36B.
6 Secs. 36B(b)(2)(A) and (c)(2)(A)(i).
7 T.D. 9590. It did so by defining "exchange," by reference to 45 C.F.R. §155.20, which states the term applies "regardless of whether the Exchange is established and operated by a State (including a regional Exchange or subsidiary Exchange) or by [the U.S. Department of Health and Human Services]."
8 Halbig v. Burwell, No. 13-0623 (D.D.C. 1/15/14), rev'd, 758 F.3d 390 (D.C. Cir. 2014).
9 King v. Sebelius, 997 F. Supp. 2d 415 (E.D. Va. 2/18/14), aff'd sub nom. King v. Burwell, 759 F.3d 358 (4th Cir. 2014).
10 Indiana, No. 1:13-cv-01612 (S.D. Ind. 10/8/13) (complaint filed), and State of Oklahoma ex rel. Scott Pruitt v. Burwell, No. CIV-11-30-RAW (E.D. Okla. 9/30/14).
11 Administrative Procedure Act, P.L. 79-404.
12 5 U.S.C. §706(2)(A). The decision to initiate the lawsuits under the Administrative Procedure Act circumvented the traditional barriers that prevent taxpayers from obtaining injunctive or declaratory relief and require them to pursue a tax refund suit. See Secs. 7421, 7422, and 6532.
13 Halbig v. Burwell, 758 F.3d 390 (D.C. Cir. 2014).
14 Id. at 412.
15 King v. Burwell, 759 F.3d 358 (4th Cir. 2014).
16 Id. at 376.
17 State of Oklahoma ex rel. Scott Pruitt v. Burwell, No. CIV-11-30-RAW (E.D. Okla. 9/30/14).
18 State of Oklahoma ex rel. Scott Pruitt v. Burwell, No. 14-7080 (10th Cir. 10/2/14) (notice of appeal filed).
19 Notice 2013-45. Enforcement has been further delayed for employers with 50 to 99 employees until 2016 (T.D. 9655).
20 Halbig v. Burwell, 758 F. 3d at 395.
21 The aggregate hours of all non-full-time employees for each month divided by 120 (Sec. 4980H(c)(2)(E)).
22 A plan does not provide minimum value if its share of the total allowed costs of benefits it provides is less than 60% (Sec. 36B(c)(2)(C)(ii)).
23 Sec. 36B(c)(2)(C); Rev. Proc. 2014-37.
24 42 U.S.C. §18071(f)(2).
25 Eligibility for reduced cost sharing is determined by the information used to determine eligibility for the Sec. 36B credit. The Department of Health and Human Services makes payments to the issuer of the qualified health plan in the amount of the reduced cost sharing (45 C.F.R. Part 155).
26 Sec. 5000A(c)(1). A bronze plan is one that is designed to provide benefits that are actuarially equivalent to 60% of the full actuarial value of the benefits provided under the plan (PPACA §1302(d)(1)(A)). For 2014, the national monthly average bronze plan premium is $204 per individual, with a maximum of $1,020 for a family of five or more (Rev. Proc. 2014-46).
27 "Household income" means the aggregate modified adjusted incomes of the taxpayer and all other individuals who were taken into account when determining the taxpayer's family size for purposes of the penalty and who have a return-filing obligation for the tax year (Sec. 5000A(c)(4)(B)).
28 McKenna and McKenna, "Health Care Reform: The Constitutional Challenge to the Individual Mandate," 99 Illinois Bar J. 246 (May 2011).
29 Sec. 5000A(e)(1).
30 For applicable percentages, see Sec. 36B(b)(3)(A). For the adjusted monthly premium of the second-lowest-cost silver plan, see "applicable benchmark plan" in Regs. Secs. 1.36B-3(e) and (f).
31 Sec. 36B(b)(2)(A) specifically refers to "an Exchange established by the State under 1311" of PPACA. The fallback federal exchanges were established under Section 1321 of PPACA.
32 According to the U.S. Centers for Medicare & Medicaid Services (see www.cms.gov), as of January 2014, 16 states and the District of Columbia had established state exchanges for individual coverage, and seven had federal-state "partnership" exchanges, leaving 27 states with exclusively federally operated exchanges.
33 Halbig v. Burwell, 758 F.3d at 396.
34 5 U.S.C. §704.
35 The Wall Street Journal reported that the cost to Klemencic for subsidized health care could have been only $1.70 per month. Kendall, "Key Question on Health-Law Subsidies: Were Plaintiffs Harmed?" The Wall Street Journal (July 23, 2014), available at online.wsj.com.
36 King v. Burwell, 759 F.3d at 396, quoting 5 U.S.C. §704.
37 Indiana, No. 1:13-cv-01612 (8/12/14) (order on motion to dismiss).
38 Codified at 42 U.S.C. §18031(b)(1).
39 Codified at 42 U.S.C. §18041(c)(1).
40 PPACA §1323(a)(1), codified at 42 U.S.C. §18043(a)(1).
41 King v. Burwell, 759 F.3d at 369.
43 Mayo Foundation for Medical Education and Research, 131 S. Ct. 704 (2011); see also McKenna and McKenna, "Workers Who Study or Students Who Work?" 23 Taxation of Exempts 19 (July/August 2011).
44 Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984).
45 Halbig v. Burwell, 758 F.3d at 412.
46 King v. Burwell, No. 14-114 (U.S. 11/7/14) (petition for cert. granted).
47 Halbig v. Burwell, No. 14-5018 (D.C. Cir. 11/12/14) (order removing case from the oral argument calendar and holding it in abeyance).
48 Oklahoma v. Burwell, No. CIV-11-30-RAW (E.D. Okla. 9/30/14). See also Circuit Rules of the D.C. Circuit, D.C. Cir. R. 35(d).
49 Oklahoma ex rel. E. Scott Pruitt v. Burwell, No. 14-586 (U.S. 11/18/14) (petition for cert. filed).
50 Halbig v. Burwell, 758 F.3d at 412–13 (Edwards, J., dissent).
51 King v. Burwell, 759 F.3d at 379 (Davis, J., concurring).
52 Id. at 374.
53 Id., n.5, quoting National Federation of Independent Business v. Sebelius, 132 S. Ct. 2566, 2674 (2012) (Scalia, Kennedy, Thomas, and Alito, JJ., dissenting)
|Brian McKenna teaches tax law at Governors State University in University Park, Ill. He is a former IRS agent and general tax attorney for Santa Fe Railway. Nancy McKenna is an attorney and a registered nurse on the faculty at the University of Saint Francis in Joliet, Ill., teaching health care law and policy. She is the former vice president and deputy general counsel for Provena Health System and former chair of the Illinois State Bar Association Health Care Council. For more information about this column, contact Mr. McKenna at firstname.lastname@example.org.|