Paying medical bills with 401(k) triggers Obamacare debt

Dear Tax Talk,
I was laid off in January of 2015. I went on unemployment while looking for a new job. I was 64 years old at the time. My girlfriend became unemployed due to stage 4 ovarian cancer during this time. She lost her health care from her job, but was able to get Affordable Care Act (ACA) insurance with discounts based on her loss of income to help cover the cost of chemo. When her savings was gone, she borrowed from her 401(k) to pay bills.

We got married in February. When we filed our taxes for 2015, we were told that even though my wife paid the taxes on her 401(k) distribution, it was also considered income. ACA wanted her health care discounts back due to the 401(k) distribution. We now owe the IRS $4,000 for discounts they say she did not deserve.

I realize that you have to let ACA know your income to get affordable health care discounts. I did not know that the 401(k) distribution, after paying the taxes, would have to be reported as additional income. Does this seem fair?
— Ralph

Dear Ralph,
First off, I must say how deeply sorry I am for your unfortunate set of events. On a personal note, I do wish that there were some IRS exception for extenuating circumstances such as yours.

But because the 401(k) income is included as gross income on your tax return, it is used in calculating your modified adjusted gross income, or MAGI. The MAGI, in turn, is a factor in the amount of premium tax credit that you may have to pay back if you go over certain thresholds.

IRS Publication 5187 clearly outlines the rules as they relate to the Affordable Care Act, and the Premium Tax Credit specifically. Your household income is calculated to be that of you, the taxpayer, as well as your spouse. IRS Form 8962, Premium Tax Credit, is used to calculate what amount, if any, you will have to repay. On the form, there is a line that includes the total health care premium tax credit received by you and your spouse as well as your MAGI. If the MAGI is greater than 400% of the “poverty line,” which is currently $15,730 in your particular situation, then you have to pay back some or all of the advance payment of premium tax credit that was received.

Unfortunately, your income must have put you over this threshold. There is still hope, though. You should certainly not be afraid of contacting the IRS directly. Their phone number is 1 (800) 829-1040. You can explain your specific circumstances and opt for an installment arrangement with them to pay what you can as you go, or you can work out what is referred to as an Offer in Compromise. An Offer in Compromise allows you to negotiate a settlement with the IRS that is less than the total owed to clear the debt.

In this case, you should call the IRS and explain your situation, and figure out what amount they may be willing to accept, as $4,000 does sound very high given that you undoubtedly have high medical bills, were unemployed for part of the year, and are of retirement age.

Thanks for the great question and all the best to you and your family in having this part of your life resolved.

ADVISER SEARCH: Need help with your personal finances? Find a financial planner in your area at Bankrate.com today!

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.

Bankrate’s content, including the guidance of its advice-and-expert columns and this website, is intended only to assist you with financial decisions. The content is broad in scope and does not consider your personal financial situation. Bankrate recommends that you seek the advice of advisers who are fully aware of your individual circumstances before making any final decisions or implementing any financial strategy. Please remember that your use of this website is governed by Bankrate’s Terms of Use.