When you receive the premium tax credit in advance, it’s an estimate based on an annual income estimate you provide to the Marketplace as part of your application. The IRS then reconciles your estimated credit with your actual income when you file your tax return the following year.
If you end up with more income than you estimated and you received too much premium tax credit in advance, you’ll have to pay some of it back in the form of a tax.
In other words, the IRS will “claw back” your tax credit. Policy advocates refer to this as the premium tax credit (“subsidy”) clawback.
How the premium tax credit clawback caps work
The IRS caps the amount you have to pay back if your income is below 400 percent of your household’s federal poverty level. But if your income is at 400 percent of the poverty level or above, you will have to repay all excess credits you received in advance. Refer to the below chart for the 2021 repayment caps. The federal government adjusts the caps each year based on the consumer price index.
Note: The American Rescue Plan waives all premium tax credit repayments for the 2020 tax year.
How to avoid the premium tax credit clawback
Estimating income can be difficult, especially for freelancers, contract workers, and entrepreneurs. It’s not uncommon for people with fluctuating incomes to have to repay some of the tax credit.
Does this mean you should fear the premium tax credit? Not at all. You just need to understand how it works and take steps to avoid a tax-time surprise.
One simple way to avoid having to repay your premium tax credit is to update your Marketplace application any time your household size or income changes. That way, the Marketplace can adjust your premium tax credit mid-year and keep it in sync with your income.
Alternatively, you can avoid the clawback altogether by choosing to defer some or all of your premium tax credit until you file your tax return. This way, you’ll receive whatever credit you're eligible for as a tax refund based on your actual income. If you go this route, you pay the full monthly premium out-of-pocket during the year and basically get reimbursed at tax time.
Finally, if you find yourself in a situation where you owe some or all of your premium tax credit back at tax time, you might consider ways to reduce your modified adjusted gross income (MAGI). For example, contributions to individual retirement accounts (IRAs) and health savings accounts (HSAs) reduce your MAGI.