During this fall, the U.S. Supreme Court has agreed to hear California v. Texas which will address the constitutionality of the Affordable Care Act (ACA).  In 2018, Texas and 19 other states filed a civil suit in the U.S. District Court for the Northern District of Texas arguing that with the passage of the Tax Cuts and Jobs Act of 2017, which eliminated the individual shared responsibility payment for not having health insurance, the individual mandate no longer had a constitutional basis and, thus the entire ACA was no longer constitutional.  The U.S. Department of Justice said it would no longer defend the ACA in court, but 17 states, led by California, stepped in to do so.  The trial court struck down the ACA individual mandate as unconstitutional and the U.S. Court of Appeals for the Fifth Circuit also affirmed this decision. It did not, however, determine if the individual mandate is severable from the rest of the ACA.  That decision will be determined by the Supreme Court.  If the Supreme Court holds that all, or a portion of the ACA is unconstitutional as a result of the elimination of the penalty for not carrying health insurance,  taxpayers may be entitled to refunds for the taxes imposed by the ACA including:

  • The net investment income tax which is an additional 3.8% tax on net investment income, imposed on single taxpayers with adjusted gross income over $200,000 and married filing jointly taxpayers with adjusted gross income over $250,000.  It also applies to certain estates and trusts when their adjusted gross incomes for the year exceed the dollar amount at which the highest tax bracket begins.  The net investment income tax is computed on Form 8960.
  • The additional Medicare tax which is an additional 0.9% tax on earned income imposed on single taxpayers with adjusted gross income over $200,000 and married filing jointly taxpayers with adjusted gross incomes over $250,000.  The additional Medicare tax is computed on Form 8959.

Potential Refund of ACA Taxes

It is expected that the Supreme Court will not render its decision in California v. Texas until the first half of 2021.  In general, most legal experts believe that a decision finding the entirety of the ACA to be unconstitutional is unlikely, particularly with respect to tax years beginning before 2019 when the removal of the penalty for not carrying health insurance became effective.  However, if the Supreme Court rules that the ACA tax provisions are unconstitutional, taxpayers who paid either or both of these taxes may be entitled to a refund of the tax paid if a refund claim is timely filed with the Internal Revenue Service.

Normally a taxpayer must file their claim for a credit or refund within three years after the date they filed their original return or within two years after the date they paid the tax, whichever is later.  For example, if a taxpayer filed their 2016 tax return on the extended due date of October 15, 2017, the claim for credit or refund must be filed by October 15, 2020.  In this instance, since the refund claim must be filed under the statute of limitations before the Supreme Court renders its decision, what can the taxpayer do to preserve its refund claim?

A taxpayer may file a protective claim for refund to preserve its right to claim a refund on a tax return.  Protective claims may be informal claims, formal claims, or amended tax returns for a refund that are normally based on expected changes in current litigation or expected changes in tax law or other legislation.  If the protective claim is filed before the statute of limitation expires, the right to receive a refund of that tax is preserved even if the case is decided after the statute of limitations.

A protective claim is filed when the taxpayer’s right to the refund is contingent on future events and may not be determinable until after the statue of limitations expires. A valid protective claim does not have to list a particular dollar amount or demand an immediate refund. However, a valid protective claim must:

  • Be in writing and signed;
  • Include the taxpayer’s name, address, SSN, and other contact information;
  • Identify and describe the contingencies affecting the claim (in this case, the pending outcome of California v. Texas);
  • Clearly alert the IRS to the essential nature of the claim; and
  • Identify the specific year(s) for which a refund is sought.; and
  • Be mailed to the address that applies to the taxpayer for 1040X or amended trust tax return.

The IRS will delay acting on the protective refund claim until the contingency affecting the claim is resolved.  Individuals, estates, and trusts that paid the net investment income tax or the additional Medicare tax should consider filing protective claims for refund with respect to those taxes paid in order to preserve their right to a refund if the Supreme Court declares the ACA unconstitutional.  For taxpayers who earned significant investment income or who are high-income earners, a refund of the net investment income tax or the additional Medicare tax may be substantial.

Therefore, with a timely ACA Protective Refund Claim filing, taxpayers would apprise the IRS that a refund may be sought (by filing an amended Form 1040 or 1041 after filing the ACA Protective Claim) upon the final resolution of the issue by the Supreme Court.  Until resolution of the constitutionality of the ACA is decided,  it is currently not possible to determine the exact amount of any refund that would be due to the taxpayer for 2016 or any later tax year in which the ACA is in force.

If you have any questions about filing a Protective Refund Claim related to the ACA, please contact one of the tax professionals at Louis Plung & Company to discuss how this pending court case applies to your specific tax situation.