To file or not to file?

 That’s the question that has been posed many times over the past week or so with respect to protective claims for refund for 2016 tax returns. Here’s what you need to know.

The Supreme Court of the United States (SCOTUS) is slated to consider California v. Texas this fall. The case will consider three issues:

1. Whether the individual and state plaintiffs in this case have established Article III standing to challenge the minimum coverage provision in Section 5000A(a); 

2. Whether reducing the amount specified in Section 5000A(c) to zero rendered the minimum coverage provision unconstitutional; and

3. If so, whether the minimum coverage provision is severable from the rest of the ACA.

The Patient Protection and Affordable Care Act (ACA) established a mandate that individuals carry minimum essential coverage or make a “[s]hared responsibility payment.” In 2012, a challenge to ACA went to SCOTUS, where it was found to be constitutional. Specifically, the Court determined that Congress had the authority to regulate tax and found that the mandate, as written, could be interpreted as a tax, and therefore it was constitutional. You can read a little background on the Act here.

In 2017, Congress set the ACA penalty at zero (which is different, legally, from eliminating the penalty), but otherwise left the Act intact. But that tweak led to the current filing. Some states, with Texas at the helm, have argued that since the penalty for not buying health insurance is now zero, it’s no longer a tax. If there’s no tax, they posit, then Congress doesn’t have the right to regulate it, and the mandate is unconstitutional. And, further, if you can’t separate the mandate from ACA, the rest of the law must be struck down.

Some other states, led by California, disagree with that take.

Since there were competing positions affecting states, the matter went before SCOTUS. SCOTUS refused to fast-track the decision but did agree to hear it. Briefs have been filed, and oral arguments are expected in 2020.

So, what does all of this have to do with your tax return?

It’s possible that SCOTUS could decide that ACA is unconstitutional. That would affect not only the shared responsibility penalty but also the related ACA-taxes, like the net investment income tax (NIIT) and the Medicare surtax. If that happens, some tax professionals believe that it might create an opportunity to recover ACA taxes paid in previous years. And since 2016 is one of those years, there is a limited window to file a protective claim for refund. Specifically, the protective claim must be filed by Tax Day, which for 2020 is July 15, 2020.

Here’s what the IRS says.

Generally, the taxpayer must file their claim for a credit or refund within 3 years after the date they filed their original return or within 2 years after the date they paid the tax, whichever is later.

 As a result of COVID-19, the due date to file a protective claim for the tax year 2016 individual income tax returns has been postponed until July 15, 2020. To file a protective claim for the tax year 2016, taxpayers make sure their claim is properly addressed, mailed, and postmarked by July 15, 2020.

According to the IRS, a valid protective claim doesn’t have to list a particular dollar amount or demand an immediate refund. However, a valid protective claim must:

  • Be in writing and signed;
  • Include your name, address, SSN or ITIN, and other contact information;
  • Identify and describe the contingencies affecting the claim;
  • Clearly alert the IRS to the essential nature of the claim; and
  • Identify the specific year(s) for which a refund is sought.

You can find out more on the IRS website here.

So, all of this has resulted in many folks wondering whether to file a protective claim. Like you, I don’t have a crystal ball. But here’s my take: it’s a very individual decision. Case-by-case. I don’t think a blanket “file a protective claim” works for everyone. For the ACA taxes to disappear for 2016, there has to a perfect storm of facts. Consider this:

  • First, SCOTUS has to find the mandate unconstitutional.
  • Second, SCOTUS has to rule that the mandate cannot be separated from ACA, making the entire Act unconstitutional.
  • Third, if SCOTUS does find ACA unconstitutional, they have to rule that the taxes were unconstitutional for previous years – including 2016. Keep in mind that in 2016, the mandate still existed. So if a zero penalty means that there’s no tax, and thus no ACA, that doesn’t mean that the same result applies to the previous years when the penalty still existed. 

Even if all of that falls into place, ACA taxes do not affect all taxpayers. For example, the NIIT and Medicare taxes generally apply to individual taxpayers with an adjusted gross income (AGI) of $250,000 or more for married filing jointly or $200,000 for single taxpayers.

The 3.8% NIIT doesn’t apply to all income. It typically includes interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from “passive activities” in business, and income from businesses involved in the trading of financial instruments or commodities. For NIIT purposes, capital gains include those not only from stocks and real estate but also gold and crypto. (You can read more here.) The tax is 3.8%, so $10,000 of qualifying income would result in a $380 tax.

And the 0.9% Additional Medicare Tax applies to wages, compensation and self-employment income, but it does not apply to income items included in NIIT. So, using the same numbers, $10,000 in wages would result in $90 of surtax.

So, for most taxpayers, even if all of the stars aligned to eliminate the ACA taxes, the numbers involved could be small and, therefore, possibly not worth the time and expense to file a protective claim. However, if all of the stars aligned to eliminate the ACA taxes, and you are (or represent) a taxpayer that would be significantly affected, it could be worth it.

The bottom line? The question of whether to file a protective claim is personal and is fact and circumstance dependent. If you’re not sure how to proceed, I highly recommend talking with your tax professional.

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Kelly Erb is a tax attorney and tax writer.

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