Circuit Courts Split on Validity of Tax Credits in Federally Facilitated Exchanges

On July 22, 2014, the U.S. Court of Appeals for the District of Columbia ruled that the Internal Revenue Service (IRS) regulation authorizing premium tax credits for low-income individuals who purchase health insurance coverage through the federally facilitated exchanges violates the clear statutory language of the Affordable Care Act (ACA). Halbig v. Burwell (D.C. Cir. 2014). Under IRS Code §36(b)(2), the amount of the premium tax credit is based on the cost of average coverage obtained through a health insurance exchange established “by the State.” Many states, however, did not establish state exchanges and opted for federally facilitated exchanges. The disputed regulation interprets this provision to authorize tax credits in both state-based and federally facilitated exchanges. The D.C. Circuit ruled the IRS regulation violated the direct wording of the statute.

On the same day, however, the Fourth Circuit Court of Appeals ruled that the statute was ambiguous, given its purpose and related provisions requiring federally facilitated exchanges to report information to the IRS about tax credits provided. The Fourth Circuit held the IRS acted within its regulatory authority to resolve the ambiguity by authorizing tax credits in both state-based and federally facilitated exchanges. King v. Burwell (4th Cir. 2014.)

While the U.S. Department of Justice said it would appeal the Halbig decision to the full D.C. Circuit Court panel, the plaintiffs in King are expected to appeal to the U.S. Supreme Court. Accordingly, it will take several more months to determine how these cases will be resolved.

In the interim, the circuit court split creates more uncertainty for employers, particularly those operating in states with federally facilitated exchanges. Although the federal government plans to continue providing tax credits during these appeals, this legal uncertainty will create confusion for the upcoming open enrollment period in November 2014, particularly in light of a recent report from the U.S. General Accounting Office (GAO) revealing it was relatively easy for government investigators to fraudulently receive tax credits using fabricated identities.

If the Halbig ruling is upheld, it also could undermine the employer mandate, whose penalties are triggered only when an employee receives tax credits through an exchange. Despite this uncertainty, employers will need to continue their compliance efforts for 2015 until resolution of this circuit court split.