On July 22, 2014, two federal courts came down on opposite sides of an issue that may have far-reaching consequences about the future of the Patient Protection and Affordance Care Act ("PPACA"). At stake is whether the PPACA federal tax credit for certain low-income taxpayers may be provided to those taxpayers who purchase health coverage through an exchange that is run by the federal government. The ultimate decision on this issue will significantly impact the potential penalties for employers and individuals alike.

1. Availability of tax credits: How did we get here?

PPACA requires states to either establish their own health insurance market exchange or the federal government will establish and administer an exchange for that state.

PPACA also provides for the availability of refundable tax credits for health coverage purchased under the exchanges operated by the states. Specifically, Section 36B of the Internal Revenue Code provides that tax credits will be available for health plans "which were enrolled in through an Exchange established by the State."1 A literal reading of Section 36B would be problematic for the federal government, given that only 14 states (and the District of Columbia) have established their own exchanges and the federal government administers exchanges in the remaining 36 states.

Relying on the structure of PPACA as a whole and the legislative history, the Internal Revenue Service (IRS) interpreted Section 36B more broadly, extending the tax credits to those who purchase coverage on federally-facilitated exchanges as well as state exchanges.2

The plaintiffs in each case3 were taxpayers in states with federally-facilitated exchanges that did not want to purchase health insurance or pay employer penalties. If the IRS's interpretation of Code Section 36B is incorrect, the individual plaintiffs would be exempt from the requirement to purchase health coverage because it would be too expensive without the tax credit. Further, the employer plaintiffs would not have to pay certain penalties if the tax credit were not made available to low-income taxpayers. The lower federal courts in both cases upheld the IRS's interpretation, finding that PPACA as a whole clearly shows Congressional intent to make the tax credits available nationwide. Both cases were appealed to the respective U.S. Circuit Courts of Appeals, the 4th Circuit Court of Appeals and the D.C. Circuit Court of Appeals.

2. Circuit Courts split, availability of tax credits on federal exchanges up in the air

The 4th Circuit Court4 found that PPACA is susceptible to multiple interpretations and agreed that the IRS's interpretation was based on a reasonable interpretation of an ambiguous statute. The 4th Circuit also noted that Congress knew of the importance of tax credits in the overall statutory scheme of PPACA, and that if it meant to limit the tax credits to coverage purchased on the state exchanges, it would done so in a much more clear fashion.

The D.C. Circuit Court5 reached the opposite conclusion finding that under the plain language of PPACA, a federal exchange is not an "Exchange established by the State" and does not authorize the IRS to provide tax credits for coverage purchased on the federally-facilitated exchanges. As a consequence, the IRS rule falls.

3. Next steps

The federal government has requested a rehearing of the case before a larger panel of judges (an en banc hearing) in the D.C. Circuit and has indicated that tax credits will continue to be available for coverage purchased on federally-facilitated exchanges for now. The Wall Street Journal, however, reported that an en banc hearing is rare (only 1 out of 500 rulings are reheard en banc) and opined that the merits of the case and ruling do not justify such a hearing.6 All signs seem to point to the Supreme Court having to reconcile the Circuit Court split, and the plaintiffs in the 4th Circuit case have already filed petitions to initiate review of that case (for certiorari) by the Supreme Court.

4. Healthcare reform without tax credits on federal exchanges: How would the D.C. Circuit ruling impact employers, employees, and the insurance markets?

Fewer employer shared responsibilities penalties: The employer shared responsibility rules provide that if an employer offers unaffordable coverage or coverage that does not provide a minimum value, the "play or pay" penalties may apply if a full-time employee purchases health coverage on an exchange and qualifies for a tax credit (as discussed in a King & Spalding publication here). Eliminating the tax credit in the 36 states that do not maintain their own exchange will lower or eliminate the penalties employers would have to pay.

Lower enrollment on the exchanges: If tax credits are not available to reduce the cost of health coverage for low-income taxpayers, many more individuals would be exempt from the individual mandate (i.e., coverage would exceed 8% of household income) and would not be required to purchase health coverage. Those that were not exempt would experience increased costs in the absence of the subsidized coverage. According to data released by the Department of Health and Human Services, the average percent reduction in premium costs as a result of tax credits on federally-facilitated exchanges is 75%.7

Unstable insurance markets: If federal tax credits are unavailable and the number of individuals required to purchase health coverage drops, insurers would be forced to raise costs to offset potential risk (as a result of a smaller risk pool). Those costs would undoubtedly be passed onto employers and individuals who do purchase health coverage in the form of higher premiums.