Could Individuals Have Standing to Challenge IRS Rule Creating Tax Credits in Federal Exchanges?

The PPACA provides for tax credits and subsidies to help eligible taxpayers purchase health insurance in state-run health insurance exchanges. Although the text of the statute only provides for the issuance of credits in exchanges “established by a state,” the IRS has issued a regulation providing for the issuance of tax credits and subsidies in federally run exchanges as well. (More here and here.) This is significant because a substantial number of states are refusing to create their own exchanges, and the question could well end up in court.

As a normal matter, individuals lack standing to challenge the legality of favorable tax treatment given to someone else. In this case, however, employers in states with federal exchanges could sue to challenge the IRS rule because the issuance of tax credits will trigger penalties on employers under the so-called employer mandate. What about individuals? It turns out, some individuals in states that do not create their own exchanges may have standing to sue as well, as Michael Cannon and I explain in the revised version of our forthcoming paper in Health Matrix.

The reason some individuals could have standing to challenge the IRS rule is that the issuance of unauthorized tax credits in federal exchanges would expose them to tax penalties under the individual mandate. This is because liability for the individual mandate tax penalty is based upon the cost an individual has to pay for qualifying health insurance. If an individual’s “required contribution” exceeds 8 percent of household income, they are exempt from the penalty. By providing a tax credit and subsidies, the IRS rule reduces the cost of purchasing a qualifying health insurance plan, thereby exposing some individuals who do not wish to purchase health insurance to the tax penalty. Therefore, an individual who lives in a state that will not establish an Exchange by 2014 and that would otherwise qualify for the affordability exemption in the absence of tax credits would have standing to challenge the rule, provided that they earn between 100 and 400 percent of the federal poverty level, do not receive health insurance from their employer, and would be exposed to the tax penalty due to the availability of tax credits under the IRS rule. Given that several million Americans satisfy these criteria, I would not be surprised to see some file suit.