Limit the self-employed health insurance deduction to net profit less half of SE tax and plan deductions

changelog.d/fix-sehi-earned-income-limit.fixed.md

@@ -0,0 +1 @@
+Limit the self-employed health insurance deduction to net profit less the deductible part of self-employment tax and self-employed retirement plan deductions, as 26 U.S.C. 162(l)(2)(A) and Form 7206 require.

policyengine_us/tests/core/test_medical_expense_premium_conservation.py

@@ -142,10 +142,14 @@ def _assert_conservation(members, simulation):
     # non-premium expenses. Check the bound separately from conservation.
     assert (schedule_a_premium_use >= 0).all()
     assert (schedule_a_premium_use >= dependent_premiums).all()
-    assert (schedule_a_premium_use + se_deduction <= paid).all()
+    # The Form 7206 earnings limit leaves cents in the derived deduction, so
+    # the sums carry float32 rounding: allow a cent.
+    assert (schedule_a_premium_use + se_deduction <= paid + 0.01).all()
     # All premiums here are otherwise eligible: unused premiums remain in
     # Schedule A's base, even when earnings cap the SE deduction.
-    np.testing.assert_array_equal(schedule_a_premium_use + se_deduction, paid)
+    np.testing.assert_allclose(
+        schedule_a_premium_use + se_deduction, paid, rtol=0, atol=0.01
+    )
 
 
 EXAMPLE_UNITS = [

policyengine_us/tests/policy/baseline/gov/irs/income/taxable_income/adjusted_gross_income/above_the_line_deductions/self_employed_health_insurance_ald.yaml

@@ -0,0 +1,164 @@
+# Form 7206 line 14 (Pub. 535 Worksheet 6-A line 14 before 2023; line 3 of the
+# Form 1040 instructions worksheet for filers with one source of
+# self-employment income): the smaller of the premiums and the earned income
+# limit. Expected values are hand-computed from the form.
+
+- name: Case 1, premiums above the limit are capped at net profit less half of self-employment tax.
+  period: 2022
+  absolute_error_margin: 0.01
+  input:
+    people:
+      person1:
+        is_self_employed: true
+        self_employment_income: 2_000
+        health_insurance_premiums: 6_000
+    tax_units:
+      tax_unit:
+        members: [person1]
+    households:
+      household:
+        members: [person1]
+        state_code: TX
+  output:
+    # 2022 Form 1040 instructions worksheet: line 1 is 6,000; line 2 is
+    # 2,000 - 141.2955 (Schedule 1 line 15) = 1,858.7045.
+    self_employed_health_insurance_ald_person: [1_858.7045]
+    self_employed_health_insurance_ald: 1_858.7045
+    # 2,000 - 141.2955 - 1,858.7045.
+    adjusted_gross_income: 0
+
+- name: Case 2, premiums below the limit are deducted in full.
+  period: 2022
+  absolute_error_margin: 0.01
+  input:
+    is_self_employed: true
+    self_employment_income: 50_000
+    health_insurance_premiums: 6_000
+  output:
+    # Line 2: 50,000 - 3,532.3875 = 46,467.6125.
+    self_employed_health_insurance_earned_income_limit: 46_467.6125
+    self_employed_health_insurance_ald_person: 6_000
+
+- name: Case 3, the plan deduction and half of self-employment tax both reduce the cap.
+  period: 2023
+  absolute_error_margin: 0.01
+  input:
+    is_self_employed: true
+    self_employment_income: 20_000
+    self_employed_pension_contributions_desired: 3_000
+    health_insurance_premiums: 20_000
+  output:
+    # Form 7206: line 3 is 20,000; line 13 is 20,000 - 1,412.955 - 3,000.
+    self_employed_health_insurance_ald_person: 15_587.045
+
+- name: Case 4, a farm business takes its share of the self-employment tax deduction.
+  period: 2024
+  absolute_error_margin: 0.01
+  input:
+    is_self_employed: true
+    self_employment_income: 30_000
+    farm_operations_income: 10_000
+    health_insurance_premiums: 40_000
+  output:
+    # Form 7206 line 13: 30,000 - 0.75 x 2,825.91 = 27,880.5675.
+    self_employed_health_insurance_ald_person: 27_880.5675
+
+- name: Case 5, each spouse's deduction is capped by their own earned income.
+  period: 2025
+  absolute_error_margin: 0.01
+  input:
+    people:
+      person1:
+        is_self_employed: true
+        self_employment_income: 3_000
+        health_insurance_premiums: 8_000
+      person2:
+        is_self_employed: true
+        self_employment_income: 40_000
+        health_insurance_premiums: 2_000
+    tax_units:
+      tax_unit:
+        members: [person1, person2]
+    marital_units:
+      marital_unit:
+        members: [person1, person2]
+    households:
+      household:
+        members: [person1, person2]
+        state_code: TX
+  output:
+    # person1: 3,000 - 3,000 x 0.9235 x 0.153 / 2 = 3,000 - 211.94325.
+    # person2: premiums of 2,000 are under the limit.
+    self_employed_health_insurance_ald_person: [2_788.05675, 2_000]
+    self_employed_health_insurance_ald: 4_788.05675
+
+- name: Case 6, no deduction with a Schedule C loss.
+  period: 2025
+  absolute_error_margin: 0.01
+  input:
+    is_self_employed: true
+    self_employment_income: -5_000
+    health_insurance_premiums: 3_000
+  output:
+    self_employed_health_insurance_ald_person: 0
+
+- name: Case 7, spouses on either side of the Social Security wage base each use their own self-employment tax deduction.
+  period: 2025
+  absolute_error_margin: 0.01
+  input:
+    people:
+      person1:
+        is_self_employed: true
+        employment_income: 200_000
+        self_employment_income: 10_000
+        health_insurance_premiums: 20_000
+      person2:
+        is_self_employed: true
+        self_employment_income: 10_000
+        health_insurance_premiums: 20_000
+    tax_units:
+      tax_unit:
+        members: [person1, person2]
+    marital_units:
+      marital_unit:
+        members: [person1, person2]
+    households:
+      household:
+        members: [person1, person2]
+        state_code: TX
+  output:
+    # person1's wages exceed the $176,100 wage base, so Schedule 1 line 15 is
+    # 10,000 x 0.9235 x 0.029 / 2 = 133.9075; person2's is
+    # 10,000 x 0.9235 x 0.153 / 2 = 706.4775.
+    self_employment_tax_ald_person: [133.9075, 706.4775]
+    # Form 7206 line 13 for each: 10,000 less their own line 15.
+    self_employed_health_insurance_ald_person: [9_866.0925, 9_293.5225]
+    self_employed_health_insurance_ald: 19_159.615
+
+- name: Case 8, a dependent's deduction is capped by their own earned income and stays off the filer's return.
+  period: 2025
+  absolute_error_margin: 0.01
+  input:
+    people:
+      parent:
+        age: 45
+        employment_income: 50_000
+      child:
+        age: 17
+        is_tax_unit_dependent: true
+        is_self_employed: true
+        self_employment_income: 3_000
+        health_insurance_premiums: 5_000
+    tax_units:
+      tax_unit:
+        members: [parent, child]
+    households:
+      household:
+        members: [parent, child]
+        state_code: TX
+  output:
+    # child: 3,000 - 3,000 x 0.9235 x 0.153 / 2 = 3,000 - 211.94325.
+    self_employed_health_insurance_ald_person: [0, 2_788.05675]
+    # The child takes it on their own return.
+    self_employed_health_insurance_ald: 0
+    dependents_self_employed_health_insurance_ald: 2_788.05675

policyengine_us/tests/policy/baseline/gov/irs/income/taxable_income/adjusted_gross_income/above_the_line_deductions/self_employed_health_insurance_earned_income_limit.yaml

@@ -0,0 +1,121 @@
+# Form 7206 lines 4-13 (Pub. 535 Worksheet 6-A before 2023). Expected values
+# are hand-computed from the form: the deductible part of self-employment tax
+# is net profit x 0.9235 x 15.3% / 2 below the Social Security wage base.
+
+- name: Case 1, one business, the limit is net profit less half of self-employment tax.
+  period: 2022
+  absolute_error_margin: 0.01
+  input:
+    self_employment_income: 2_000
+  output:
+    # Schedule 1 line 15: 2,000 x 0.9235 x 0.153 / 2 = 141.2955.
+    self_employment_tax_ald_person: 141.2955
+    # Line 13: 2,000 - 141.2955.
+    self_employed_health_insurance_earned_income_limit: 1_858.7045
+
+- name: Case 2, the SEP, SIMPLE and qualified plan deduction also reduces the limit.
+  period: 2023
+  absolute_error_margin: 0.01
+  input:
+    self_employment_income: 20_000
+    self_employed_pension_contributions_desired: 3_000
+  output:
+    # Schedule 1 line 15: 20,000 x 0.9235 x 0.153 / 2 = 1,412.955.
+    self_employment_tax_ald_person: 1_412.955
+    # Schedule 1 line 16 (within the $66,000 annual additions limit).
+    self_employed_pension_contribution_ald_person: 3_000
+    # Lines 8 to 10: 20,000 - 1,412.955 - 3,000.
+    self_employed_health_insurance_earned_income_limit: 15_587.045
+
+- name: Case 3, a farm business takes its share of the self-employment tax deduction.
+  period: 2024
+  absolute_error_margin: 0.01
+  input:
+    self_employment_income: 30_000
+    farm_operations_income: 10_000
+  output:
+    # Schedule 1 line 15: 40,000 x 0.9235 x 0.153 / 2 = 2,825.91.
+    self_employment_tax_ald_person: 2_825.91
+    # Lines 5 to 8: 30,000 / 40,000 = 0.75; 30,000 - 0.75 x 2,825.91.
+    self_employed_health_insurance_earned_income_limit: 27_880.5675
+
+- name: Case 4, a partnership's self-employment earnings take their share too.
+  period: 2024
+  absolute_error_margin: 0.01
+  input:
+    self_employment_income: 30_000
+    partnership_self_employment_net_earnings: 30_000
+  output:
+    # Schedule 1 line 15: 60,000 x 0.9235 x 0.153 / 2 = 4,238.865.
+    self_employment_tax_ald_person: 4_238.865
+    # Lines 5 to 8: 30,000 / 60,000 = 0.5; 30,000 - 0.5 x 4,238.865.
+    self_employed_health_insurance_earned_income_limit: 27_880.5675
+
+- name: Case 5, a farm loss is left out of line 5, so the plan business takes the whole deduction.
+  period: 2024
+  absolute_error_margin: 0.01
+  input:
+    self_employment_income: 30_000
+    farm_operations_income: -10_000
+  output:
+    # Schedule 1 line 15: (30,000 - 10,000) x 0.9235 x 0.153 / 2 = 1,412.955.
+    self_employment_tax_ald_person: 1_412.955
+    # Lines 5 to 8: line 5 is 30,000, so line 6 is 1; 30,000 - 1,412.955.
+    self_employed_health_insurance_earned_income_limit: 28_587.045
+
+- name: Case 6, wages above the Social Security wage base leave only the Medicare part.
+  period: 2025
+  absolute_error_margin: 0.01
+  input:
+    employment_income: 200_000
+    self_employment_income: 10_000
+  output:
+    # Wages exceed the $176,100 wage base, so Schedule 1 line 15 is
+    # 10,000 x 0.9235 x 0.029 / 2 = 133.9075.
+    self_employment_tax_ald_person: 133.9075
+    self_employed_health_insurance_earned_income_limit: 9_866.0925
+
+- name: Case 7, net earnings under $400 owe no self-employment tax, so the limit is net profit.
+  period: 2025
+  absolute_error_margin: 0.01
+  input:
+    self_employment_income: 400
+  output:
+    # 400 x 0.9235 = 369.40, under the $400 threshold of section 1402(b)(2).
+    self_employment_tax_ald_person: 0
+    self_employed_health_insurance_earned_income_limit: 400
+
+- name: Case 8, a Schedule C loss leaves no limit.
+  period: 2025
+  absolute_error_margin: 0.01
+  input:
+    self_employment_income: -5_000
+    partnership_self_employment_net_earnings: 20_000
+  output:
+    self_employed_health_insurance_earned_income_limit: 0
+
+- name: Case 9, a plan deduction as large as net profit leaves no limit.
+  period: 2023
+  absolute_error_margin: 0.01
+  input:
+    self_employment_income: 20_000
+    self_employed_pension_contributions_desired: 20_000
+  output:
+    # Schedule 1 line 15: 20,000 x 0.9235 x 0.153 / 2 = 1,412.955.
+    self_employment_tax_ald_person: 1_412.955
+    # Schedule 1 line 16: the model caps the plan deduction at net profit.
+    self_employed_pension_contribution_ald_person: 20_000
+    # Lines 8 to 13: max(0, 20,000 - 1,412.955 - 20,000).
+    self_employed_health_insurance_earned_income_limit: 0
+
+- name: Case 10, SSTB and non-SSTB Schedule C income are one plan business, so an SSTB loss reduces line 4.
+  period: 2025
+  absolute_error_margin: 0.01
+  input:
+    self_employment_income: 30_000
+    sstb_self_employment_income: -10_000
+  output:
+    # Schedule 1 line 15: 20,000 x 0.9235 x 0.153 / 2 = 1,412.955.
+    self_employment_tax_ald_person: 1_412.955
+    # Lines 4 and 5 are both 20,000, so line 6 is 1; 20,000 - 1,412.955.
+    self_employed_health_insurance_earned_income_limit: 18_587.045

policyengine_us/tests/policy/baseline/gov/irs/income/taxable_income/adjusted_gross_income/above_the_line_deductions/self_employment_income.yaml

@@ -8,11 +8,13 @@
 
 - name: Self-employed health insurance ALD uses SSTB income
   period: 2024
+  absolute_error_margin: 0.01
   input:
     sstb_self_employment_income: 10_000
     self_employed_health_insurance_premiums: 12_000
   output:
-    self_employed_health_insurance_ald_person: 10_000
+    # Form 7206 line 13: 10,000 - 10,000 x 0.9235 x 0.153 / 2.
+    self_employed_health_insurance_ald_person: 9_293.5225
 
 - name: Self-employed pension ALD uses SSTB income
   period: 2024

policyengine_us/tests/policy/baseline/gov/irs/income/taxable_income/deductions/itemizing/medical_expense_deduction.yaml

@@ -22,16 +22,20 @@
 
 - name: An earnings-limited derived SE deduction leaves unused premiums on Schedule A.
   period: 2025
+  absolute_error_margin: 0.01
   input:
     is_self_employed: true
     health_insurance_premiums: 6_000
     self_employment_income: 1_000
     other_medical_expenses: 500
     adjusted_gross_income: 30_000
   output:
-    self_employed_health_insurance_ald: 1_000
-    itemized_medical_expenses: 5_500
-    medical_expense_deduction: 3_250
+    # Form 7206 line 13: 1,000 - 1,000 x 0.9235 x 0.153 / 2 = 929.35225.
+    self_employed_health_insurance_ald: 929.35225
+    # 6,000 - 929.35225 + 500.
+    itemized_medical_expenses: 5_570.64775
+    # 5,570.64775 - 7.5% of 30,000.
+    medical_expense_deduction: 3_320.64775
 
 - name: Fully deducted premiums leave only non-premium medical expenses.
   period: 2025
@@ -87,6 +91,7 @@
 
 - name: Each filing unit excludes its own SE deduction independently of pretax premiums.
   period: 2025
+  absolute_error_margin: 0.01
   input:
     people:
       person1:
@@ -116,9 +121,11 @@
         members: [person3]
         adjusted_gross_income: 30_000
   output:
-    self_employed_health_insurance_ald: [1_000, 1_000, 0]
-    itemized_medical_expenses: [5_500, 5_500, 6_500]
-    medical_expense_deduction: [3_250, 3_250, 4_250]
+    # Form 7206 line 13: 1,000 - 1,000 x 0.9235 x 0.153 / 2 = 929.35225.
+    self_employed_health_insurance_ald: [929.35225, 929.35225, 0]
+    # 6,000 - 929.35225 + 500; the pretax premiums are not on Schedule A.
+    itemized_medical_expenses: [5_570.64775, 5_570.64775, 6_500]
+    medical_expense_deduction: [3_320.64775, 3_320.64775, 4_250]
 
 - name: A filer SE deduction cannot consume premiums attributed to a dependent.
   period: 2025

policyengine_us/tests/policy/baseline/gov/states/mi/tax/income/mi_household_resources.yaml

@@ -1125,18 +1125,13 @@
     state_code: MI
   output:
     # Line 14: 40,000. Line 16: 3,000.
-    # PolicyEngine's pre-existing federal simplification limits the health
-    # insurance deduction to net self-employment income before deductible
-    # self-employment tax: 3,000 here.
-    # Line 30 in PolicyEngine: self-employment tax deduction, half of 3,000 x
-    # 0.9235 x 15.3% = 211.94, plus health insurance 3,000 = 3,211.94.
-    # Line 31: premiums of 5,000, less the 3,000 deducted on line 30 = 2,000.
-    # Line 33: 43,000 - 3,211.94 - 2,000 = 37,788.06. The premiums come off
-    # once in all: 3,000 on line 30 and 2,000 on line 31.
-    # 2025 Form 7206 lines 7-8 instead limit the health insurance deduction
-    # to 3,000 - 211.94 = 2,788.06. Then line 30 is 3,000 and line 31 is
-    # 5,000 - 2,788.06 = 2,211.94: 43,000 - 3,000 - 2,211.94 = 37,788.06.
-    # The Michigan total is unchanged because every premium comes off once.
+    # Line 30: the self-employment tax deduction, half of 3,000 x 0.9235 x
+    # 15.3% = 211.94, plus the health insurance deduction, which 2025 Form
+    # 7206 lines 7-8 limit to 3,000 - 211.94 = 2,788.06: 3,000 in all.
+    # Line 31: premiums of 5,000, less the 2,788.06 deducted on line 30 =
+    # 2,211.94.
+    # Line 33: 43,000 - 3,000 - 2,211.94 = 37,788.06. The premiums come off
+    # once in all: 2,788.06 on line 30 and 2,211.94 on line 31.
     mi_household_resources: 37_788.06
   absolute_error_margin: 0.01