Small Business Health Care Tax Credit

Certain small businesses and tax-exempt employers that pay at least half of the premiums for employee health insurance coverage may be eligible for a special tax credit under Health Care Reform, called the small businesses health care tax credit. For tax years 2010-2013, the maximum credit is 35% for small business employers and 25% for small tax-exempt employers. An enhanced version of the credit will be available for tax years beginning in 2014 or later.

Special Update: Effect of Sequestration on Small Business Health Care Tax Credit
Part of the automatic cuts that took place as of March 1, 2013 reduce the refundable portion of the Small Business Health Care Tax Credit for certain small tax-exempt employers. The sequestration reduction rate will be applied until the end of the fiscal year (Sept. 30, 2013) or intervening Congressional action, at which time the sequestration rate is subject to change.

Employer Eligibility

In order to be an eligible small employer:

• An employer must have fewer than 25 full-time equivalent employees (FTEs) for the taxable year;
• The average annual wages of its employees for the year must be less than $50,000 ($50,800 for calendar year 2014); and
• The employer must pay at least 50% of the premium cost for single health care coverage for each employee.

Calculating the Credit

For each year from 2010 through 2013, the maximum credit is 35% of premiums paid by eligible small businesses and 25% of premiums paid by eligible tax-exempt organizations. Beginning in 2014, the maximum credit will increase to 50% of premiums paid by eligible small businesses and 35% of premiums paid by eligible tax-exempt organizations.

The credit phases out gradually for eligible small employers if the number of FTEs exceeds 10, or if the average annual wages for FTEs exceed $25,000 (as adjusted for inflation for taxable years beginning after December 31, 2013).

Special Update: For tax year 2014, the maximum credit is phased out based on the employer's number of full-time equivalent employees in excess of 10 and the employer's average annual wages in excess of $25,400, up from $25,000 for 2013. Click here for more information.

What Expenses Count?

Only premiums paid by the employer under a qualifying arrangement count.

• For tax years 2010 through 2013, only premiums paid to a health insurance issuer, such as an insurance company or HMO, count for purposes of the credit. For tax years beginning in 2014, only premiums paid for qualified health plans offered through a SHOP Exchange count for purposes of the credit. (Note: Until online functionality for the federally-facilitated SHOP is available, small business owners may work with an agent or broker to enroll employees in a qualified health plan and apply for SHOP eligibility.)
• Premiums for insurance that covers a wide variety of conditions, such as a major medical plan, and premiums for coverage that is more limited in scope, such as dental or vision, also count.
• Employer contributions to health reimbursement arrangements (HRAs), health flexible spending arrangements (FSAs) and health savings accounts (HSAs) are not taken into account for purposes of the credit.

The employer must pay at least 50% of coverage. However, if the employer provides more than one type of coverage or if the employer's health insurance provider does not charge the same premium for all enrolled employees, the employer may qualify even if he or she paid less than 50% of the premium cost for some employees.

• If an employer pays only a portion of the premiums and employees pay the rest, the amount counted to calculate the credit is only the portion paid by the employer.  For example, if an employer pays 80% of the premiums, and employees have the other 20% taken out of their pay, only the 80% paid by the employer counts.
• In addition, the amount of an employer's premium payments that are taken into account in calculating the credit is capped. The employer's premium payment may not be more than the average premium for the small group market in the state where the employer offers coverage. If an employer pays 80% of the premiums, what counts is the 80% paid by the employer or 80% of the small group market average-whichever is less.

Determining FTEs and Average Annual Wages

How to Calculate FTEs

The number of full-time equivalent employees (FTEs) is determined by dividing the total hours of service for which the employer pays wages to employees during the year (not more than 2,080 hours for any employee) by 2,080. If the result is not a whole number, it is rounded to the next lowest whole number.

An employee's hours of service include each hour for which he or she is paid, or entitled to payment, during the employer's tax year. Hours of service may be calculated using one of three methods:

1. Determine actual hours of service from records of hours worked and hours for which payment is made or due, including hours for paid leave;
2. Use a days-worked equivalency whereby the employee is credited with 8 hours of service for each day for which payment is made or due including days of paid leave; or
3. Use a weeks-worked equivalency whereby the employee is credited with 40 hours of service for each week for which payment is made or due including weeks of paid leave.

Example: For the tax year, an employer pays five employees wages for 2,080 hours each, three employees wages for 1,040 hours each, and one employee wages for 2,300 hours. The employer uses a method that counts hours actually worked. The employer's FTEs would be calculated as follows:

Total hours not exceeding 2,080 per employee is 15,600 hours:
10,400 hours for the five employees paid for 2,080 hours each (5 x 2,080)
3,120 hours for the three employees paid for 1,040 hours each (3 x 1,040)
2,080 hours for the one employee paid for 2,300 hours (lesser of 2,300 and 2,080)

Based on 15,600 hours of service, the employer has seven FTEs (15,600 divided by 2,080 = 7.5, rounded to the next lowest whole number).

How to Calculate Average Annual Wages

The amount of average annual wages is determined by dividing the total wages paid by the employer during the tax year by the number of FTEs for the year. The result is then rounded down to the nearest $1,000 (if not otherwise a multiple of $1,000). For this purpose, an employer should use wages as defined for FICA purposes (without regard to the wage base limitation).

Example: For the tax year, an employer pays a total of $224,000 in wages to employees and has ten FTEs. The employer's average annual wages are $22,000 ($224,000 divided by 10 = $22,400, rounded down to the nearest $1,000).

How to Claim the Credit

An employer (other than a tax-exempt employer) claims the credit on the employer's annual income tax return, with an attached Form 8941 showing the calculation of the credit. Small business employers who did not owe tax during the year may be able to carry the credit back or forward to other tax years.

 

Tax-exempt organizations claim the credit by filing Form 990-T with an attached Form 8941 showing the calculation of the credit. The credit is refundable for tax-exempt employers, so the employer may receive a refund even if it has no taxable income. However, the amount of the credit cannot be more than the total amount of income and Medicare tax the employer is required to withhold from employees' wages for the year and the employer share of Medicare tax on employees' wages for the year.

Additional Resources

• 3 Simple Steps for Employers to Qualify
• Examples
• FAQs for Employers
• Form 8941 and Instructions
• Notice 2010-44 and Notice 2010-82 (IRS Guidance)
• Proposed Regulations
• Small Business Health Care Tax Credit Flyer
• What Employers Need to Know

Small Business Tax Credit Calculators

• Small Business Tax Credit Calculator (Aetna)

• Small Business Tax Credit Calculator (United Healthcare)