The new health reform law includes a tax credit to help small businesses afford the cost of covering employees and is specifically targeted for those with low- and moderate-income workers. The credit is designed to encourage small employers to offer health insurance coverage for the first time or maintain coverage they already have. In general, the credit is available to small employers that pay at least half the cost of single coverage for their employees. To find out if your business qualifies and what expenses count toward the credit, access this IRS flier outlining three simple steps to determining your eligibility, and read our Q&A below.
Which employers are eligible for the small business health care tax credit?
Small employers that provide health care coverage to their employees and that meet certain requirements (“qualified employers”) generally are eligible for a federal income tax credit for health insurance premiums they pay for certain employees. In order to be a qualified employer, you must:
- Have fewer than 25 full-time equivalent employees for the tax year (if some workers are part time, an employer with more than 25 employees may qualify).
- Have average annual wages for employees for the year less than $50,000 per full-time equivalent employee.
- Pay the premiums under a “qualifying arrangement” described below.
Companies with more than 25 employees: An employer with 25 or more employees could qualify for the credit if some of its employees work part time. For example, an employer with 46 half-time employees (meaning each employee is paid wages for 1,040 hours) has 23 full-time equivalent employees and therefore may qualify for the credit.
Seasonal workers: Seasonal workers are disregarded in determining full-time equivalent employees and average annual wages, unless the seasonal worker works for the employer on more than 120 days during the tax year. However, premiums paid by the employer on behalf of seasonal employees may be counted in determining the amount of the employer’s credit.
Family members working in the business: A family member of any of the business owners or partners, or a member of such a business owner’s or partner’s household, is not considered an employee for purposes of the credit. Thus, neither their wages nor their hours are counted in determining the number of full-time equivalent employees or the amount of average annual wages, and premiums paid on their behalf are not counted in determining the amount of the credit.
For this purpose, a “family member” is defined as a child (or descendant of a child); a sibling or step-sibling; a parent (or ancestor of a parent); a step-parent; a niece or nephew; an aunt or uncle; or a son-in-law, daughter- in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law. In addition, spouses of certain business owners are not considered employees for purposes of the credit.
Specifically, the following spouses are not taken into account for purposes of the credit: the employee-spouse of a shareholder owning more two percent of the stock of an S corporation; the employee-spouse of an owner of more than five percent of a business; the employee-spouse of a partner owning more than a 5 percent interest in a partnership; and the employee-spouse of a sole proprietor.
Business owners working in the business: A sole proprietor, a partner in a partnership, a shareholder owning more than 2 percent of an S corporation, and any owner of more than 5 percent of other businesses are not considered employees for purposes of the credit. Thus, the wages or hours of these business owners and partners are not counted in determining either the number of FTEs or the amount of average annual wages, and premiums paid on their behalf are not counted in determining the amount of the credit.
International employers: For tax years beginning in 2010 through 2013, a qualified employer located outside the United States (including an employer located in a U.S. territory), which has income effectively connected with the conduct of a trade or business in the United States, may claim the small business health care tax credit only if it pays premiums for an employee’s health insurance coverage that is issued in and regulated by one of the 50 states or the District of Columbia.
What expenses are counted in calculating the credit?
Only premiums paid by the employer under an arrangement meeting certain requirements (a “qualifying arrangement”) are counted in calculating the credit. Under a qualifying arrangement, the employer pays premiums for each employee enrolled in health care coverage offered by the employer in an amount equal to a uniform percentage (not less than 50 percent) of the premium cost of the coverage. However, a qualifying arrangement also includes an arrangement under which the employer pays at least 50 percent of the premium cost for single (employee-only) coverage for each employee enrolled in any health insurance coverage offered by the employer.
Also, if the employer provides employees with more than one type of health insurance coverage or if the employer’s health insurance provider does not charge the same premium for all employees enrolled in single (employee-only) coverage, the employer may meet the qualifying arrangement requirement even though the employer paid less than 50 percent of the premium cost for some employees enrolled in single (employee-only) coverage.
For tax years beginning in 2010 through 2013, only premiums paid to a health insurance issuer, such as an insurance company or HMO, for health care coverage are counted for purposes of the credit. Premiums for health care coverage that covers a wide variety of conditions, such as a major medical plan, are counted and premiums for certain coverage that is more limited in scope, such as limited-scope dental or vision coverage, are also counted.
However, if an employer offers more than one type of coverage, such as a major medical plan and a separate limited-scope dental or vision plan, the employer must separately satisfy the requirements for a qualifying arrangement with respect to each type of coverage (meaning the employer cannot aggregate these different plans for purposes of meeting the qualifying arrangement requirement). In addition, 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 small business health care tax credit.
If an employer pays only a portion of the premiums for the coverage provided to employees under the arrangement, with employees paying the rest, the amount of premiums counted in calculating the credit is only the portion paid by the employer. For purposes of the credit, including the requirement to make a uniform contribution of not less than 50 percent of the premium, any premium paid pursuant to a salary reduction arrangement under a section 125 cafeteria plan is not treated as paid by the employer. For example, if an employer pays 80 percent of the premiums for employees’ coverage, with employees paying the other 20 percent pursuant to a salary reduction arrangement under a cafeteria plan, only the 80 percent premium amount paid by the employer counts in calculating the credit.
In addition, the amount of an employer’s premium payments that counts for purposes of the credit is capped by the premium payments the employer would have made under the same arrangement if the average premium for the small group market in the state in which the employer offers coverage were substituted for the actual premium. For example, if an employer pays 80 percent of the premiums for coverage provided to employees and the employees pay the other 20 percent, the premium amount that counts for purposes of the credit is the lesser of 80 percent of the total actual premiums paid or 80 percent of the premiums that would have been paid for the coverage if the average premium for the small group market in the state were substituted for the actual premium. The average premium for the small group market does not apply separately to each type of coverage the employer offers, but rather provides an overall cap for all health insurance coverage provided by a qualified employer.
Contact us for more information on the credit and how it may apply to your business.
by Mary Torres, Tax Manager, TR Moore & Company, A Doeren Mayhew Firm
