Employee Benefits Group
The small employer health insurance tax credit was enacted by the Patient Protection and Affordable Care Act (the “ACA”) to help small businesses and small Sec. 501(c) tax-exempt organizations afford the cost of providing health insurance coverage for their employees. Because the maximum potential credit increased for 2014, employers that take the time to make the calculation may find that they are eligible for a substantially larger credit than in prior years. The following is a brief review of the original credit and how the credit has evolved under the final guidance recently released by the IRS.
It All Began In 2010 . . .
As you know, the ACA generally requires large employers to offer health care to their full-time employees or pay a penalty. Small employers are generally exempt from this mandate. However, the ACA incentivizes small employers to offer health care by offering tax credits to eligible small businesses that choose to provide insurance to their employees for the first time, or maintain the coverage they already have.
This small employer tax credit was available for tax years 2010 through 2013 if the following requirements were satisfied:
- The employer must employ fewer than 25 full-time equivalent employees (“FTEs”);
- The employer must pay average annual wages of less than $50,000 per FTE; and
- The employer must contribute a uniform percentage (but not less than 50%) toward employees’ self-only (not family or dependent) health insurance premiums.
If the above conditions were satisfied, the maximum amount of the credit during those tax years was 35 percent of the premiums paid by small business employers and 25 percent of premiums paid by small tax-exempt employers.
In 2014 Some Things Changed . . .
Beginning with the 2014 tax year and for subsequent tax years, the credit is slightly different. Specifically, the maximum credit increases to 50 percent of premiums paid by small business employers and 35 percent of premiums paid by small tax-exempt employers. However, with the advent of the small business health plan exchanges (the Small Business Health Options Program (“SHOP”) Marketplaces) in order to be eligible for the credit in 2014 and later years, a small employer must pay premiums on behalf of employees enrolled in a qualified health plan offered through a SHOP Marketplace (or qualify for an exception to this requirement). Employers utilizing the credit may do so only for two consecutive taxable years, beginning with the first taxable year in or after 2014.
Calculating the Credit
The amount of the credit payable to employers operates on a sliding scale and is specifically targeted for those businesses with low- and moderate-income workers. In other words, the smaller the business or charity, the bigger the credit. For instance, employers with more than 10 FTEs or whose average annual wage is more than $25,000, will only be eligible for reduced credit amounts.
Additionally, there are limitations on the amount of the credit available. Specifically, an employer’s eligible premium contribution (used in calculating the credit) is limited to the average cost of health insurance for the small group market in the employer’s state or an area of the state. In effect, this limitation prevents an employer from claiming the credit on the portion of employer paid premiums that exceeds the average premium charges in the state’s small group market. The average premium for the small group market in a state will be determined by the Department of Health and Human Services and will be published by the IRS. Publication of the average premium for the small group market on a state-by-state basis is included in the IRS Form 8941 instructions. For instance, the 2013 average premium for employee-only coverage in the Nebraska small group market was $5,463.
Full-Time Equivalent Employees
In determining FTEs, the regulations provide that FTEs should be calculated by computing the employer’s total hours of service for the taxable year (more on that later) and dividing the total by 2,080. If the result is not a whole number, the result is rounded down to the next lowest whole number, except if the result is less than one, then the employer rounds up to one FTE. Additionally, the final regulations provide that leased employees are counted in computing a service recipient’s FTEs and average annual wages.
A sole proprietor, a partner in a partnership, a shareholder who owns 2% of an S corporation, a person who owns more than 5% of any other business, and family members or dependents of any of the above are excluded from the calculation of the credit.
Hours of Service
Consistent with the proposed regulations, the final regulations provide that an employee’s hours of service for a year include the hours for which the employee is paid, or entitled to payment, for the performance of duties for the employer during the employer’s taxable year. Further, the regulations provide three methods for calculating the total number of hours of service for employees for the taxable year. To figure the total number of hours of service for a taxable year, employers can use any of the following methods:
Actual hours worked method. Determine the actual hours of service from records of hours worked and hours for which payment is made or due. Payment is considered “due” where payment is made or owed for vacation, holiday, illness, incapacity, etc.
Days-worked equivalency method. The employer may use a days-worked equivalency whereby the employee is credited with 8 hours of service for each day for which the employee would be required to be credited with at least one hour of service.
Weeks-worked equivalency method. Use a weeks-worked equivalency whereby the employee is credited with 40 hours of service for each week for which the employee would be required to be credited with at least one hour of service.
How Do I Claim the Credit?
Small business employers that did not owe taxes during the year, are allowed to carry the credit back or forward to other tax years. Additionally, the employer can continue to claim a business expense deduction for the premiums in excess of the credit.
With respect to small tax-exempt employers, the credit is refundable. In other words, tax-exempt employers can still benefit from the credit even if they do not have any taxable income. However, tax-exempt employers are only eligible to receive the credit as a refund so long as it does not exceed their income tax withholding and Medicare tax liability.
Employers must use Form 8941, Credit for Small Employer Health Insurance Premiums, to calculate the credit. Small businesses should include the amount as part of the general business credit on the business income tax return. Form 990-T with an attached Form 8941 is required for a tax-exempt eligible small employer to claim the credit, even if the employer is not otherwise required to file Form 990-T.
Employers wishing to utilize the credit who may have missed the opportunity in prior years, may file an amended return. Generally, a claim for refund must be filed within 3 years from the time the original return was filed or 2 years from the time the tax was paid, whichever of such periods expires later.
Calculating the credit can be complicated and cumbersome and most employers will only be eligible for partial credits. However, the benefit to eligible small employers who already provide health insurance to their employees makes it worth the time it takes to make the calculation. The credit may very well be a considerable amount for a small employer who is eligible for the full credit, and it may be just enough to encourage employers to offer health insurance to employees. If you think your business may be eligible for the credit, or if you have questions regarding the calculation of the credit, contact a member of the McGrath North Tax Group or Employee Benefits group to assist you.