Beginning in 2010, small businesses are eligible for a tax credit by providing qualified health care coverage for their employees. The credit starts off smaller during 2010 to 2013, but fully kicks in starting 2014. Despite the hype, very few businesses have qualified for this credit due to its limitations on the number of employees and average wage of employees.
How Much is the Credit?
During 2010 to 2013, the maximum credit is 35% of the employer’s premium expenses. Starting in 2014, the maximum credit is increased to 50% of the employer’s premium expenses.
Who Qualifies for the Credit?
Small businesses must meet three requirements to qualify for the credit:
- employers must have fewer than 25 full time equivalent (FTE) employees
- the average annual wages must be less than $50,000 per FTE
- the employer must pay the premiums under a qualifying arrangement.
Determining Number of FTEs
Employers calculate the number of FTEs by dividing the total number of employee hours worked (by both full time and part time employees) during a year by 2,080. If the result is not a whole number, the result is rounded down.
Example: ABC Corp reviews its payroll reports and determines that all of its employees (full and part time) worked 10,000 hours during the year. ABC Corp divides the 10,000 total hours worked by 2,080 to calculate its FTEs (10,000 hours divided by 2,080 equals 4.81 rounded down to 4 FTEs).
Determining Average Annual Wages
To calculate average annual wages, the employer divides its total wages for the year by the number of its FTEs.
Example: ABC Corp has $80,000 total payroll for the year. To determine if its average annual wages are under $50,000 it divides its total payroll ($80,000) by the number of its FTEs (4). Its average annual wages for the year is $20,000.
In calculating average annual wages, wages for seasonal employees and owners and their families are excluded from the calculation.
What, Pray Tell, is a Qualifying Arrangement?
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%) of the premium cost of coverage. The credit only applies to the employer paid portion.
Example: ABC Corp pays 80% of the premiums for each of its employees. Since it pays more than 50% of each employee’s premium, it qualifies for the credit (but only on the 80% that the employer pays, not on the 20% paid by employees).
Example 2: ABC Corp pays 40% of the premiums for each of its employees. Since it pays less than 50% of each employee’s premium, it does not qualify for the credit.
Example 3: ABC Corp pays 60% of the premiums for some employees, and 30% of the premiums for other employees. ABC Corp does not qualify for the credit because it does not pay a uniform percentage of each employee’s health premium.
There is an upper limit on the amount of premiums that qualify for the credit. If the average premium for a small group market in a State is less than the premiums paid by the employer, the amount of the average premium for a small group market in the state will be used instead of the actual premiums paid by the employer.
Calculating the Credit Phaseout
The full credit is allowed if the employer has up to 10 employees and up to $25,000 average annual wages. If the employer has more than 10 employees OR average annual wages exceeding $25,000 the credit begins to phase out.
The credit reduction for the FTE phaseout is calculated as:
Number of FTE over 10 divided by 15
ABC Corp has $80,000 of insurance premiums, and its maximum credit for 2010 is $28,000 ($80,000 times the 35% credit).
If ABC Corp has 18 employees, the credit reduction is calculated as follows:
(18 minus 10) divided by 15 = 53%
The FTE phaseout reduces the $28,000 credit from above by 53%. The credit must be reduced by $14,840.
The credit reduction for the average wage phaseout is calculated as:
Amount of Average Wages over $25,000 divided by $25,000.
If ABC Corp has average annual wages of $30,000, the phaseout is calculated as:
($30,000 minus $25,000) divided by $25,000 = 20%.
The average annual wage phaseout reduces the $28,000 credit from above by 20%. The credit must be reduced by $5,600.
When the employer has more than 10 FTEs and more than $25,000 in average annual wages, the FTE credit reduction and the wage credit reduction are added together. Thus, ABC Corp’’s total reductions are 20,440 ($14,840 FTE reduction plus $5,600 wage phaseout). So, ABC Corp’s credit is $7,560 (total credit of $28,000 reduced by total credit reductions of $20,440).
At this point you’re probably sick of reading this post, so I’ll leave you with a few quick bullet points:
The credit is claimed on the employer’s annual income tax return
it is NOT a refundable credit
It is a general business credit that can be carried back 1 year and forward 20 years
However, since 2010 is the first year, it cannot be carried back for 2010.
Tax exempt organizations qualify for the credit under slightly different rules (check back for upcoming blog posts).
There you have it, a brief 3 page overview of the new small business health care credit. I’ll be posting more frequently (possibly twice a week) over the next few months to keep you up to date on the constant tax law changes. The tax laws are a-changin’.
If you have any questions on how this applies to your business, please feel free to give us a call.
Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.
Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230