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.
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. However, beginning in 2014, health insurance must be purchased through 
the Small Business Health Options Program (SHOP) to qualify for the credit. Additionally, the credit may only be claimed for 2 years on or after 2014. Claiming the credit for years between 2010 and 2013 does not count toward the 2 year limit.
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. Businesses that have qualified tended to receive a substantially reduced credit because of the phaseouts. However, the increased credit amount beginning in 2014 may increase the amount of the credit for businesses in the phase out range, and so may be worth another look.
It is important to note that the credit can only be claimed for 2 years in or after 2014. Businesses may not want to begin providing health insurance coverage to their employees based on this credit since the credit will only be available for 2 years of coverage.
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.
To qualify for the full 35% (50% in 2014 and later) credit, the employer must have 10 or fewer full time equivalent employees and the average annual wage must be $25,000 or less. These are very restrictive requirements which have barred many businesses from qualifying for a substantial credit.
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 at least 50% of the premium for single only coverage, regardless if the employee has single or family 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.
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 2013 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).
The above example applies to employer provided health coverage from 2010 to 2013. The credit amount for 2014 and later is 50% of premiums for a qualifying arrangement. However, there are two important limitations:
- beginning in 2014, the credit can only be claimed for two years
- the health coverage must be obtained through a SHOP
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
- Tax exempt organizations qualify for the credit under slightly different rules (check back for upcoming blog posts).
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.