Editorial · June 10, 2013
Health care tax credit: how small businesses qualify
The health care tax credit is worth up to 35 percent of the health insurance premiums a small employer pays for its staff. Tax-exempt groups, such as charities, can get up to 25 percent. The credit comes from the Affordable Care Act, which became law on March 23, 2010. To qualify, an employer needs fewer than 25 full-time equivalent employees and average wages under $50,000 a year. It also has to pay at least half of the premium. Employers figure the credit on IRS Form 8941.
A May 2012 report by the Government Accountability Office (GAO) found that 170,300 small employers claimed the credit for tax year 2010, fewer than were estimated to be eligible. Government agencies and small business advocacy groups had put the eligible pool at 1.4 million to 4 million. Tax preparer groups the GAO met with generally said the time needed to figure the credit discouraged some employers from claiming it.
Who qualifies for the health care tax credit
An employer has to pass three tests.
- Size. It has fewer than 25 full-time equivalent employees, or FTEs. Two half-time workers count as one FTE.
- Wages. Its average annual wages are under $50,000 per FTE.
- Premiums. In general, it pays at least 50 percent of each enrolled worker's premium. The share must be the same for everyone in a tier of coverage, such as single or family. Some billing setups have special rules.
The credit starts to shrink once you pass 10 FTEs or $25,000 in average wages. It falls to zero at 25 FTEs or $50,000, or sooner when both cuts apply.
Tax-exempt groups described in section 501(c) can qualify too if they pass the same tests. Businesses under common control, or in an affiliated service group, count as one employer.
How to count employees and wages
Add up the paid hours of the employees who count, but no more than 2,080 for any one person. Divide the total by 2,080 and round down, but never below 1. The IRS says 46 half-time workers equal 23 FTEs, so an employer with 25 or more people may still qualify.
Next, find average wages. Divide the wages you paid by the number of FTEs, then round down to the nearest $1,000. Use wages subject to Social Security and Medicare tax, with no wage cap. For example, $224,000 in wages and 10 FTEs gives $22,400, which rounds down to $22,000.
Owners are generally left out of every count, along with their hours, pay and premiums. That means sole proprietors and partners, S corporation shareholders who own more than 2 percent, and owners of more than 5 percent of other businesses. Their family members are left out too. Seasonal workers who work 120 days or fewer are left out of the FTE and wage counts. Premiums you pay for them can still count toward the credit.
How much the credit is worth
For tax years 2010 through 2013, the top rate is 35 percent of the premiums you pay, or 25 percent for a tax-exempt employer. Generally, only premiums paid to a health insurance issuer, such as an insurance company or HMO, count. Employer payments into health reimbursement, flexible spending or health savings accounts do not count. Neither does the part of a premium that workers pay through payroll deductions. Dental and vision plans count if you pay at least 50 percent of their cost.
There is a cap. If your plan costs more than the average small group premium in the state where the worker works, the credit is figured as if it cost the average. For tax years that began in 2012, the IRS table of state averages for single coverage ran from $4,460 in Arkansas to $7,321 in Alaska.
The credit shrinks as your staff and wages grow. For each FTE above 10, it loses one fifteenth of its starting amount. For each $1,000 of average wages above $25,000, it loses one twenty-fifth.
The IRS gives this example. An employer that is not tax-exempt has 12 FTEs and average wages of $30,000. It pays $96,000 in premiums, which does not go over the state cap. The starting credit is 35 percent of $96,000, or $33,600. The two extra FTEs cut it by two fifteenths, or $4,480. Wages $5,000 above $25,000 cut it by one fifth, or $6,720. The credit is $33,600 minus $11,200, or $22,400.
How to claim the credit
Figure the credit on Form 8941, Credit for Small Employer Health Insurance Premiums, and attach it to your return. A taxable business carries the result to Form 3800, the general business credit. Partnerships and S corporations pass it to their owners on Schedule K-1.
The credit can offset regular income tax and the alternative minimum tax, within limits. It cannot lower payroll tax deposits, but you can reflect it in your estimated tax payments. A taxable business that owes no tax can carry the credit back or forward to other years. Your deduction for premiums is cut by the amount of the credit, and you can still deduct the rest. If you can benefit from the credit this year but forgot to claim it, the IRS says there is still time to file an amended return.
Tax-exempt employers claim it on Form 990-T, line 44f, even if they do not usually file that form. The credit is refundable for them, up to the income tax and Medicare tax they withhold plus the employer share of Medicare tax. The IRS says automatic cuts that took place as of March 1, 2013 reduce the refundable part of a claim by 8.7 percent for certain small tax-exempt employers. That rate applies until September 30, 2013, or until Congress acts, when it may change.
What changes after 2013
The IRS says an enhanced credit starts on January 1 of next year. In general, the top rate rises to 50 percent for businesses and 35 percent for tax-exempt employers. The law ties the higher credit to plans offered through a health insurance exchange and limits it to two years in a row. The IRS says it will post more details as they become available.