Questions and Answers about the Health Care Tax Credit

The Health Reform Law, the Patient Protection and Affordable Care Act, signed by President Obama on March 23, 2010, gives a tax credit to certain small employers that provide health coverage to their employees, effective for tax years beginning in 2010. As a small business owner, what does this mean to you? Are there real tax savings from providing health insurance coverage to your employee? Maybe. Use the following as your guide when talking to your tax preparer:

How does this affect the normal business deduction for expenses paid for employee health insurance premiums?

This credit is in addition to your normal business deduction taken for expenses paid for employee health insurance premiums under IRC Section 162. HOWEVER, the credit will reduce your deduction total by the amount of the credit, [IRC Section 280C(h); IRS Notice 201-44]. Generally, tax credits translate into greater tax savings than deductions, so converting a portion of a general business deduction is advantageous. If you have adult children on your health care plans, read our blog about getting adult children their own health care plan.

Which employers are eligible for the small employer 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:

  • the employer must have fewer than 25 full-time equivalent employees (“FTEs”) for the tax year;
  • the average annual wages of its employees for the year must be less than $50,000 per FTE; and
  • the employer must pay the premiums under a “qualifying arrangement” described below.

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What if I am a sole proprietor or self employed?

Generally, a sole proprietor is considered a single employer, even if he or she has two or more businesses. There are rules for married taxpayers that are both sole proprietors or are an employee of their spouse, so ask your tax preparer. Additionally, no more than 50% of the gross income of any business can be derived from royalties, rents, dividends, interest, and annuities.

Can a household employer be a qualified employer, even if not directly engaged in a trade or business?

Yes. For tax years beginning in 2010 through 2013, an employer may still be a qualified employer even though the employees of the employer are not performing services in a trade or business. Find out who is a dependent on health insurance plans.

What is a qualified arrangement and how is it used to calculate 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. Section III.G of Notice 2010-82 provides your tax preparer detailed guidance on meeting the qualifying arrangement requirement.

How are employer contributions to a multiemployer plan treated for purposes of the credit?

Contributions by an employer to a multiemployer plan that are used to pay premiums for health insurance coverage for employees covered by the multiemployer plan are treated as payment of health insurance premiums by the employer for purposes of the credit. However, in order to be eligible for the credit, 100 percent of the cost of coverage for all employees covered by the multiemployer plan must be paid from employer contributions, and not by employees. See Notice 2010-82 for further guidance. If your former employees are taking a beating with COBRA and affecting your rates, read our blogs about getting them off your plan.

What is the maximum credit for a qualified employer?

For tax years beginning in 2010 through 2013, the maximum credit is 35 percent of the employer’s premium expenses that count towards the credit. Better health insurance is available, get a quote now.

Can premiums paid by the employer in 2010, but before the new health reform legislation was enacted, be counted in calculating the credit?

Yes. In computing the credit for a tax year beginning in 2010, employers may count all premiums described above for that tax year.

What effect do state credits and state subsidies for health insurance have on the amount of the federal health care tax credit?

Some states offer tax credits or a premium subsidy to certain small employers that provide health insurance to their employees. Generally, the premium subsidy is provided in the form of payments made either directly to the employer or to the employer’s insurance company. The effect these credits and subsidies have on the amount of an employer’s federal health care tax credit depends on whether the direct recipient of the state payment is the employer or the employer’s insurance company. Your tax preparer should examine the rules for your state, as applicable.

Can an employer with 25 or more employees qualify for the credit if some of its employees are part-time?

Yes. Because the limitation on the number of employees is based on Full Time Equivalents (FTEs), 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 they are paid wages for 1,040 hours) has 23 FTEs and therefore may qualify for the credit.

Are seasonal workers counted in determining the number of FTEs and the amount of average annual wages?

Generally, no. Seasonal workers are disregarded in determining FTEs 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. Seasonal workers that need health insurance can get a free quote here.

Are leased employees counted in determining the number of FTEs and the amount of average annual wages?

Leased employees (as defined in section 414(n)) are counted in computing an employer’s FTEs and average annual wages. However, premiums for health insurance coverage paid by a leasing organization for a leased employee are not taken into account by the service-recipient in computing the service-recipient’s section 45R credit. Read our blog and determine whether you are an employee, freelance worker, independent contractor and why you should care.

If an owner of a business also provides services to the business, does the owner count as an employee?

Generally, no. A sole proprietor, a partner in a partnership, a shareholder owning more than two percent of an S corporation, and any owner of more than five 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.

Do family members of a business owner who work for the business count as employees?

Generally, no. 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 FTEs 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 five percent interest in a partnership; and the employee-spouse of a sole proprietor.

How does an employer (other than a tax-exempt employer) claim the small business health care tax credit?

An employer (other than a tax-exempt employer) claims the credit on the employer’s annual income tax return, with an attached Form 8941 showing the calculation of the credit.

May an employer use the small business health care tax credit to offset its alternative minimum tax (AMT) liability?

Yes. The credit can be used to offset an employer’s AMT liability for the year, subject to certain limitations based on the amount of an employer’s regular tax liability, AMT liability and other allowable credits. See section 38(c)(1), as modified by section 38(c)(4)(B)(vi).

May an employer reduce employment tax payments (i.e., withheld income tax, social security tax, and Medicare tax) during the year in anticipation of the credit?

No. The credit applies against income tax, not employment taxes. Read our Human Resources blogs for more tips on dealing with employees.

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