For small business owners, the recently enacted Health Care Act provides a tax break to encourage small businesses to adopt or maintain existing health care plans. Starting in 2010, the Health Care Act provides a 35% tax credit to an employer for the cost of health insurance premiums paid by the employer for health plans covering its employees. The tax credit is designed to encourage small businesses to adopt and maintain existing health care plans to increase the number of people covered by health insurance. The employer is eligible for the tax credit provided it pays for at least 50% of the premium cost. Amounts contributed by employees are not eligible for the employer tax credit.
Tax Credit Available Only to Small Businesses. The tax credit is available for businesses with 25 or fewer full-time equivalent employees and average annual wages per full-time equivalent employee of $50,000 or less. However, the full amount of the tax credit is available only if the business has 10 or fewer full-time equivalent employees and average annual wages per full-time equivalent employee of $25,000 or less.
Claiming the Tax Credit. The tax credit is not payable in advance by the government. To receive the tax credit, an employer must claim it on the tax return for the year in which the premiums are paid. A tax credit reduces income tax on a dollar-for-dollar basis. Accordingly, the tax credit results in a tax savings only if the business has net income and is subject to tax. If the tax credit cannot be used for the current year, the tax credit may be carried back one year and carried forward twenty years until fully used. The tax credit is also creditable against alternative minimum tax (AMT).
Illustration. A simple example illustrates the increased tax savings for providing health insurance coverage for employees. Assume that an employer has 10 full-time employees, an average annual wage cost of under $25,000 and an average health care premium cost per employee of $5,000 per year. The total health care premium cost for the employer is $50,000 ($5,000 per employee multiplied by 10 employees). The tax benefits for the premium payments would be as follows: (i) a $17,500 tax credit; and (ii) a $32,500 tax deduction ($50,000 of premiums, net of the $17,500 tax credit). Assuming the owner is in a 35% income tax bracket, the $32,500 tax deduction would result in a tax savings of $11,375 ($32,500 x 35%). Together with the $17,500 tax credit, the total tax savings would be $28,875. Accordingly, the after-tax cost to the owner for the premium expense would be $21,125, or 42.25% of the total premium expense.
Illustration 2: If the average annual wages were instead $37,500, the tax credit would be $8,750. The amount of the tax credit is ratably reduced since the average annual wages are greater than $25,000, but less than $50,000. The tax deduction for the premium is $41,250, which results in tax savings of $14,438 (assuming a 35% tax rate). The total tax benefit is $23,188 ($8,750 plus $14,438). The after-tax cost for the premiums would be $26,812, and the employer’s after-tax cost for the premium is 54%.
Tax Credits for Premiums Paid Through 2015. The credit is available for health insurance premiums paid by the employer during each of the years 2010 through 2015. However, starting in 2014, States are required to have established so-called “exchanges” through which health plans will be offered by insurers. To encourage small business employers to continue to pay health insurance premiums, the tax credit is increased to 50% in 2014 but will be available only if an employer adopts a health plan offered through an exchange.
Full-Time Equivalent Employees. It is important to understand how the number of full-time equivalent employees is calculated. The number of full-time equivalent employees is equal to the total number of hours worked by the employees divided by 2,080 per year. Thus, two part-time employees who each work 1,040 hours per year would be equal to one full-time equivalent employee. Moreover, if a single employee works in excess of 2,080 hours per year, such excess hours are not taken into account for this purpose. Also, seasonal workers are excluded.
Owners and Family Members Excluded. The tax credit is not available for premiums paid for health insurance for owners and their family members and dependents. An owner includes a two-percent or more owner of an S corporation or partnership, or a five-percent or more owner of a C corporation. However, one benefit of this exclusion is that it may make it easier for an employer to satisfy the average annual wages limitation since the owner’s (and family members’) earned income from the business would not be taken into account.
Tax Exempt Entities. Nonprofit and other tax-exempt organizations that otherwise qualify as small employers are also entitled to a refundable tax credit of up to 25% of the amount of premiums paid for health insurance.
Tax Credit Limit on More Expensive Plans. If an employer provides a more expensive health plan, the amount of premiums eligible for the tax credit will be limited to the “average premium for the small group market in the State in which the employer is offering the heath insurance coverage.” The Secretary of Health and Human Services is directed to determine the amount of the average premium geographically.
Aggregation of Controlled Entities. Entities that are under common control are required to be treated as one employer for purposes of determining eligibility for the tax credit. Accordingly, using multiple commonly-owned entities will not avoid the small employer requirements.
Other Tax-Related Provisions of the Health Care Act. The Health Care Act contains several provisions designed to raise revenue to help offset the government’s projected cost of the Health Care Act. Set forth below are two such provisions that are relevant to business owners; these provisions take effect starting in 2013.
- Starting in 2013, the Medicare Tax will be increased to a rate of 3.8% on earned income in excess of $250,000 for joint filers ($125,000 for married filing separate, and $200,000 in all other cases).
Small Business Exception for Mandated Employer-Provided Insurance. The Health Care Act exempts employers having less than 50 full-time employees from the requirement to offer health insurance coverage to its employees. For employers with an average of at least 50 full-time employees, penalties apply to employers who fail to offer health insurance coverage starting in 2014.
If you have any questions regarding the Health Care Act, please contact Mario J. Fazio at 216-831-0042 or firstname.lastname@example.org.
IRS CIRCULAR 230 DISCLAIMER: To the extent that this written communication may address certain tax issues, it is not intended or written to be used, and cannot be used by any persons to avoid any potential tax penalties that may be asserted by the Internal Revenue Service. In addition, this communication may not be used by anyone in promoting, marketing or recommending the transaction or matters addressed herein.