Credit for Small Employer Health Insurance Premiums

health insurance creditOn March 30, 2010, President Obama signed the Health Care Reconciliation Act which added a tax credit for employee health insurance expenses of small employers for taxable years beginning in 2010 through taxable years beginning in 2013.

The tax credit is available if:

(1) the employer has fewer than 25 full-time equivalent employees (FTEs)
(2) the average annual wages per FTE  is less than $50,000, and
(3) the employer maintains a “qualifying arrangement”

The credit is fully available to an employer with 10 FTEs and average annual wages of $25,000. The credit phases out pro rata so that an employer with 25 FTEs with average annual wages of $50,000 is not entitled.

Number of Employees for the Taxable Year

The number of FTEs is determined by counting employees who perform services for the employer. Generally, sole proprietors, partners in a partnership, more than 2 percent shareholders of an S corporation, and more than 5 percent owners of any other business are not included in the count. In addition, seasonal workers who work fewer than 120 days in the year are not counted.

Next, determine the number of hours that each worker who is included in the count works during the taxable year, but not more than 2080 hours for any employee. Generally, you count hours for which the employee is paid for working.  You can also count up to 160 hours of paid time off.

Determine the number of FTEs by dividing the total number of hours worked by each employee by 2080. A fraction is rounded down to the next whole number.

Average Annual Wages per FTE for the Taxable Year

Determine the average annual wages by dividing

(1) the total wages paid by the employer  to the employees counted as FTEs by
(2) the number of FTEs for the year, and
(3) rounding the result down to the nearest $1,000.

For example, if the employer pays $224,000 in total wages and has 10 FTEs, it pays average annual wages per FTE of $22,000 ($224,000 divided by 10 equals $22,400, which is rounded down to the nearest $1,000).

Qualifying Arrangement

The credit is available only for premiums paid by the employer under a qualifying arrangement. The health plan is a qualifying arrangement if the employer pays a uniform percentage (but not less than 50%) of the premium.

The amount of employer-paid premiums that can be used in calculating the credit is limited to the average premium for the small group market in the employer’s state. The average premium information is included in the instructions for Form 8941(used to compute the credit)

Transition Relief for 2010.

Because the credit applies to 2010, including premiums paid by the employer before the Healthcare Reform Act became law, if the employer pays at least 50 percent of the premium for single coverage, it will be deemed to satisfy the uniformity requirement.

Determining the Credit

For taxable employers, the maximum credit is 35 percent of the employer’s premium payments. For a tax exempt employer, the credit is 25 percent.

The credit phases out if the number of FTEs is greater than 10 and/or the average wage per FTE exceeds $25,000. The reduction has two parts: a reduction if the number of FTEs is greater than 10 and a reduction if the average wage is greater than $25,000. If the number of FTEs is greater than 10, the credit is reduced by a fraction, the numerator of which is the number of FTEs over 10 and the denominator of which is 15. If the average wage exceeds $25,000, the credit is reduced by a fraction, the numerator of which is the amount of wages over $25,000 and the denominator of which is $25,000. If both reductions apply, each amount is subtracted from the credit.

For example, if a taxable employer has 12 FTEs, average wages of $30,000, and an initial credit of $33,600, the reductions are determined as follows:

  • reduction for FTEs over 10: 2/15 times $33,600 equals $4,480
  • reduction for average wages over $25,000: 5,000/25,000 times $33,600 equals $6,720

The total reduction is $11,200 ($4,480+$6,720) and the allowable credit is $22,400.

Claiming the Credit

Form 8941 if used to figure the credit . A taxable employer treats the credit as a general business credit and offsets its tax liability for the year by the amount of the credit. The credit can be used in some cases against the employer’s alternative minimum tax liability.