- IRS Issues Guidance on Small Employer Health Care Tax Credit
- December 30, 2010 | Author: Sara Tountas
- Law Firm: Miller Johnson - Grand Rapids Office
Under Health Care Reform, certain small employers are eligible to claim a tax credit of up to 35 percent of their contributions toward the cost of health insurance for their employees. The credit is available for tax years beginning on or after January 1, 2010. The IRS recently issued guidance regarding the tax credit and published forms to calculate and claim the tax credit for 2010.
Which Small Employers are Eligible for the Credit?
An employer (including a tax-exempt employer) will qualify for the tax credit if it satisfies the following requirements:
The employer employs fewer than 25 full-time equivalent employees (FTEs) during the tax year;
- The average annual wages for the tax year are less than $50,000 per FTE; and
- The employer paid health insurance premiums during the tax year under a “qualifying arrangement.”
The number of FTEs is determined by dividing total number of hours of service for all employees during the year (but not exceeding 2,080 hours per employee) by 2,080. Average annual wages is determined by dividing the total wages paid during the year by the number of FTEs.
Seasonal employees who do not work more than 120 days during the year are excluded in determining the number of FTEs and average annual wages (although premiums paid for seasonal employees are counted in calculating the tax credit).
Sole proprietors, partners in a partnership, more-than-2 percent shareholders in an S corporation, and more-than-5 percent owners in any other business are excluded in calculating FTEs, and average annual wages. Family members of these individuals are also generally excluded. Additionally, health insurance premiums paid on behalf of these individuals are not counted in calculating an employer’s tax credit.
Leased employees are included in determining an employer’s FTEs and average annual wages, but premiums paid by a leasing company on behalf of a leased employee are not taken into account in determining the amount of the tax credit. Employees employed by any other entity in an employer’s IRS “controlled group” are also counted in determining whether an employer is eligible for the tax credit.
What is a Qualifying Arrangement?
The new tax credit is based on the amount of premiums paid by the employer under a “qualifying arrangement.” A “qualifying arrangement” is one where the employer pays a uniform percentage of the premium cost for each employee enrolled in health insurance coverage offered by the employer. The uniform percentage must be at least 50 percent of the premium cost.
Special Transition Rules for 2010
For tax years beginning before 2014, only amounts paid by the employer for fully-insured health coverage (including major medical insurance, as well as stand-alone dental or vision insurance) are counted for purposes of the tax credit. Employer contributions to self-funded health coverage, including a health flexible spending account, a health reimbursement arrangement, or a health savings account are generally not counted (although there is an exception for self-funded church welfare plans). Health insurance premiums paid by employee salary reduction contributions under a Section 125 cafeteria plan are not considered to be paid by the employer.
For the 2010 tax year, an employer may still qualify for the tax credit even if it does not satisfy the uniformity requirement described above. Under a special transition rule, an otherwise eligible employer will qualify for the tax credit for 2010 if it contributes an amount equal to at least 50 percent of the single-employee premium coverage for each employee enrolled in coverage (even if the employee is enrolled in family coverage). Additionally, even employers that do not satisfy the transition rule may still be eligible for the tax credit for 2010 under other special rules described in IRS Notice 2010-82. The special rules in the IRS Notice 2010-82 provide additional opportunities for small employers to qualify for the tax credit, particularly in situations where an employer offers more than one type of health insurance coverage, or where an insurer does not charge the same premium for each employee enrolled in single-employee coverage.
Amount of the Tax Credit
The amount of the tax credit is equal to a percentage of the employer’s total premium contributions during the tax year under each qualifying arrangement. But contributions counted for purposes of the tax credit are capped by the amount the employer would have contributed if the total premium cost for coverage were equal to the average premium for the small group insurance market in the state where the coverage is offered. The 2010 average small group premiums for each state were published in the IRS Rev. Rw. 2010-13. (For 2010, the average premium in the small group market in Michigan is $5,098 for single coverage and $12,364 for family coverage.)
The applicable percentage of the tax credit depends on the number of FTEs and the average annual wages of the employees. The maximum tax credit is 35 percent of the premium contributions (or 25 percent of the premium contribution for tax-exempt employers). However, the percentage is ratably reduced to the extent the employer either has more than 10 FTEs or average annual wages exceed $25,000.
For tax-exempt employers, the amount of the tax credit also may not exceed the sum of the income and Medicare taxes withheld from employees’ wages during the year and the employer’s share of Medicare taxes on wages for the year.
Claiming the Tax Credit
Eligible employers may claim the tax credit by completing a new IRS Form 8941. Taxable employers will attach Form 8941 to their income tax return. Tax-exempt employers will file Form 990-T and attach Form 8941.
For tax-exempt employers, the tax credit is refundable. Therefore, a tax-exempt employer can receive a tax refund for the credit even though it has no taxable income for the year.
For a taxable employer, the deduction that the employer may claim for health insurance premiums for the year is reduced by the amount of the tax credit.