Small businesses that pay at least half the cost of employee health coverage may qualify for a federal tax credit, called the small employer health insurance credit. The credit helps to reduce the companies' costs of this important employee benefit. However, according to the General Accountability Office (GAO), few eligible companies claimed the credit in 2010, the first year it was available. That year, 170,300 small employers claimed the credit, while government agencies estimate pool of qualifying small businesses ranges anywhere from 1.4 million to 4 million. Confusion about the credit accounts for part of the shortfall.
Now proposed regulations issued in late August help to clarify many of the complex and confusing rules for claiming the credit. They are designed to be effective on January 1, 2014, but are also helpful with the credit for 2013. Here's what you need to know:
The small employer health insurance credit was created by the Affordable Care Act in 2010. There are really two credits: 1) a credit of up to 35% of premiums, which applies in 2010 through 2013, and 2) a credit of up to 50%, which runs only for 2014 and 2015. While many of the rules are the same for all years, there are important differences.
For 2014 and 2015, the credit applies only if coverage is obtained through a Small Business Health Insurance Options Program (SHOP). These marketplaces open on October 1, 2013, for coverage starting on January 1, 2014. However, for 2014, only one plan will be offered in the 33 states where the federal government (rather than the state) is running the program. States with their own programs can opt to delay multiple offerings. Details about SHOP options in your state can be found at www.healthcare.gov.
In the first year of the credit, of all those claiming it, 83% had a reduced credit because of phase-outs. The eligibility rules, including the phase-outs are the same for all years.
- The full credit applies only if you have 10 or fewer full-time equivalent (FTE) employees. A partial credit applies if you have fewer than 25 FTEs.
- The full credit applies if average annual wages do not exceed $25,000. A partial credit applies if they average under $50,000. The $25,000 limit is indexed for inflation after this year.
Who is counted and who is not?
Do not count:
- Independent contractors
- S corporation shareholders owning more than 2%
- Family members (spouse, child or grandchild, sibling, step- sibling, parent or grandparent, step-parent, niece or nephew, aunt or uncle, in-laws, or member of the owner's family who is claimed as a dependent)
- Seasonal employees who work 120 or fewer days during the taxable year, such as holiday workers for retailers and summer employees. However, premiums paid on their behalf are counted in determining the amount of the credit
- Leased employees (those who are not employees of the service recipient but who provides services to the service recipient under an agreement with a leasing organization). Leased employees only include those who worked full time for at least one year under the direction and control of the service recipient.
Can a business owner avoid the limitations by splitting a company into separate operations? No, because of the aggregation rule. Under this rule, all employers are treated as a single employer so that all employees' hours and wages are aggregated.
Aggregation applies to:
- Corporations in a controlled group of corporations
- Members of an affiliated group
- Partnerships, S corporations, and sole proprietorships under common control as defined for purposes of qualified retirement plans under Code Sec. 414(c). (Tax-exempt employers can also be aggregated under this rule.)
Employers must pay a uniform portion of premiums (at least 50%) to claim the credit. The percentage must be applied uniformly. Application of the uniform percentage requirement depends on the way in which premiums are figured; new terminology applies:
- Composite billing: A uniform premium is paid for each employee or there is a single aggregate premium charge for covered employees
- List billing: Separate premiums are paid for each employee based on age and other factors
Another term: A qualified health plan (QHP) is the only plan for which premiums are taken into account for purposes of the credit.
How do you know whether you're paying premiums for employees on a nondiscriminatory basis? Here are some examples:
- If you offer one QHP under a composite billing system: pay at least 50% of premium for self-only coverage.
- If you offer one QHP under a composite billing system with different tiers of coverage (self-only, family coverage):
- Pay the same amount for each enrolled employee (and that amount is at least 50% of the premium for the tier), or
- Pay an amount for each enrolled employee in the more expensive tiers that is the same for all employees and is no less than the amount that the employer would have contributed for self-only coverage (and that amount is at least 50% of the premium for self-only coverage).
- If you offer one QHP under a list billing system: more complex rules apply.
- If you offer more than one QHP, different rules apply.
If you receive a state tax credit or premium subsidy for paying toward employee health coverage, the amount you receive is effectively treated as your own premium payment. However, the amount of the federal credit cannot exceed your net premiums paid (the amount of premiums paid minus the state tax credit or premium subsidy received).
If your state pays your premium subsidy directly to the insurer, this, too, is treated as your payment. However, the amount of the federal credit you can claim cannot exceed your actual premium payments.
FTEs and the employer mandate
Different rules apply for FTEs under the credit and for purposes of the employer mandate. The number of employees capped for the small employer health insurance credit is based in part on full-time workers and FTEs. For this credit (in contrast to the employer mandate that's been postponed until 2015), full-time workers are those working 40 hours or more (only the first 40 hours are taken into account); hours of part-timers are aggregated and divided by 2080 to find FTEs. For purposes of the employer mandate that has been postponed until 2015, it means 30 hours a week or more; part-timers' hours are aggregated and then divided by 30 hours to find FTEs.
Still confused? You're not alone; many small businesses continue to be baffled by this credit. You can use National Federation of Independent Business's (NFIB's) calculator to see whether you qualify. When in doubt, talk with your tax advisor.