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June 6th, 2014

Small Business Health Tax Credit

NAPEO has prepared a healthcare small business tax credit guide to understand the credits, including how much can be claimed, which small businesses are eligible to receive the credits, and how to calculate credits. Calculating the credit is complicated and this guide is a valuable tool developed to assist client with this complex issue. With phase one of the healthcare small business tax credits effective immediately, it is important that employers and their tax advisors understand its implications.

Please feel free to reach out to a member of the ManagedPAY Benefits Team for assistance with the small business tax credit guide.

Questions and Answers regarding the Small Business Health Tax Credit

  1. How does my client determine if they are eligible for the Small Business Tax Credit?

    Answer: It is a lot more complicated than just counting noses. There is first a formula that a
    client must use to determine whether they qualify as a “small business.” This is done as follows:

    Step 1. Determine the total number of employees (not counting owners or family members):

    Full Time Employees [40 + hours per week]
    + Full Time Equivalents for Part time Employees*
    Total FTEs:

    [*Full Time Equivalent of Part-time Employees = Total Annual Hours of Part-time Employees 2080. Note: this does not include seasonal workers working less than 120 days during the tax year]

    >> If Total FTE is less than 25, proceed to Step 2

    Step 2. Determine the total annual wages paid to employees (excluding wages paid to owners or family members):

    Total Annual Wages
    Number of Employees (from Step 1)
    = Average Wage

    >> If the Average Wage is less than $50,000, proceed to Step 3

    Step 3. Determine if the client pays at least 50% of the health insurance premium of employees at the single (employee only) coverage rate. If yes, then the client is eligible.

  2. What is the amount of the credit?

    Answer: The credit varies based on the number of FTEs and Average Annual Wage and is less for a tax-exempt employer. The credit is based on the amount of premium that the company pays, not to include the amount paid by employees and also excludes any amounts paid for coverage on owners and their family members.

    According to the IRS, the credit is worth up to 35 percent of a small business’ premium costs for years 2010 through 2013 (25 percent for tax-exempt employers). On Jan. 1, 2014, this rate increases to 50 percent (35 percent for tax-exempt employers) for years 2014 and 2015. No further credits are expected at that time.

    The credit is 100% for small businesses with less than 10 employees. Also the credit is for payments made during the entire year and not just since enactment.

    Note: This credit phases out gradually for firms with average wages between $25,000 and $50,000 and for firms with the equivalent of between 11 and 25 full-time workers.

  3. Can you give examples of this determination?

    Answer: The IRS has provided three examples:

    Example 1: Auto Repair Shop with 10 Employees Gets $24,500 Credit for 2010

    • Employees: 10
    • Wages: $250,000 total, or $25,000 per worker
    • Employee Health Care Costs: $70,000

    2010 Tax Credit: $24,500 (35% credit)
    2014 Tax Credit: $35,000 (50% credit)

    Example 2: Restaurant with 40 Part-Time Employees Gets $28,000 Credit for 2010

    • Employees: 40 half-time employees (the equivalent of 20 full-time workers)
    • Wages: $500,000 total, or $25,000 per full-time equivalent worker
    • Employee Health Care Costs: $240,000

    2010 Tax Credit: $28,000 (35% credit with phase-out) (See Question 4)
    2014 Tax Credit: $40,000 (50% credit with phase-out)

    Example 3: Foster Care Non-Profit with 9 Employees Gets $18,000 Credit for 2010

    • Employees: 9
    • Wages: $198,000 total, or $22,000 per worker
    • Employee Health Care Costs: $72,000

    2010 Tax Credit: $18,000 (25% credit)
    2014 Tax Credit: $25,200 (35% credit)

  4. Is there a sliding scale or phase out that applies to the credit?

    Answer: Yes. The credit is reduced to the extent the number of FTEs is above ten and/or the average annual wage is above $25,000.

    The calculation is the sum total of the following reductions to the otherwise applicable credit (but not to reduce the credit below zero):

    v If the number of FTEs exceeds 10, then multiply the credit times a fraction (that is the number of FTEs in excess of 15 over the number 15)

    v If the average annual wage exceeds $25,000, then multiply the credit times a fraction (that is the amount of the average annual wage in excess of $25,000 over the number
    25,000)

  5. Is there an example of how this sliding scale applies to the credit?

    Answer: The IRS has provided the following example:

    Example: For the 2010 tax year, a qualified employer has 12 FTEs and an average annual wage of $30,000. The employer pays $96,000 in health care premiums for those employees (which does not exceed the average premium for the small group market in the employer’s State and/or region) and otherwise meets the requirements for the credit.

    The credit is calculated as follows:

    (1) Initial amount of credit determined before any reduction: (35% x $96,000) = $33,600

    (2) Credit reduction for FTEs in excess of 10: ($33,600 x 2/15) = $4,480

    (3) Credit reduction for the average annual wage in excess of $25,000: ($33,600 x $5,000/$25,000) = $6,720

    (4) Total credit reduction: ($4,480 + $6,720) = $11,200

    (5) Total 2010 tax credit: ($33,600 – $11,200) = $22,400.

    This is also why the tax credit in the second example to question 3 equals $28,000 and not simply 35% of $240,000 (which would equal $84,000). The following would be the Phase-out for that above example:

    (1) Initial amount of credit determined before any reduction: (35% of $240,000) = $84,000

    (2) Credit reduction for FTEs in excess of 10: ($84,000 x 10/15) = $56,000

    (3) Credit reduction for average wage in excess of $25,000 = none

    (4) Total credit reduction: ($56,000)

    (5) Total 2010 tax credit ($84,000 – $56,000) = $28,000

  6. Can a client of a PEO receive this credit?

    Answer: Yes. NAPEO believes (see NAPEO Advisory) that a colloquy on the Senate floor between Senator Nelson of Florida and Senators Baucus of Montana and Grassley of Iowa express the clear intent of those shepherding the legislation through the Congress that the credit should be available to clients of a PEO.

  7. What amount of premium is used in the calculation?

    Answer: An employer may only count the amount of premium paid by the employer. It may not count the portion paid by the employee. For example, if the employer pays 75% and the employee pays 25% of the premium, only the 75% is used in calculating premiums paid by the employer. An employer may not count the amount of premium paid by the employer for coverage on owners and their family members.

    v CAVEAT: Premium paid under a salary reduction arrangement under a section 125 cafeteria plan is not treated as paid by the employer.

    v CAVEAT: There will be a cap on the amount of the employer’s premium payments cannot be greater than the amount that would have been paid for the average premium for the small group market in the state. So in the case above, not more than 75% of what the average premium would have been in the small group market. (That amount is to be determined by HHS and published by the IRS)

  8. Will all premiums in 2010 be counted, including those incurred before the passage of the Act?

    Answer: Yes

  9. Where can I go for further help on this?

    Answer: It is expected that the IRS will continue to develop information and guidance on this issue. Go to IRS.gov or directly to their health care tax credit page for information.

    In addition, look to the NAPEO web site and to NAPEO programming for additional information and educational programming throughout the year.

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