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Small Business Health Care Tax Credit

Tax Credit up to 35% of Employer Contribution

The Affordable Care Act amended the Internal Revenue Code and added the Small Business Health Care Tax Credit. This tax credit went into effect immediately after the enactment of the law. This credit will allow eligible small employers to receive a tax credit of up to 35% of all nonelective contributions made towards the premium costs of employee healthcare.

Small Business Tax Credit Calculator

Calculator property of Small Business Majority and its subsidiary website California Health Coverage Guide

Calculating the Credit

The maximum tax credit (35% for eligible small employers or 25% for tax-exempt eligible small employers) is only available to employers with 10 or fewer FTEs and average annual wages of $25,000 or less. The tax credit is phased out as the number of FTEs and average annual wages increase. The table on the right (click table to enlarge) shows the tax credit as a percentage of employer contributions to premiums. This table is an extremely helpful resource to “eyeball” whether your company would be eligible for the Small Business Health Care Tax Credit. You should begin your eligibility determination by quickly referencing this table to see whether you would be eligible for any credit at all.

To calculate the credit for an eligible employer, the following steps are performed:

  • Step 1: Determine the full credit amount by multiplying the nonelective premiums paid, by 35 percent.
  • Step 2: Multiply the initial full credit amount by a fraction with a numerator equal to the employer’s FTEs in excess of 10 and a denominator of 15.
  • Step 3: Multiply the initial full credit amount by a fraction with a numerator equal to the employer’s average annual wages above $25,000 and a denominator of $25,000.
  • Step 4: Add the amounts arrived at in the second and third steps and subtract that sum from the initial full credit amount (calculated in Step 1). This gives you the amount of tax credit that is available to the small employer.

Encourages Small Employers to Offer Coverage

The goal of this tax credit is to encourage small employers to offer small business health insurance to their employees. Expansion of healthcare coverage is one of the major goals of healthcare reform, and small businesses present a great opportunity to do that. In the past, small businesses have struggled to offer coverage due to rising healthcare costs and their lack of knowledge regarding benefits administration. Small businesses lack the resources to stay apprised of the changing employee benefits environment, especially since healthcare reform began. This credit will go a long way to help small businesses control or contain their healthcare costs.

Employer Eligibility

To qualify as an eligible employer for the tax credit, a small employer must meet the following three requirements within any given tax year:

  1. The employer must not have more then 25 full-time equivalent employees (FTEs) for the tax year;
  2. The employer’s full-time equivalent employees (FTEs) must have annual average wages that do not exceed $50,000; and
  3. The employer must have a contribution arrangement in effect that meets the requirements of Code Sec. 45R(d)(4).

Step 1: Calculating Full-Time Equivalent Employees

The first step in determining eligibility is to calculate the number of full-time equivalent employees employed by the company. The Internal Revenue Code requires the employer to exclude the hours and wages of “excludable workers” in the calculation.

These excluded individuals are as follows:

  • Self-employed individuals, including sole proprietors and partners in a partnership,
  • Individuals owning more than 2% of a subchapter S corporation,
  • Individuals owning more than 5% of a corporation, and
  • Certain family members and dependents of these individuals

Therefore, these excluded employees’ hours of service worked, and wages received are not included in the full-time equivalent calculation. Seasonal workers are counted only if they work for the employer on more than 120 days during the taxable year.

After excluding the employees allowed by the Internal Revenue Code guidance, the next step in the full-time equivalent employee calculation is to aggregate the number of hours of service each employee worked in the tax year under consideration. The maximum number of hours allowed in the calculation for a single employee is 2,080. (52 weeks per year multiplied by 40 working hours a week = 2,080 hours).

The Internal Revenue Code provides the following three different methods to aggregate the hours of service:

  1. actual hours of service — compiled from employers’ records that show the actual hours worked by all nonexcludable employees
  2. days-worked equivalency — this method credits an employee for eight hours of service for each day the employee is credited with at least one hour of service
  3. weeks-worked equivalency — this method credits an employee 40 hours of service for each week for which the employee would be credited with at least one hour of service

After you determine the aggregate hours for each employee, compute the total aggregate hours for all (non-excludable) employees, and divide that number by 2,080. The result is the number of full-time equivalent employees.

Step 2: Calculating Average Annual Wages

The next step in the eligibility determination is to determine the average annual wages paid to each full-time equivalent employee. To be eligible for the Small Business Health Care Tax Credit, the employer’s full-time equivalent employees must have average annual wages that do not exceed $50,000. This calculation is made by dividing the aggregate wages paid to all non-excludable employees by the number of full time equivalent employees, as determined in Step 1. Divide the total aggregated wages paid by the number of full-time equivalent employees as calculated in Step 1.

Step 3: Contribution Arrangement Requirements

An employer’s contribution arrangement will satisfy the Code’s requirements if the employer makes a nonelective contribution on behalf of each employee in an amount equal to a uniform percentage (not less than 50%) of the premium cost of health insurance coverage offered to employees by the employer. The premiums must be for “health insurance coverage”. It is important to note that the credit is available for not only premiums paid for “health insurance coverage”, but also for premiums paid for several other ancillary benefits such as limited-scope dental or vision plans, long-term care, nursing home care, home health care, and several others. If the employer has a contribution arrangement in place that satisfies the requirements of the Internal Revenue Code, and they have satisfied the first two requirements of the eligibility determination process, then they are eligible for the Small Business Health Care Tax Credit.

Small Business Tax Credit - Data.png

Tax Credit in 2014 and Beyond

In 2014, the maximum small business health care tax credit that will be available for eligible small employers will increase from 35 percent to a maximum of 50 percent of nonelective contributions. However, the contribution arrangement requirements will also change. Beginning in 2014 the contributions must be made on behalf of employees who enroll in a qualified health plan offered through a health benefit exchange.

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