Money Talk: Employee Health Care Tax Credit

The Small Business Health Care Credit, part of the Patient Protection and Affordable Care Act (“Health Care Reform) is designed to encourage small employers to offer health insurance coverage or maintain the coverage they already offer their employees. Imagine, a tax credit, a direct reduction of the rural building business’s tax bill, equal to as much as 35 percent of the premiums paid.

Unlike a tax “deduction” that merely reduces the income upon which the tax bill is based, a tax “credit,” reduces the tax bill. Naturally, taking advantage of the tax credit or actually claiming the health care tax credit, is not a cut-and-dried process and not every employer will qualify — or will want to qualify.

The Internal Revenue Service has already begun encouraging small businesses to explore and, if qualified, claim the new small health insurance coverage credit. Small employers (no more than 25 employees and average wages below $50,000 annually) are eligible for a federal tax credit, a direct reduction of the building operation’s tax bill, for the amount spent on health insurance for their employees — up to 35 percent.

The full amount of the credit is, however, available only to an employer with 10 or fewer full-time equivalent employees (FTEs) and whose employees have average annual full-time equivalent wages from the employer of less than $25,000. These wage limits would be indexed to the Consumer Price Index for Urban Consumers beginning in 2014.

Self-employed contractors and builders, including partners and sole proprietors, 2 percent shareholders of an S corporation, and 5 percent owners of the building business are not treated as employees for the Small Business Health Insurance Credit. In fact, a special rule prevents sole proprietors from receiving the credit as the owner as well as for their family members.

In 2010, the health care tax credit was generally available to small employers contributing an amount equivalent to at least half the cost of single coverage towards buying health insurance for their employees. The credit is specifically targeted to help small businesses and tax-exempt organizations primarily with moderate- and lower-income workers.

For tax years 2010 to 2013, the maximum credit is 35 percent of premiums paid by eligible small business employers and 25 percent of premiums paid by eligible employers that are tax-exempt organizations. Beginning in 2014, the maximum tax credit will go up to 50 percent of premiums paid by eligible small business employers and 35 percent of premiums paid by eligible, tax-exempt organizations for two years. The maximum credit goes to smaller employers — those with 10 or fewer full-time equivalent (FTE) employees — paying annual average wages of $25,000 or less.

Because the limitation on the number of employees is based on FTEs, an employer with 25 or more employees could qualify for the credit if some of its employees work part-time.  For example, an employer with 46 half-time employees (meaning they are paid wages for 1,040 hours) has 23 FTEs and therefore may qualify for the credit. The number of an employer’s FTEs is determined by dividing (1) the total hours of service for which the employer pays wages to employees during the year (but not more than 2,080 hours for any employee) by (2) 2,080.  The result, if not a whole number, is then rounded to the next lowest whole number. 

Only premiums paid by the employer under an arrangement meeting the tax law’s requirements (a so-called “qualifying arrangement”) are counted in calculating the credit.  Under a qualifying arrangement, the employer pays the premiums for each employee enrolled in an amount equal to a uniform percentage (not less than 50 percent) of the premium cost of the coverage. 

For years prior to 2014, only premiums paid to a health insurance issuer, such as an insurance company or HMO, for health care coverage are counted for purposes of the credit.  Premiums for health care insurance that cover a wide variety of conditions, such as a major medical plan, are also counted, as are the premiums for coverage that is somewhat more limited in scope, such as limited scope dental or vision coverage.

Although the IRS only recently announced the ground rules for the businesses that are eligible for this new federal tax credit, the owners of many small building businesses may be in for a big surprise if they — or their advisors — do not carefully follow the new rules: The tax credit penalizes employers if they hire more workers or increase salaries.

That’s right, as businesses grow, they will be penalized if they hire more workers or raise employee wages. As the building operation’s average pay rises above $25,000, the tax credit slowly decreases at a rate of 4 percentage points for every additional $1,000 in average pay. The tax credit completely disappears once average pay reaches $50,000.

Many building businesses pay their workers more than $25,000 a year, so the average tax credit for the few who qualify is about 10 percent of the cost of the policy. That’s less than $200 per worker — not enough to spur many business owners to start providing coverage. And don’t forget the all-important role of profits: no profits, no tax bill.

Generally, an employer (other than a tax-exempt employer) cannot claim the credit if the operation has no taxable income and no alternative minimum tax (AMT) liability for the year. Except in the case of a tax-exempt employer, the credit for a year offsets only an employer’s actual income tax liability or its (AMT) liability.

Starting in 2014, the health care reform law will require nearly all Americans to have health insurance, either through an employer, a government program or by buying it directly. That year, new insurance markets will open for business, health plans will be required to accept all applicants and tax credits will start flowing to millions of people, helping them pay the premiums.

Those who continue to go without coverage will have to pay a penalty to the IRS, except in cases of financial hardship. Fines will vary by income and family size.

In 2014, building businesses employing more than 50 workers will be required to provide health coverage and most people will be required to have health insurance. The tax on high-cost “Cadillac” policies will not go into effect until 2018; the increase in Medicare payroll taxes begins in 2013; while the tax credits available to small employers for health-care related expenses started in 2010.

The Health Care Credits are a temporary solution until small employers can shop on insurance exchanges. States will start implementing the insurance pools in 2014, but it could be two more years until every state has an exchange accommodating businesses with up to 100 employees, according to many experts.

For a business with 25 or fewer employees, the tax credits are a big help. But bigger firms will have to wait for the exchanges. In the meantime, the question remains: will the Small Business Health Care Credit help your building business provide this invaluable employee benefit or encourage the operation to offer it? RB

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