Small Business Health Insurance Credit Explained

When the Patient Protection and Affordability Act became law this past March, many small businesses immediately qualified for a substantial, retroactive tax credit - a credit that will reduce their health insurance cost by up to 35 percent. What had remained unclear, however, was a detailed definition of which employers, employees and policies qualify for the credit.

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Fortunately, the IRS recently released guidance to answer these questions. Unfortunately, this guidance complicates what originally seemed a straightforward proposition. Does your business or organization qualify for the Small Employer Health Care Credit? Today, we’ll assemble some of the credit’s major components to help you construct an answer.

To qualify for the health care tax credit, businesses and tax-exempt organizations must meet three criteria: First, pay at least 50 percent of their employees’ single-rate health care premiums; Second, employ less than 25 “full-time equivalent” employees; and third, pay these FTEs an average of less than $50,000 per year.

Qualifying employers also must utilize a “qualifying arrangement” and pay at least 50 percent of employees’ health insurance premiums when calculated at the single (worker-only) rate. A qualifying arrangement exists if the employer pays a “uniform percentage” (the same percentage for each employee) of at least 50 percent of each employee’s single-rate health care premium. However, for 2010, this rule is relaxed. A “qualifying arrangement” will be considered to exist so long as the employer pays at least 50 percent (but not necessarily the same percentage) of premiums for each employee enrolled in employer-offered coverage.

Although total premiums are utilized when determining whether an employer has paid a qualifying percentage of premiums, only premiums actually paid by the employer are used to calculate the credit. For example, if the employer pays 60 percent of an employee’s coverage, only the premium actually paid by the employer (60 percent) is utilized to calculate the credit.
The amount of premium that can be used to calculate the credit also is capped by the average premium paid for “small group” market coverage in the state (or geographic area) where the insurance is offered. This small group premium limit is determined by the Department of Health and Human Services and published via Revenue Ruling 2010-13. When calculating the amount of “qualifying premium,” employers must use the lesser of the single-rate premium actually paid for the employee (calculated at the employee-only rate) or the amount listed on Revenue Ruling 2010-13.

Several additional calculations must be made to determine whether or not the employer is eligible for the credit. First the employer must calculate their number of FTEs. To calculate the number, take the total hours worked by all employees (do not count over 2,080 hours for any one employee) and divide that total by 2,080 - then, round the answer up to the next whole number. Employers also must determine the average wage paid to each FTE. The average wage per FTE is calculated by taking the total wages paid during the tax year, dividing it by the total number of FTEs, then rounding down to the nearest $1,000. When determining the number of FTEs and average wage, do not include the hours or wages of seasonal workers (working less than 121 days per the tax year), business owners or the family members of business owners. But be careful - there are special rules for determining which owners or family members to exclude.

Businesses and nonprofits that employee less than 25 FTEs who earn an annual average of less than $50,000 qualify for the credit. Through 2013, the maximum credit is 35 percent of qualifying premiums for small businesses and 25 percent for nonprofits. The credit, however, is skewed so that only employers who employ 10 FTEs or less who earn an average of $25,000 or less qualify for the maximum credit. The credit is reduced for employers with FTEs or average wages exceeding these amounts. This too requires additional calculations.
Today we constructed a bare-bone skeleton of the Small Employer Health Insurance Credit. We did not flesh out details that may impact your specific business or organization. This credit will prove a valuable tool for many businesses struggling to provide their employees health care coverage. But it is also cumbersome, complex and should not be claimed without some professional guidance. For more information, please feel free to contact our office or consult with another qualified tax professional.

Brett Hersh's avatar
  • Author: Brett Hersh
  • Bio: Brett Hersh, EA, MBA, is the owner of HBS TAX & Small Business Experts. He is an Enrolled Agent (EA) with the IRS and licensed by the US Treasury Department to prepare all tax returns and represent taxpayers before the IRS for audits, collections and appeals. He is also Dave Ramsey’s ELP for Tax and Accounting, a continuing education instructor for tax professionals through Lorman Education, and a local speaker/presenter on the topics of tax and business growth. He can be reached at (304) 267-2594.