Kevin Bickerstaff, Tax Specialist

One of the benefits of the Health Care and Education Reconciliation Act of 2010 is the creation of the Small Business Health Care Tax Credit. For businesses that qualify, this credit helps offset the cost of health insurance premiums paid by the businesses on behalf of its employees. The credit for small employers from 2010-2013 can be as much as 35% of premiums paid and 50% in 2014. For tax-exempt small employers, the credit limit from 2010-2013 is 25% and 35% beginning in 2014.

Who is Eligible?

There are three main requirements in order to be eligible for the small business credit. The first is that your business employs fewer than 25 full-time equivalent employees (“FTEs”) during the year. The second requirement stipulates that average annual wages paid to FTEs during the year is less than $50,000 per FTE. The third component of an eligible business requires that businesses pay no less than 50% of the healthcare insurance premiums for each employee enrolled in the company’s health insurance plan using the single (employee-only) coverage rate. This rate will be explained in further detail below. Owners, partners, 2% shareholders, and family members of these individuals are excluded from the FTE and wage calculations. Also, please note that employers who are corporations in a controlled group of corporations are treated as a single employer when figuring the credit.

Credit Limitations

There are a number of phase-outs and limitations involved with the small business credit, as described below:

State Average Premium

This limitation involves what is called the state average premium for small group markets. The credit will be reduced if employer premiums paid are more than the employer premiums that would have been paid if employees had enrolled on their own in a plan with a premium equal to the average premium for the small group market in the particular state in which that employee works. For example, in 2010, the Rhode Island state average for single coverage is $5,887 and $13,786 for family coverage. If a Rhode Island business pays on average more than this amount for their employees, the credit will be limited to the Rhode Island 2010 rates.

FTE Limitation

A phase-out of the credit is caused by the FTE limitation. FTEs are calculated by taking the total service hours worked for all eligible employees and dividing that figure by 2,080. Do not include hours of services for any seasonal employee who worked 120 or fewer days during the year. Also, no more than 2,080 hours of service from any employee can be used in calculating total hours worked. With regards to the number of FTEs a business has, the full 25% for tax-exempt and 35% credit for other small employers is eligible if the business has 10 or less FTEs during the year. The credit is phased out for businesses that have between 11-25 employees. The phase-out is calculated as follows:

Example: During 2010, XYZ Company, which is not a tax-exempt organization, has 13 FTEs and paid $60,000 in health care premiums for those employees. Before limitation, XYZ’s maximum credit using the 35% rate is $21,000 ($60,000 X 35%). However, because XYZ has more than 10 FTEs, the $21,000 credit will be reduced. The reduction is calculated by multiplying the maximum credit by the fraction which is created when taking the number of FTEs that exceed 10 and dividing that figure by 15. In this example the reduction calculation would be ($21,000 X 3/15) = $4,200. The maximum credit after the FTE limitation would be $16,800.

Average Annual Wage Limitation

This phase-out reduces the small business credit if the employer paid average annual wages of more than $25,000 to eligible employees during the year. As mentioned previously, if average wages exceed $50,000, the credit is reduced to zero. Similar to the FTE limitation, the average annual wage limitation is calculated by multiplying the maximum credit by the fraction which is created when taking wages in excess of $25,000 and dividing that figure by $25,000. The phase-out is calculated as follows:

Example: Using the same scenario above to calculate the FTE limitation, XYZ’s maximum credit at the 35% rate is $21,000 ($60,000 X 35%). If XYZ paid its FTEs an average of $31,000 during 2010, the $21,000 credit will be reduced. The reduction calculation is ($21,000 X $6,000/$25,000) = $5,040. After the FTE and average wage limitations, the maximum credit of $21,000 has now been reduced to $11,760.

How to Claim the Credit

An eligible employer who is not a tax-exempt organization can claim the small business health care credit by attaching Form 8941 with their corporate tax return. Please note that the amount of health insurance premium expense a business can deduct on its tax return is reduced by the amount of credit taken when claiming this credit.

Eligible tax-exempt organizations can claim this credit by attaching form 8941 with its annual Form 990-T tax return. For tax-exempt employers, this credit is a refundable credit so the tax-exempt organization may receive a refund in the amount of the credit if the organization has no taxable income.

For more details on the small business health care credit and whether your company is eligible to take it, please contact a SK&Co professional at 401-331-0500 with questions or concerns.