Begin Planning Now to Take Full Advantage of This Opportunity

James Calnan

The tax credit is included in the Patient Protection and Affordable Care Act, which became law March 23, 2010 and is effective Jan. 1, 2010. The new law is intended to encourage small employers to offer health insurance coverage for low- and moderate-income workers by subsidizing premiums paid with a tax credit. Section 45R of the Internal Revenue Code was added to provide for this credit. IRS Notice 2010-44 was written to provide guidance in determining eligibility and to assist in calculating the tax credit.

Amount of the Tax Credit
The maximum amount of the credit is 35% (25% for tax-exempt employers) of a small-business employer’s premium costs in 2010. This rate increases to 50% (35% for tax-exempt) in 2014. To obtain the maximum credit, an employer must have no more than 10 full-time-equivalent employees (FTEs), and the average annual wages of its employees must be no more than $25,000.
For employers with more than 10 but less than 25 FTEs or with average annual wages of more than $25,000 but less than $50,000, the credit gradually phases out according to a formula.
For tax-exempt employers, there is an additional limitation. The maximum credit cannot exceed the sum of income and Medicare tax withheld from employees’ wages for the year and the employer share of Medicare tax on employees’ wages for the year.

Who is Eligible for the Tax Credit?
A qualifying employer must have fewer than the equivalent of 25 FTEs as defined in the act, the average annual wages of its employees must be less than $50,000 per FTE, and the employer must maintain a ‘qualifying arrangement’ under which the employer pays premiums for each employee enrolled in the health-insurance plan in an amount equal to a uniform percentage (not less than 50%) of the cost of coverage. For 2010, under transitional rules, paying 50% of the cost of single insurance coverage will satisfy this requirement.

Do Owners of the Business Count as Employees?
A sole proprietor, a partner in a partnership, a shareholder owning more than 2% of an S corporation, and any owner of more than 5% of any other corporation or business and their family members or members of their household are not considered employees for purposes of the credit. Their wages, hours worked, and premiums paid on their behalf are excluded from any calculations in determining the amount of the credit. This is significant because, in many cases, including owners would disqualify the related employer for the credit.

What is an FTE?
For purposes of this credit, an FTE is an employee that is paid for at least 2,080 hours of service, including vacations and other paid time off. So if an employee works part-time and is paid for 1,040 hours, the employee is considered a half or 0.5 FTE. The law allows three different methods for determining hours of service. To calculate the number of employee FTEs, divide the total hours of service by 2,080 and round down to the next-lowest whole number. Therefore, an employer with 25 or more employees may qualify for the credit if some of the employees work part-time.
Seasonal or temporary workers may be disregarded in determining FTEs and average annual wages unless each works for the employer more than 120 days during the taxable year; however, premiums paid on their behalf may be counted in determining the amount of the tax credit.

Determining the Average Annual Wages
To determine the average annual wages, divide the total wages (as defined for FICA purposes) paid by the employer during the year to the employees that were taken into account in determining FTEs by the FTEs for the same year, and round the result down to the nearest $1,000.

Qualified Insurance Premiums
For years prior to 2014, only premiums paid by the employer to health-insurance issuers, such as an insurance company or HMO licensed to engage in the business of insurance, are counted for purposes of the credit. Qualified health-insurance coverage plans include major medical, dental, long-term care, nursing-home care, home health care, community-based care, or any combination of the above. Also included are specific disease or illness plans, indemnity insurance plans, Medicare, and other supplemental plans.
Each type of plan must separately satisfy the qualifying arrangement requirement first before aggregating the premiums paid by the employer to calculate the allowable tax credit; i.e., at least 50% of premiums must be paid by the employer.
Finally, for taxable years beginning before 2014, the amount of the credit is limited to a percentage of the lesser of 1) the amount of non-elective contributions (premiums) paid by the eligible small employer on behalf of employees under the arrangement during the taxable year, and 2) the amount of non-elective contributions the employer would have paid under the arrangement if each such employee were enrolled in a plan that had a premium equal to the average premium for the small-group market in the state (or in an area of the state) in which the employer is offering health-insurance coverage. The secretary of Health and Human Services (HHS) determines whether separate average premiums will apply for areas within a state (‘sub-state areas’) and also determines the average premium for a state or sub-state area. Revenue Ruling 2010-13 sets forth the average premium for the small-group market in each state for the 2010 tax year. This table can be accessed through www.irs.gov.

Claiming the Credit
The credit is claimed on the small employer’s annual income-tax return. Information will be forthcoming from the IRS for tax-exempt employers on how to claim the credit. It is currently contemplated that the credit will be refundable for tax-exempt employers. Small-business employers whose credit exceeds their current-year income tax can carry the excess credit back one year (except for 2010) and forward 20 years.

Devil in the Details
As with most tax benefits, there are exceptions, conditions, and other complications that can limit the amount of the credit and tax savings:
• Members of a controlled group or an affiliated service group, as defined in the tax regulations, are treated as a single employer for purposes of the credit. Therefore, all employees and all related wages of the control group must be aggregated to determine eligibility.
• The amount of the employer’s deduction for health insurance premiums must be reduced by the amount of the credit claimed in that year.
• There are specific rules as to the effect that state tax credits and subsidies for health insurance may have on the amount of tax credit allowable to the employer.
Although the rules and calculations involved are somewhat complex, the tax credits can save a small employer tens of thousands of dollars in cash flow each year, so it behooves you to do the math.

Start Planning Now
You should engage your CPA or tax advisor now to ascertain whether you might likely qualify for this in 2010. The following steps must be followed to determine whether you are eligible for the tax credit under IRS Code Section 45R:
• Determine the employees who are taken into account for purposes of the credit.
• Determine the number of hours of service performed by those employees.
• Calculate the number of the employer’s FTEs.
• Determine the average annual wages paid per FTE.
• Determine the premiums paid by the employer that are taken into account for purposes of the credit. Specifically, the premiums must be paid by an employer under a qualifying arrangement and must be paid for health insurance that meets the requirements of Section 45R.
• Determine if there are any state tax credits or premium subsidies related to the employer’s health-insurance program.
Running a pro-forma calculation now not only gives you an indication of your eligibility, but also identifies an action plan to take over the remainder of the year to maximize the tax credit, such as timing of premium payments and changing the policy relative to employer-paid premiums.
The accompanying examples of small-employer tax credits published by the IRS (see box) shows the potential savings to small employers.

Conclusion
The small-business health care tax credit could represent the largest federal tax credit ever made available to small employers. Go to www.irs.gov and search for ‘small-business health care tax credit’ to learn more about this credit, including a fact sheet, a worksheet to determine eligibility, frequently asked questions, examples of applying the rules, Notice 2210-44, and Notice 2010-13. n

James B. Calnan, CPA, is a partner with Meyers Brothers Kalicka, P.C. in Holyoke, certified public accountants and business strategists; (413) 536-8510; www.mbkhealthcare.com

Small-Business Health Care Tax Credit Scenarios
Examples of Employers Receiving the Credit

Example 1: Auto-repair shop with 10 employees receives $24,500
credit for 2010.
Main Street Mechanic
n Employees: 10
n Wages: $250,000 total, or $25,000 per worker
n Employee health care costs: $70,000
n 2010 Tax Credit: $24,500 (35% credit)
n 2014 Tax Credit: $35,000 (50% credit)

Example 2: Restaurant with 40 part-time employees receives $28,000
credit for 2010.
Downtown Diner
n Employees: 40 half-time employees (the equivalent of 20 full-time workers)
n Wages: $500,000 total, or $25,000 per full-time equivalent worker
n Employee health care costs: $240,000
n 2010 Tax Credit: $28,000 (35% credit with phase-out)
n 2014 Tax Credit: $40,000 (50% credit with phase-out)

Example 3: Foster care nonprofit with nine employees receives $18,000
credit for 2010.
First Street Family Services
n Employees: 9
n Wages: $198,000 total, or $22,000 per worker
n Employee health care costs: $72,000
n 2010 Tax Credit: $18,000 (25% credit)
n 2014 Tax Credit: $25,200 (35% credit )

Recently Enacted Legislation Has Provisions That Impact the Bottom Line

Kristina Drzal Houghton

Tax credits to certain small employers that provide insurance. The new law provides small employers with a tax credit (i.e., a dollar-for-dollar reduction in tax) for non-elective contributions to purchase health insurance for their employees. The credit can offset an employer’s regular tax or its alternative minimum tax (AMT) liability.

Small-business employers eligible for the credit. To qualify, a business must offer health insurance to its employees as part of its compensation and contribute at least half the total premium cost. The business must have no more than 25 full-time-equivalent employees (FTEs), and the employees must have annual full-time equivalent wages that average no more than $50,000. However, the full amount of the credit is available only to an employer with 10 or fewer FTEs and whose employees have average annual full-time equivalent wages from the employer of less than $25,000.

Years the credit is available. The credit is initially available for any tax year beginning in 2010, 2011, 2012, or 2013. Qualifying health insurance for claiming the credit for this first phase of the credit is health-insurance coverage purchased from an insurance company licensed under state law. For tax years beginning after 2013, the credit is available only to an eligible small employer that purchases health-insurance coverage for its employees through a state exchange, and is only available for two years. The maximum two-year coverage period does not take into account any tax years beginning in years before 2014. Thus, an eligible small employer could potentially qualify for this credit for six tax years, four years under the first phase and two years under the second phase.

Calculating the amount of the credit. For tax years beginning in 2010, 2011, 2012, or 2013, the credit is generally 35% (50% for tax years beginning after 2013) of the employer’s non-elective contributions toward the employees’ health-insurance premiums. The credit phases out as firm size and average wages increase.

Special rules. The employer is entitled to an ordinary and necessary business-expense deduction equal to the amount of the employer contribution minus the dollar amount of the credit. For example, if an eligible small employer pays 100% of the cost of its employees’ health insurance coverage and the amount of the tax credit is 50% of that cost (i.e., in tax years beginning after 2013), the employer can claim a deduction for the other 50% of the premium cost.

Self-employed individuals, including partners and sole proprietors, 2% shareholders of an S corporation, and 5% owners of the employer are not treated as employees for purposes of this credit. There is also a special rule to prevent sole proprietorships from receiving the credit for the owner and their family members. Thus, no credit is available for any contribution to the purchase of health insurance for these individuals, and the individual is not taken into account in determining the number of full-time equivalent employees or average full-time equivalent wages.

Most small businesses are exempted from penalties for not offering coverage to their employees. Although the new law imposes penalties on certain businesses for not providing coverage to their employees (so-called ‘pay or play’), most small businesses won’t have to worry about this provision because employers with fewer than 50 employees aren’t subject to the pay-or-play penalty. For businesses with at least 50 employees, the possible penalties vary depending on whether or not the employer offers health insurance to its employees. If it does not offer coverage and it has at least one full-time employee who receives a premium tax credit, the business will be assessed a fee of $2,000 per full-time employee, excluding the first 30 employees from the assessment.
So, for example, an employer with 51 employees who doesn’t offer health insurance to his employees will be subject to a penalty of $42,000 ($2,000 multiplied by 21). Employers with at least 50 employees that offer coverage but have at least one full-time employee receiving a premium tax credit will pay $3,000 for each employee receiving a premium credit (capped at the amount of the penalty that the employer would have been assessed for a failure to provide coverage, or $2,000 multiplied by the number of its full-time employees in excess of 30). These provisions take effect Jan. 1, 2014.

The ‘Cadillac tax’ on high-cost health plans. The new law places an excise tax on high-cost, employer-sponsored health coverage (often referred to as ‘Cadillac health plans’). This is a 40% excise tax on insurance companies, based on premiums that exceed certain amounts. The tax is not on employers themselves unless they are self-funded (this typically occurs at larger firms). However, it is expected that employers and workers will ultimately bear this tax in the form of higher premiums passed on by insurers.
Here are the specifics. The new tax, which applies for tax years beginning after Dec. 31, 2017, places a 40% non-deductible excise tax on insurance companies and plan administrators for any health coverage plan to the extent that the annual premium exceeds $10,200 for single coverage and $27,500 for family coverage. An additional threshold amount of $1,650 for single coverage and $3,450 for family coverage will apply for retired individuals age 55 and older and for plans that cover employees engaged in high-risk professions.
The tax will apply to self-insured plans and plans sold in the group market, but not to plans sold in the individual market (except for coverage eligible for the deduction for self-employed individuals). Standalone dental and vision plans will be disregarded in applying the tax. The dollar-amount thresholds will be automatically increased if the inflation rate for group medical premiums between 2010 and 2018 is higher than projected. Employers with age and gender demographics that result in higher premiums could value the coverage provided to employees using the rates that would apply using a national risk pool.
The excise tax will be levied at the insurer level. Employers will be required to aggregate the coverage subject to the limit and issue information returns for insurers indicating the amount subject to the excise tax.

Kristina Drzal Houghton, CPA, MST, is partner-in-charge of Taxation at Meyers Brothers Kalicka, P.C. in Holyoke; (413) 536-8510.