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Debbie  Mitchell
Debbie Mitchell
Small Employer Health Insurance Premiums Credit

Limitations divulged.

April 14, 2011
by Debbie Mitchell, CPA, MST

The credit for health insurance premiums is a welcome relief for small employers because of the high costs of these premiums. However, there are limitations on the credit. Basically to get the maximum 35 percent credit on health insurance premiums paid, the employer would have 10 or fewer full-time equivalent employees with an average annual salary of $25,000 or less. Businesses that are part of a controlled group or are under common control are considered to be one employer.

Small Employer Health Insurance Premium Credit

The small employer health insurance premium credit is effective from 2010 through 2013. The Patient Protection and Affordable Care Act (Healthcare Act) was signed into law on March 23, 2010. It was later modified by the Healthcare and Education Reconciliation Act of 2010 (Reconciliation Act), which was signed on March 30, 2010, and together they are referred to as health reform legislation. After 2013, the credit will only be available to employers who purchase coverage through a state-run insurance exchange and will be available for a maximum of two consecutive years, but the amount of the credit goes up to 50 percent of their contribution.

The health insurance premium credit is reported on Form 8941 (PDF) and is a nonrefundable credit. It may be carried back one year (but not to any year prior to 2010) and forward 20 years. The credit is considered to be a general business credit and all carryovers must be reported on Form 3800 (PDF). For S corporations and partnerships the credit is reported on Schedule K and passed through to shareholders or partners. When an employer takes the health insurance deduction, the amount taken as a credit is reduced.

The credit is calculated at up to 35 percent of the lesser of:

  • Employer’s contribution to qualified health insurance arrangement for employees for the year or
  • Amount that would have been contributed if the applicable premium from Average Health Insurance Premium for the Small Group Market table was substituted for the actual premium. This table provides a listing of State average premiums, for employee-only coverage and family coverage, which is found in the instructions (PDF) for Form 8941 (PDF).

Eligibility of Nonprofit Firms

Nonprofit organizations are also eligible for the credit up to a 25-percent credit, which is limited to the amount of certain payroll taxes paid and can be claimed as refundable credit on
Form 990-T (PDF).

To be eligible for this credit, the employer must be an eligible small employer including sole proprietors. To qualify as an eligible small employer:

  • The employer must pay premiums for employee health insurance coverage under a qualifying agreement.
  • The employer must have fewer than 25 full-time equivalent employees (FTE).
  • The employees’ average annual wages must be less than $50,000.

There is a phase out between 10 to 25 full-time equivalent employees and also for wages between $25,000 and $50,000. Since these phase-outs are calculated separately, it is possible to reduce the credit to zero even with less than 25 FTE and $50,000 of annual wages.

Qualified Health Insurance Agreement

For purposes of the credit, a qualified health insurance agreement is an agreement in which the employer pays premium coverage for each employee enrolled in health insurance coverage. The agreement should have a uniform percentage that is at least 50 percent of the premium. For taxable year 2010, there is an exception to the uniformity requirement as long as the employer pays at least 50 percent of the premium for single coverage.

Health Insurance Coverage

Health insurance coverage means benefits consisting of medical care (provided directly or through insurance or reimbursement or otherwise) by a health-insurance provider or health maintenance organization (HMO). It also includes coverage under plans for limited scope dental or vision, long-term care (LTC), nursing-home care, home healthcare and community-based care. In addition coverage for a specified disease or illness, hospital indemnity insurance and Medicare supplemental health insurance and certain other supplemental coverage qualify as health insurance coverage.

Full-time Equivalent (FTE)

To determine the amount of full-time equivalent (FTE) employees divide total hours worked by all employees for the year by 2,080 even when an employee works in excess of 2,080, after obtaining total hours rounding it down to the lowest whole number. If there are any seasonal workers, their hours are not included unless they work for more than 120 days during the year. Leased employees re considered employees, but the employer and not the leasing organization must pay for health insurance premiums.

Owners are not included in this calculation and therefore are not considered to be employees. This rule encompasses self-employed individuals, general partners, sole proprietors, more than two percent of S corporation shareholders, more than five percent of owners of entities other than S corporations. Related party rules also apply so that children, grandchildren, siblings, parents, grandparents, aunts, uncles, nieces, nephews, in-laws and dependents are also not eligible employees.

Average Annual Wages

Employers must pay annual wages averaging less than $50,000 to qualify for the credit. To determine average annual wages divide total wages by number of FTE employees rounded down to the nearest $1,000. For purposes of this calculation owners’ wages are not included in the number for total wages, as described in the FTE calculation. If seasonal workers are not counted for FTE purposes — because they worked less than 120 days — they are also not counted for annual wage purposes. Wages are considered to be Federal Insurance Contributions Act (FICA) wages, without taking the wage limitation into considerations.

Conclusion

A 35-percent credit on health-insurance payments made by eligible small business employers sounds like a great tax credit, it is also subject to strict limitations as far as average annual wages and full-time equivalents, along with recordkeeping requirements for small employers to track the health insurance payments.

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Debbie Mitchell, CPA, MBA, MST, is a principal with Braver PC Accountants and Advisors.