Tax Credits for Small Employers Offering Health Coverage

The Patient Protection and Affordable Care Act provides a tax credit for an eligible small employer (ESE) for nonelective contributions to purchase health insurance for its employees. The term "nonelective contribution" means an employer contribution other than an employer contribution pursuant to a salary reduction arrangement.

  • 2010 through 2013 – For tax years 2010 through 2013, qualified small employers, generally those with no more than 25 full-time employees with an average annual full-time equivalent wage of no more than $50,000 will be eligible for a tax credit of up to 35% of the cost of nonelective contributions to purchase health insurance for its employees.  (Note, however, that the phase-out of the credit operates in such a way that an employer with exactly 25 full-time equivalent employees or with average annual wages exactly equal to $50,000 is not eligible for the credit The maximum credit is available to employers with no more than 10 full-time equivalent employees with annual full-time equivalent wages from the employer of less than $25,000.

No requirement to be in a trade or business - For tax years beginning in 2010 through 2013, an employer may still be a qualified employer even though the employees of the employer are not performing services in a trade or business, meaning a household employer may be eligible to claim the credit.

  • 2014 and Later - In 2014 and later, eligible small employers who purchase coverage through the Insurance Exchange would be eligible for a tax credit for two years of up to 50% of their contribution.

An eligible small employer generally is an employer with no more than 25 full-time equivalent employees employed during its tax year, and whose employees have annual full-time equivalent wages that average no more than $50,000.

The credit percentage that can be claimed varies with the number of employees and average wages. The full amount of the credit is available only to an employer with 10 or fewer full-time equivalent employees and whose employees have average annual full-time equivalent wages (AAEW) from the employer of less than $25,000.

Calculating the credit amount - The credit is equal to the lesser of the following two amounts multiplied by an applicable tax credit percentage (shown in the table below) and subject to the phase-outs discussed later:

(1) The amount of contributions the eligible small employer made on behalf of the employees during the tax year for the qualifying health coverage.

(2) The amount of contributions that the employer would have made during the tax year if each employee had enrolled in coverage with a small business benchmark premium. Contributions under this method are determined by multiplying the benchmark premium by the number of employees enrolled in coverage and then multiplied by the uniform percentage that applies for calculating the level of coverage selected by the employer.

*For years after 2013, only available for a maximum coverage period of two consecutive tax years


Computing the Credit Phase-Out – The full credit is only available to eligible small employers with 10 or less full-time equivalent employees with an average annual full-time equivalent wage (AAEW) of $25,000 or less.  If either or both of these thresholds are exceeded, then the credit is reduced. 

There is no credit reduction if there are 10 or less full-time equivalent employees FTEs with an AAEW of $25,000 or less.

 

There is no credit if the full-time equivalent employees exceed 25 or the AAEW exceeds $50,000.

To figure the reduction of credit when the limits are exceeded, the number of the employer’s full-time equivalent employees and average annual full-time equivalent wages (AAEW) for the year must be determined.

Figuring the number of full-time equivalent employees - An employer's full-time equivalent employees (FTEs) is determined by dividing the total hours the employer pays wages during the year (but not more than 2,080 hours per employee) by 2,080. The result, if not a whole number, is then rounded down to the next lowest whole number if any (unless the result is less than one, in which case, the employer rounds up to one FTE).

Calculating average annual wages (AAEW) - Average annual equivalent wages is determined by dividing the employer’s total FICA wages (without regard to the wage base limitation) for the tax year by the number of the employer's full-time equivalent employees for the year (rounded down to the nearest $1,000 if need be).

Credit reduction - If the number of full-time equivalent employees exceeds 10 or if AAEW exceed $25,000, the amount of the credit is reduced (but not below zero).  Both reductions can apply at the same time!

Example – Joe owns a small California wood working business and has 12 employees, not counting himself or family members.  The total FICA wages (without regard for wage base limitations) for the year were $297,500 and total hours worked by his employees during the year were 24,400.  None of his employees worked more than 2,080 hours during the year.   Joe made nonelective contributions to purchase health insurance for his employees in the amount of $49,800 for the year.  Joe’s credit is determined as follows:

  • Small Business Benchmark Premium (from Table Below) = 12 x 4,628 = $55,536
  • Smaller of actual premium paid or Benchmark premium = $49,800
  • Tentative credit = $49,800 x 0.35 = $17,430
  • Full-time equivalent employees (FTEs) = 24,400/2080= 11.7 rounded down = 11
  • Average annual full-time equivalent wages (AAEW) = $297,500/11 = $27,045 rounded down = $27,000
  • FTE Reduction = ((11-10)/15) x $17,430 = $1,162
  • AAEW Reduction = ((27,000-25,000)/25,000) x $17,430 = $1,394
  • Joe’s health insurance tax credit = $17,430 - $1,162- $1,394 = $14,874

Other Issues:

  • The credit reduces the employer's deduction for employee health insurance. 
  • Special rules apply if the employer benefits from state tax credits or a premium subsidy paid by the state for providing health insurance for its employees.
  • Aggregation rules apply in determining the employer. 
  • 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's a special rule to prevent sole proprietorships from receiving the credit for the owner and their family members. 
  • The credit is a general business credit and can be carried back one year and forward for 20 years. However, because an unused credit amount cannot be carried back to a year before the effective date of the credit, any unused credit amounts for taxable years beginning in 2010 can only be carried forward. 
  • The credit is available to offset tax liability under the alternative minimum tax. 
  • 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 generally health insurance coverage purchased from an insurance company licensed under State law.
  • For tax years beginning in years after 2013, the credit is only available to an eligible small employer that purchases health insurance coverage for its employees through a State exchange and is only available for a maximum coverage period of two consecutive tax years beginning with the first year in which the employer or any predecessor first offers one or more qualified plans to its employees through an exchange.

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