This is the clearest explanation that I could find on the health care tax credit. This information was put together by 15 attorneys that specialize in interpreting these types of laws. This is very complicated. What was spun as a simple tax credit is very difficult to qualify and understand. A small business might end up spending more on professional services to get the credit than what the tax credit is worth.
Who is Eligible for the Credit? To be eligible for the Credit, an employer must be an “eligible small employer” for the year – requiring all 4 criteria to be satisfied:
1. taxable employer or a 501(c) tax-exempt employer (e.g., colleges and universities);
2. fewer than 25 full-time equivalent employees (“FTE”) for the taxable year;
- • FTE: In order to determine the number of FTEs, the employer must divide the total “hours of service” (but not more than 2,080 hours for an employee) of the”employees” by 2,080, and round down to the next lowest whole number.
- • Employees: For this purpose, count employees who perform services for the employer (which is a controlled group concept), excluding (1) partners, soleproprietors, 2% S-corp. owner, and 5% owners (along with any family members),and (2) seasonal employees unless they work more than 120 days during the taxable year (but always count these premiums).
- • Hours of Service: Hours include (1) each hour for which an employee is paid, orentitled to pay, for work performed; and (2) each hour for which an employee is paid, or entitled to pay, for periods the employee did not perform work due to a vacation, holiday, illness, incapacity disability, layoff, jury duty, military duty or leave of absence (maximum 160 hours for a single continuous period). This calculation may be a challenge depending on your pay types and payroll records;therefore, the IRS permits using either an 8 hours/day or 40 hours/week equivalency (which should be considered if it lowers the hours). We recommend reviewing the available options with your payroll department.
3. “average annual wages” for FTEs must be less than $50,000; and
- • Average Annual Wages: The employer divides the total Medicare wages paid by the employer for the “hours of service” during the taxable year by the number o FTEs, rounded down to the nearest $1,000. Unfortunately, this may not simply line up with box 5 of the W-2 because this is only wages attributable to “hours of service.”
4. employer pays “health insurance coverage” through a “qualifying arrangement.”
- • Heath Insurance Coverage: The Notice provides an expansive list of medical care coverage (whether insured or self-funded, which should include HRAsand HSAs), including HMO/PPO, dental, vision, long-term care, nursing home care, specified disease or illness, hospital indemnity, and Medicaresupplemental. The list excludes, among others, accident or disability insurance and worker’s compensation insurance. Importantly, the credit only covers employer paid premiums and does not include employee pre-tax or post-tax payments (e.g., section 125 payments are not eligible). Also, in general, State tax credits or premium subsidies are counted as employer paidpremiums and will not negatively affect the amount of the Credit.
• Qualifying Arrangement: The employer pays a uniform percentage of not less than 50% of the premium cost for the coverage. (Each type of coverage is tested separately for this purpose.) For 2010, the employer only needs to pay an amount equal to at least 50% of the premium for single (employee-only) coverage for each enrolled employee, and all premiums paid in 2010 will count (even if paid prior to the March 23, 2010 enactment date).
What is the Amount of the Credit? The maximum Credit is currently 35% of the employer paid “health insurance coverage” premiums (25% for tax-exempt employers). The maximum Credit is increased to 50% beginning in 2014 but will only be available if the coverage ispurchased through the Exchange. Importantly, the Credit is phased out rather quickly if the employer has more than 10 FTEs or the “average annual wage” exceeds $25,000. The following steps can be taken to calculate the 2010 Credit:
Step 1: Determine that you meet the definition of “eligible small employer” for the year.
Step 2: Determine the employer portion of the premium paid for the year for each “employee” (which includes any State subsidy).
Step 3: Take the lesser of Step 2 amount or the employer’s percentage of average small group market rates set forth in Revenue Ruling 2010-13 (by State) for each “employee” and sum this amount.
Step 4: Multiple Step 3 amount by 35% (25% for a tax-exempt employer).
Step 5: For a tax-exempt employer, enter the smaller of Step 4 amount or the aggregate federal income tax withholding and employer and employee share of Medicare taxes paid/withheld for the year (which will likely require a review of Form 944 and again help from your payroll department). For a taxable employer, enter the amount from Step 4.
Step 6: Reduce Step 5 amount by the sum of: (1) if more than 10 FTEs: (FTE – 10)/15 x Step 5, and (2) if “average annual wages” exceeds $25,000: (“average annual wages” – $25,000)/$25,000 x Step 5. (If negative, then the Credit is zero and stop here.)
Step 7: Reduce Step 6 amount to not exceed the employer’s net premium payments if State credits or subsidies for health insurance are available to the employer (e.g., amount actually paid by the employer excluding the State subsidy).
How is the Credit Claimed? For taxable employers, the Credit is claimed on the employer’s annual income tax return (e.g., Form 1120 and presumably Form 3800) a nonrefundablegeneral business tax credit (which can be carried forward 20 years and may offset AMT). Note that a deduction for the health care costs is not permitted for the amount of the Credit, which should be considered when determining the value of the Credit. For tax-exempt employers, the IRS is still working on how to receive the refundable credit (e.g., likely Form 990-T to offset unrelated business income tax or result in a refund, but for small employersthat may rarely file Form 990-T, a new schedule to Form 990/990-EZ would be preferred). When valuing the Credit for these employers, the loss of the deduction is not a factor but theCredit is limited to the annual employment taxes (federal income tax withholding andemployer and employee share of Medicare tax), which may impact the value of the Credit. Importantly, for all employers, the Credit has no impact on employment tax forms/deposits(e.g., no impact on Form 944 or related deposits), which is a which is a helpful clarification.