Fed Tax Incentives: "Small Business Health Care Tax Credit"

Background: Credit for Small Employer Health Insurance Premiums 

26 U.S. Code § 45R (IRC § 45R) was added to the Code by section 1421 of the Patient Protection and Affordable Care Act, enacted March 23, 2010, Pub. L. No. 111–148 (PPACA). Section 45R offers a tax credit to certain small employers that provide health insurance coverage to their employees (eligible small employers). The credit was first available for taxable years beginning after December 31, 2009.

For taxable years beginning after December 31, 2013, the credit is available only for the credit period, which is the two-consecutive-taxable year period beginning with the first taxable year that an eligible small employer claims the credit. In addition, the credit is available only with respect to premiums paid by an eligible small employer for a Qualified Health Plan (QHP) offered by the employer to its employees through a Small Business Health Options Program (SHOP) Exchange. An eligible small employer claims the credit by filing a federal income tax return and attaching Form 8941, “Credit for Small Employer Health Insurance Premiums” (or for eligible small employers that are tax-exempt organizations, by filing Form 990–T, “Exempt Organization Business Income Tax Return,” and attaching Form 8941).

The Treasury Department and the IRS issued final regulations under section 45R on June 30, 2014 (79 FR 36640). The regulations provide guidance on determining eligibility for the credit and calculating and claiming the credit.

Small Business Health Care Tax Credit Summarized Benefits:

  • The maximum credit is

    • 50% of employer-paid premiums paid for small business employers and

    • 35% of employer-paid premiums paid for small tax-exempt employers 

  • Small employers may claim the credit for only two consecutive taxable years beginning in tax year 2014 and beyond.

  • If you had more than 10 Full-Time-Employees (FTEs) and average annual wages of more than $27,000 (adjusted annually for inflation), the FTE and average annual wage limitations (discussed later) will separately reduce your credit.

    • This may reduce your credit to zero even if you had fewer than 25 FTEs and average annual wages of less than $55,000 (adjusted annually for inflation).

  • Generally, small business employers are required to purchase a Qualified Health Plan from a Small Business Health Options Program Marketplace to be eligible to claim the credit.  

    • Transition relief from this requirement maybe be available to certain small employers.

In general, the Small Business Health Care Tax Credit benefits employers who:

  • have fewer than 25 full-time equivalent (FTE) employees;

  • Pay average wages of less than $55,000 a year per full-time equivalent (indexed annually for inflation beginning in 2014);

    • For tax year 2014, the inflation-adjusted amount is $51,000

    • For tax year 2015, the inflation-adjusted amount is $52,000

    • For tax year 2016, the inflation-adjusted amount is $52,000

    • For tax year 2017, the inflation-adjusted amount is $53,000

    • For tax year 2018, the inflation-adjusted amount is $54,000

    • For tax year 2019, the inflation-adjusted amount is $55,000

  • Offer a qualified health plan to its employees through a Small Business Health Options Program (SHOP) Marketplace (or qualify for a limited exception to this requirement); and

  • Pay at least 50% of the cost of employee-only health insurance premiums (not family or dependent) regarding health care coverage for each employee.​​

Important Information to complete the Form 8941, Credit for Small employer Health Insurance Premiums  

  • SHOP QHP documentation or letter of eligibility from SHOP (unless transition relief applies)

  • Numbers of full-time and part-time employees and numbers of hours worked

  • Average annual wages for employees

  • Employer premiums paid per employee (if applicable)

  • Relevant K-1s and other pass-through credit information

  • Cost of coverage for each employee

  • Payroll tax liability – for tax-exempt organizations only

  • Pass-through credit info – for K-1s of other small employers

The amount of the credit you receive works on a sliding scale. The smaller the employer, the bigger the credit. So if you have more than 10 full-time equivalent employees or if the average wage is more than $27,000 (as adjusted for inflation), the amount of the credit you receive will be less. For example, if you pay $50,000 a year toward employees’ health care premiums, and if you qualify for a $10,000 credit each year, you can save $20,000 over the course of two years

Even if your small business does not  owe tax during the year, you can carry the credit back or forward to other tax years. Also, since the amount of the health insurance premium payments is more than the total credit, eligible small businesses can still claim a business expense deduction for the premiums in excess of the credit. That’s both a credit and a deduction for employee premium payments.

The credit is refundable, so if you’re tax-exempt and have no taxable income, you may be eligible to receive the credit as a refund so long as it does not exceed your income tax withholding and Medicare tax liability. However, refund payments issued to small tax-exempt employers claiming the refundable portion of the credit are subject to sequestration.

You can benefit from the credit this year or in previous years. If you didn’t claim it on your tax return, there’s still time to file an amended return. Refund limitations may apply. Generally, a claim for refund must be filed within three years from the time the return was filed or two years from the time the tax was paid, whichever of such periods expires the later, or if no return was filed by the taxpayer, within two years from the time the tax was paid.

For information about State-based SHOPs participating in the direct enrollment process, such as the one adopted by federally-facilitated SHOP Marketplaces (link), see the Centers for Medicare & Medicaid Services (CMS) FAQs (link) about flexibilities for State-based SHOP direct enrollment. The requirement to purchase insurance through the SHOP Marketplace did not apply to tax years prior to 2014.

Determining Full-Time Employees (FTEs) 

In general, you’ll consider all employees who perform services for the small employer during the tax year  when determining the number of your full-time equivalent employees, as well as average annual wages and premiums paid.

In general, all employees of the eligible small employer are taken into account when determining FTEs and average annual FTE wages, including employees who terminated employment during the tax year, employees covered under a collective bargaining agreement, and employees who are not enrolled in health care coverage.

The following individuals are NOT considered employees for purposes of the credit and their wages and hours worked, nor the premiums paid on their behalf should be included for the calculation:

  • owners of the small business, such as sole proprietors, partners, shareholders owning more than 2% of an S corporation or more than 5% of a C corporation;

  • spouses of these owners; and

  • family members of these owners, which include a child, grandchild, sibling or step-sibling, parent or ancestor of a parent, a step-parent, niece or nephew, aunt or uncle, son-in-law or daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law. A spouse of any of these family members should also not be counted as an employee.

For purposes of the health care tax credit, one FTE generally equals 2,080 hours per year.

  • This is different from other provisions of the Affordable Care Act that count 30 hours per week as one FTE.

  • Any number of part-time employees that work a combined number of hours equal to that of a full-time employee equals one FTE. However, the hours of service does not include hours worked for a year in excess of 2,080 by a single employee.

    • As such, add up the total hours of service for which the employer pays wages to employees during the year (but not more than 2,080 hours for any employee), and divide that amount by 2,080. If the result is not a whole number, round to the next lowest whole number. (If the result is less than one, however, round up to one FTE.)

      • Example: For the 2014 taxable year, an employer pays five employees wages for 2,080 hours each, three employees wages for 1,040 hours each, and one employee wages for 2,300 hours. The employer uses a method that counts hours actually worked. The employer’s FTEs would be calculated as follows:

        • 10,400 hours for the five employees paid for 2,080 hours (5 x 2,080)

        • 3,120 hours for the three employees paid for 1,040 hours (3 x 1,040)

        • 2,080 hours for the one employee paid for 2,300 hours (lesser of 2,300 and 2,080)

        • The total hours counted is 15,600 hours. The employer has seven FTEs (15,600 divided by 2,080 = 7.5, rounded to the next lowest whole number).

    • Note, leased employees (as defined in section 414(n)) are counted in the FTE and average annual wage calculation. A leased employee is a person who is not an employee of the service recipient and who provides services to the service recipient pursuant to an agreement with the leasing organization.

  • In general, exclude seasonal employees who work 120 or fewer days per year from the calculation of the number of FTEs and average annual wages; however, the health insurance premiums paid by the employer on behalf of these employees may be counted in determining the amount of the credit. 

    • Seasonal workers are workers who perform labor or services on a seasonal basis as defined by the Secretary of Labor, and retail workers employed exclusively during holiday seasons. For this purpose, employers may apply a reasonable, good faith interpretation of the term “seasonal worker.”

    • Seasonal workers are not employees for purposes of the credit unless the seasonal worker provides services to the employer on more than 120 days during the taxable year; however, premiums paid on behalf of a seasonal worker are counted in determining the amount of the credit.

Permissible ways to Count Hours of Service to Determine FTEs
An employee’s hours of service for a year include hours for which the employee is paid, or entitled to payment, for the performance of duties for the employer during the employer’s tax year. Hours of service also include hours for which the employee is paid for vacation, holiday, illness, incapacity (including disability), layoff, jury duty, military duty or leave of absence.

In general, there are three primary methods for calculating the total number of hours of service for a single employee for the taxable year:

  • (1) Actual Hours Worked;

    • An employer may determine actual hours of service from records of hours worked and hours for which payment is made or due, including hours for paid leave. For example, if payroll records indicate an employee worked 2,000 hours and was paid for an additional 80 hours on account of vacation, holiday and illness, the employee must be credited with 2,080 hours of service (2,000 hours worked + 80 hours for which payment was made or due).​

  • (2) Days-Worked Equivalency; and

    • An employer may use a days-worked equivalency whereby the employee is credited with 8 hours of service for each day the employee would be required to be credited with at least one hour of service, including hours for paid leave. For example, if an employer uses the days-worked equivalency for an employee who works from 8:00a.m.–12:00p.m. every day for 200 days, the employee must be credited with 1,600 hours of service (8 hours for each day the employee would otherwise be credited with at least one hour of service x 200 days).​

  • (3) Weeks-Worked Equivalency.

    • An employer may use a weeks-worked equivalency whereby the employee is credited with 40 hours of service for each week for which payment is made or due including weeks of paid leave. For example, if an employee worked 49 weeks, took two weeks of vacation with pay, and took one week of leave without pay, the employee must be credited with 2,040 hours of service (51 weeks x 40 hours per week).​

Employers do not need to use the same method for all employees and may apply different methods for different classifications of employees if the classifications are reasonable and consistently applied. For example, an employer may use the actual hours worked method for all hourly employees and the weeks-worked equivalency method for all salaried employees.

Determining Average Annual Wages

All wages paid to employees (including overtime pay) are taken into account in computing an eligible small employer’s average annual wages.

  • Add up the total wages paid by the employer during the taxable year to its employees, and divide that number by the number of FTEs for the year. The result is then rounded down to the nearest $1,000 (if not otherwise a multiple of $1,000).

  • Include only wages paid for hours of service.

  • Use wages as defined for purposes of the Federal Insurance Contributions Act (FICA) (without regard to the social security wage base limitation).

Calculating average annual wages

Example: For the taxable year, an employer pays a total of $224,000 in wages to employees and has 10 FTEs. The employer’s average annual wages are $22,000 ($224,000 / 10 = $22,400, rounded down to the nearest $1,000).
 

Average annual wages and FTEs during a short taxable year
In accordance with general accounting principles, average annual wages and FTEs must be pro-rated or annualized in calculating the credit. For example, if a small employer has only been in business and paying premiums for 6 months during its first taxable year, it must pro-rate or annualize the employee hours worked and wages earned to reflect the 6 months the employer has been in operation.

How is the credit reduced if the number of FTEs exceeds 10 or average annual wages exceed $27,000?
The credit may phase out for eligible small employers if the number of FTEs exceeds 10, or if the average annual wages for FTEs exceed $27,000 (as adjusted for inflation annually beginning in 2014). If the number of FTEs exceeds 10, the reduction is determined by multiplying the otherwise applicable credit amount by a fraction, the numerator of which is the number of FTEs in excess of 10, and the denominator of which is 15.

If average annual FTE wages exceed $27,000 (annually adjusted for inflation), the reduction is determined by multiplying the otherwise applicable credit amount by a fraction, the numerator of which is the amount by which average annual FTE wages exceed $27,000 and the denominator of which is $27,000. The credit will be reduced based on the sum of the two reductions. This may reduce the credit to zero for some employers with fewer than 25 FTEs and average annual FTE wages of less than $55,000 (as adjusted annually for inflation).

Example 1: For the 2019 taxable year, Employer has 12 FTEs and average annual wages of $30,000. Employer pays $96,000 in employee premiums, which does not exceed the average premium for the small group market in the employer's rating area.

  • Credit determined before any reduction: (50% x $96,000) = $48,000   

  • Credit reduction for FTEs in excess of 10: ($48,000 x 2/15) = $6,400

  • Credit reduction for average annual wages in excess of $25,400: ($48,000 x $3,000/$27,000) = $5,333

  • Total credit reduction: ($6,400 + $5,333) = $11,733

    • Total 2019 tax credit: ($48,000 – $11,733) = $36,267

Example 2 (Tax-Exempt Eligible Small Employer): Same facts as Example 1, but Employer is a tax-exempt eligible small employer and the total amount of Employer’s payroll taxes equals $30,000 for calendar year 2019.  

  • Credit determined before any reduction: (35% x $96,000) = $33,600   

  • Credit reduction for FTEs in excess of 10: ($33,600 x 2/15) = $4,480

  • Credit reduction for average annual wages in excess of $25,400: ($33,600 x $3,000/$27,000) = $3,733

  • Total credit reduction: ($4,480 + $3,733 = $8,213)

  • Employer’s payroll taxes:  $30,000

    • Total 2019 tax credit: ($33,600 – $8,213) = $25,387 (the lesser of $25,387 and $30,000)

How is eligibility for the credit determined if the employer is a member of a controlled group or an affiliated service group?
Members of a controlled group (e.g., businesses with the same owners) or an affiliated service group (e.g., related businesses where one performs services for the other) are treated as a single employer for purposes of the credit.

 

For example, all employees of the controlled group or affiliated service group, and all wages paid to employees by the controlled group or affiliated service group, are counted in determining whether any member of the controlled group or affiliated service group is a qualified employer. Rules for determining whether an employer is a member of a controlled group or an affiliated service group are provided under sections 414(b), (c), (m) and (o) of the Code.

 

Example: A taxpayer owns 100% of a sole proprietorship and files a Schedule C. The taxpayer also owns at least 80% of the voting power or value of the shares of an S Corporation. Even if the sole proprietorship and the S Corporation individually meet the requirements for the small business health care tax credit, section 414 of the Code and related regulations provide that there is common control under section 1563(a) of the code and when there is common control, the taxpayer must calculate their credit including the employees, their wages and premiums paid for all entities as one entity.

How to Claim the Credit

In general, an employer (other than a tax-exempt employer) claims the credit on the employer’s annual income tax return, with an attached Form 8941, Credit for Small Employer Health Insurance Premiums, showing the calculation of the credit. If you’re a small business, include the amount as part of the general business credit on your income tax return.

Moreover, the credit may be reflected in determining estimated tax payments for a year and taking the credit does affect an employer’s deduction for health insurance premiums.In determining the employer’s allowable deduction for health insurance premiums, the amount of premiums that can be deducted is reduced by the amount of the credit. Thus, the employer may claim both a credit and a partial deduction for the same premium payments.

However, an employer may not reduce employment tax payments (withheld income tax, Social Security tax and Medicare tax) during the year in anticipation of the credit. The credit applies against income tax, not employment taxes.

Tax-exempt employer claiming the credit
An employer that is described in section 501(c) and exempt from tax under section 501(a) claims the credit by filing the Form 990-T, Exempt Organization Business Income Tax Return, with an attached Form 8941 showing the calculation of the claimed credit. Filing Form 990-T with an attached Form 8941 is required for a tax-exempt eligible small employer to claim the credit, even if it is not otherwise required to file Form 990-T. 

Credit to offset its alternative minimum tax (AMT) liability

The credit can be used to offset its alternative minimum tax (AMT) liability, subject to certain limitations based on the amount of an employer’s regular tax liability, AMT liability and other allowable credits. See section 38(c)(1) of the Internal Revenue Code (Code), as modified by section 38(c)(4)(B)(vi).

Can an employer (other than a tax-exempt employer) claim the credit if it has no taxable income and no AMT liability for the year?
In general, yes. The credit offsets only an employer’s actual income tax liability or AMT liability for the year, subject to certain limitations. But if the non-tax-exempt employer does not have taxable income and no AMT liability for the year, the credit is not refundable. However, under the general business credit rules, carryback and carry forward rules apply to utilize the credit in 

Can a tax-exempt employer claim the credit if it has no taxable income for the year?
In general, yes. For a tax-exempt employer, the credit is refundable, so even if the employer has no taxable income, the employer may receive a refund (so long as it does not exceed the employer’s income tax withholding and Medicare tax liability.


Effect of Sequestration on Small Business Health Care Tax Credit ("Small Tax-Exempt Employers Claiming the Refundable Credit")

Pursuant to the requirements of the Balanced Budget and Emergency Deficit Control Act of 1985, as amended, refund payments issued to, and credit elect and refund offset transactions for certain small tax-exempt employers claiming the refundable portion of the Small Business Health Care Tax Credit under Internal Revenue Code Section 45R, are subject to sequestration. This means that refund payments and credit elect and refund offset transactions processed on or after Oct. 1, 2018 and on or before Sept. 30, 2019 will be reduced by the fiscal year 2019 6.2 percent sequestration rate, irrespective of when the IRS received the original or amended tax return. The sequestration reduction rate will be applied unless and until a law is enacted that cancels or otherwise affects the sequester, at which time the sequestration reduction rate is subject to change.

Affected taxpayers will be notified through correspondence that a portion of their requested payment was sequestered and the amount.

The sequestration reduction rate will be applied unless and until a law is enacted that cancels or otherwise impacts the sequester, at which time the sequestration reduction rate is subject to change. See IRS Effect of Sequestration on Small Business Health Care Tax Credit (fiscal 2019).

Who Gets the Tax Credit

Who is eligible?
A small employer is eligible for the credit if

  • (a) it has fewer than 25 full-time equivalent employees,

  • (b) the average annual wages of its employees are less than $55,000 (adjusted for inflation beginning in 2014), and

  • (c) it pays a uniform percentage for all employees that is equal to at least 50% of the premium cost of employee-only insurance coverage.

Each part-time employee counts as a fraction of a full-time equivalent employee (for example, two half-time employees equal one full-time equivalent employee for purposes of the credit). For tax years beginning in 2014 or later, the employer generally must contribute toward premiums on behalf of each employee enrolled in a qualified health plan (QHP) offered by the eligible small employer through a Small Business Health Options Program (SHOP Marketplace) established as part of the Affordable Care Act to qualify for the credit.

Tax-exempt organization(s) are eligible for the credit
A tax-exempt organization described in section 501(c) of the Internal Revenue Code (Code) and exempt from tax under section 501(a) of the Code that otherwise meets the definition of an eligible small employer may qualify for the credit. The credit is refundable for tax-exempt employers but is limited to the amount of the tax-exempt employer’s payroll taxes withheld during the calendar year in which the taxable year begins. 

QHP Enrollment through designated SHOP Marketplace
Beginning in 2014 and forward, employers generally must enroll in a QHP through their designated SHOP Marketplace (or through a direct enrollment process if available). To properly claim the credit, the employer must generally offer coverage through a SHOP Exchange or coverage meeting the requirements for relief. 

In some circumstances, an employer whose plan year and tax year do not match may still claim the credit, as may eligible small employers located in specific counties where QHPs are not available through a SHOP Marketplace. For the applicable taxable year, transition rules regarding varying enrollment periods, switching plans mid-year for compliance, QHP SHOP marketplace county availability limitations, see transition rules applicable to the SHOP Marketplace pursuant to §1.45R-3(i) final regulations and referenced IRS resources (links below) for additional information.

 
To see whether a particular county has coverage available through a SHOP Marketplace for 2018 and beyond, employers may refer to the See Plans and Prices Tool on www.healthcare.gov/small-business. When employers arrive at www.healthcare.gov/small-business, they should select “Get Coverage” and then “See Plans and Prices”. Employers in states operating a State-based SHOP may visit their State-based SHOP’s website directly, or use the See Plans and Prices Tool on www.healthcare.gov/small-business to be redirected to their State-based SHOP to see whether a particular county has coverage available for 2018 and beyond.

Employer(s) outside the U.S. may be eligible for the credit
An employer located outside the United States (including a U.S. territory) may be an eligible small employer if the employer has income effectively connected with the conduct of a trade or business in the United States, and otherwise meets the requirements for claiming the credit.

Section 521 farmers cooperative are eligible for the credit
A section 521 farmers cooperative subject to tax under section 1381 may be eligible for the credit if it otherwise meets the definition of an eligible small employer. 

AFFORDABLE CARE ACT SECTION 1332 WAIVERS
Section 1332 of the PPACA permits a state to waive certain PPACA provisions, including the requirement to operate a SHOP Exchange, as part of an application for a State Innovation Waiver to pursue innovative strategies for providing their residents with access to high quality, affordable health insurance while retaining the basic protections of the PPACA. To fund their reforms, states may receive the aggregate amount of subsidies, including the credit, that would have otherwise gone to the state’s residents.

On December 30, 2016, Hawaii’s application for a 5-year State Innovation Waiver was approved. As a result, Hawaii is not required to operate a SHOP Exchange for 2017–2021 and employers in Hawaii may not claim the credit for plan years beginning during this five-year period. For more information on the waiver, visit www.cms.gov.

 

In addition, any future State Innovation Waivers that provide that a state is not required to operate a SHOP Exchange and that employers in the affected state may not claim the credit will supersede the relief provided in this notice.

See IRS Link for additional background:

Need more details? Contact us

We are here to assist. Contact us by phone, email or via our Social Media channels.