Health Care Reform

 Health Care Tax Credit for Small Businesses

The New Health Care Reform law gives an income tax credit to certain small employers that provide health care coverage to their employees effective for tax years beginning in 2010. The credit is taken on the employer’s 2011 tax return. For 2010, the credit is worth up to 35% of the health insurance premiums that an employer pays for his qualifying employees. For not-for-profit organizations, the credit is only worth 25% of any health insurance premiums that the employer pays on behalf of his employees and the credit cannot exceed the not-for profit’s payroll taxes for the applicable year. Exempt organizations that are agencies of a federal, state, local, or Indian tribal government do not qualify for the credit.

There are some things to keep in mind regarding this new credit:

  1. It is not a refundable credit. So, if the employer has no tax due on their tax return and calculates a $300.00 health care tax credit on their return they will not receive a $300.00 refund because of the credit.
  2. The tax law allows for the credit to offset any Alternative Minimum Tax liability that the employer may have.
  3. If the employer files a partnership or S-Corporation return, the health care tax credit will pass-thru to the employer’s personal tax return and be reported to the employer on their Form K-1.
  4. The health care tax credit calculates on a year to year basis. If you qualify for the credit in 2010, it doesn’t necessarily mean that you will qualify for the credit in 2011. Each year must stand alone meaning the calculation must be done each year.

Who Qualifies for the credit?

Obviously, you must have employees and be providing health care coverage for them in order to qualify for the credit. The following individuals, however, are not considered employees for the purposes of this credit:

Owners of a business which includes sole proprietors, partners, and shareholders of more than 2% of an S-Corporation or 5% of a C-Corporation, family members of the owner or any party related to the owner, partner, or shareholder.

Seasonal employees hired by the business. For example, if the business is only open during the summer and hires employees solely to meet the demand during that time frame and then lays them off at the end of the summer, those employees do not qualify for the credit.

The employer must have fewer than 25 full time equivalent (FTE) employees for a tax year. You get the maximum credit if you have no more than 10 FTE employees. The credit is ratably phased out if the employer has between 10 and 25 FTE employees. It is completely phased out when the employer has more than 25 FTE employees.

The average annual wages paid by the employer must be less than $50,000 per employee.

The employer pays health insurance premiums under a qualifying arrangement. A qualifying arrangement is one where the employer pays no less than 50% of health insurance premiums for their employees. For purposes of the credit, premiums paid by the employer equals the lesser of premiums actually paid or the average premium for small group markets by state. For more information about your state’s small market group average premium please see IRS Revenue Ruling 2010-13.

Furthermore, the employer is required to pay the same percentage of health insurance coverage for all employees enrolled in the plan. A transition rule is in effect for 2010 to ease application of the health care credit to employers who do not pay the same percentage of health premiums for all employees. So long as the employer pays at least 50% of the premium for qualifying employees, the employer is eligible for the credit if he did not pay a uniform % to all employees. So, if an employer had 2 FTE qualifying employees, one that he paid 65% of the annual health insurance premium for and another that he paid only 51% , the employer would be eligible for the credit as long as he met the other requirements.

How is the credit computed?

The credit can be computed in three steps:

  1. Determine the number of Full Time Equivalent Employees. This is usually done on an annual hours worked basis. A full time employee can work no more than 2,080 hours per year. (40 hours per week x 52 weeks in a year). For purposes of the credit calculation, decimals are rounded to the next lowest number.
  2. Determine the average annual wages paid to employees. For this calculation, the Internal Revenue Code says you use FICA wages without regard to any limits. Therefore you add up all the FICA wages shown on each employee’s W-2 form and divide by the number of Full Time Equivalent Employees calculated in Step 1. Again, the number is rounded down to the next lowest number.
  3. Determine the tax credit. Suppose an employer paid a total of $60,000 in health insurance premiums during 2010. The credit would be $21,000 ($60,000 x 35%). Keep in mind that the $21,000 reduces the employer’s deduction for health insurance premium expense to a total of $39,000. This stipulation prevents the business from deducting the $21,000 in health insurance premiums twice: once as a tax credit and once as health insurance premium expense.

While the Small Business Health Insurance Tax Credit seems like a good thing in that it allows business owners to attract and retain a quality workforce, remember to never hire a new employee solely for income tax savings. There are plenty of other reasons you should consider when deciding to add to your workforce. Please consult your own tax professional as to whether the Health Care Credit applies to your particular tax situation. Also, for more information on the credit and more in-depth calculation examples, please visit, IRS-Frequently Asked Questions

Health Care Coverage for Adult Children

One aspect of the health care reform bill recently signed by President Obama is that adult children can remain on their parent’s health care policy until they reach the age of 27. This requirement became effective on March 30, 2010. Not only does this added health care tax benefit apply to various workplace and retiree health plans, but also to self-employed individuals who qualify for the self-employed health insurance deduction on their federal income tax return.

Employees with children who will not have reached age 27 by the end of 2010 are eligible for this new benefit from March 30, 2010 onward. The health care reform bill defines a child as a son, daughter, stepchild, adopted child, or eligible foster child.

This new benefit is considered a tax free fringe benefit to the employee. Beginning in 2011, the aggregate value of employer health coverage (the cumulative total of health insurance coverage provided regardless of who paid for it) must be reported on the employee’s Form W-2. Employers with cafeteria plans may permit employees to immediately begin making pre-tax salary reduction contributions even if the cafeteria plan has not yet been amended to include this new benefit. Plan sponsors, usually the employer, have until the end of 2010 to incorporate the new language into their plans. The extended coverage must be provided to eligible employees no later than plan years beginning on or after September 23, 2010.