Calculating and Claiming the Small Employer Health Care Tax Credit

The Affordable Care Act (ACA) added Section 45R to the Internal Revenue Code (Code) to create a tax credit for eligible small employers that provide health insurance coverage to their employees. The tax credit became effective with tax years beginning in 2010. Both taxable and tax-exempt small employers may be eligible for the tax credit.

Since 2014, the small employer health care tax credit is:

  • Only available to an employer for two consecutive tax years; and
  • Only when coverage is purchased through a SHOP Exchange.

The IRS has described specific steps for calculating the amount of the tax credit. Both small businesses and tax-exempt organizations use the IRS Form 8941 to calculate the credit. This ACA Overview explains how eligible small employers should calculate and claim the tax credit.

STEP 1: CALCULATE THE MAXIMUM AMOUNT OF THE CREDIT

For 2014 and later tax years, the maximum health care tax credit is:

  • 50 percent of the premium payments taken into account for taxable small employers; and
  • 35 percent of premiums paid for tax-exempt small employer organizations.

For purposes of the credit, only premiums paid for a qualified health plan (QHP) purchased through a SHOP Exchange count. Employer contributions to health reimbursement arrangements (HRAs), health flexible spending accounts (FSAs) and health savings accounts (HSAs) are not taken into account for purposes of the credit. However, a stand-alone dental health plan offered through a SHOP Exchange is considered a QHP for purposes of the tax credit.

If an employer pays only a portion of the premiums for the coverage (with employees paying the rest), the amount of premiums counted in calculating the credit is only the portion paid by the employer.  For example, if an employer pays 80 percent of the premiums for employee health insurance coverage (with employees paying the other 20 percent), the 80 percent paid by the employer is taken into account when calculating the credit.

Beginning with the 2014 tax year, the amount of an employer’s premium payments that counts for purposes of the credit is limited by the average premium in the small group market in the rating area in which the employee enrolls for coverage through a SHOP Exchange. For a tax-exempt employer, there is an additional cap on the amount of the credit. It cannot exceed the total amount of income tax and Medicare tax that the employer is required to withhold from employees’ wages for the year.

STEP 2: REDUCE THE MAXIMUM CREDIT UNDER THE PHASE-OUT RULE

The tax credit is gradually phased out for small employers with more than 10 FTEs or average annual wages in excess of $25,000 (as adjusted). The dollar amount is increased for inflation each year (to $25,400 for 2014; $25,800 for 2015; $25,900 for 2016; $26,200 for 2017; $26,600 for 2018; $27,100 for 2019; and $27,600 for 2020).

The following rules apply to the phase-out calculation:

  • If the number of FTEs exceeds 10, the reduction is determined by multiplying the otherwise applicable credit amount by a fraction. The numerator of the fraction is the number of FTEs in excess of 10 and the denominator is 15.
  • If average annual wages exceed $25,000 (as adjusted), the reduction is determined by multiplying the otherwise applicable credit amount by a fraction. The numerator of this fraction is the amount by which average annual wages exceed $25,000 (as adjusted) and the denominator is $25,000 (as adjusted).

In both cases, the result of the calculation is subtracted from the otherwise applicable credit to determine the employer’s actual credit.

For an employer with both more than 10 FTEs and average annual wages exceeding $25,000 (as adjusted), the total reduction is the sum of the two reductions. This may reduce the credit to zero for some employers with fewer than 25 FTEs and average annual wages of less than $50,000 (as adjusted).

STEP 3: FOR EMPLOYERS RECEIVING A STATE CREDIT OR SUBSIDY FOR HEALTH INSURANCE, DETERMINE THE EMPLOYER’S ACTUAL PREMIUM PAYMENT

Some states offer tax credits or a premium subsidy to certain small employers who provide health insurance to their employees. Generally, the premium subsidy is in the form of direct payments to the employer or to the employer’s insurance company.

The effect these credits and subsidies have on an employer’s federal health care tax credit depends on whether the direct payment goes to the employer or the insurance company.

  • If a state tax credit or a premium subsidy is paid directly to the employer, the effect on calculation of the federal health care tax credit in general is zero.
  • If a state makes payments directly to an insurance company, the state is treated as making these payments on behalf of the employer.

A state-administered program (such as Medicaid) may make payments directly to a health care provider or insurance company on behalf of eligible individuals and their families. Those payments are not taken into account in determining the employer’s federal health care tax credit.

See the following page for examples.

CLAIMING THE CREDIT

The health care tax credit is claimed on an eligible small business’s annual income tax return. Tax-exempt organizations claim the health care tax credit on an IRS Form 990-T. In both cases, employers must attach an IRS Form 8941, showing the calculation of the claimed credit.

For a small business, the credit is a general business credit that offsets the employer’s actual tax liability for the year. Any unused credit amount can be carried back one year and carried forward 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 could only be carried forward.)

For a tax-exempt small employer, the credit is a refundable credit, so that even if the employer has no taxable income, the employer may receive a refund, as long as it does not exceed the tax-exempt employer’s total income tax withholding and Medicare tax liability for the year.

The credit can be reflected in determining estimated tax payments for the year in which the credit applies, in accordance with regular estimated tax rules. The credit can also be used to offset an employer’s alternative minimum tax (AMT) liability for the year, subject to certain limitations. However, because the credit applies against income tax, an employer may not reduce employment tax deposits and payments during the year in anticipation of the credit. Finally, employers cannot deduct the portion of the health insurance premiums which is equal to the amount of the health care tax credit.

MORE INFORMATION

More information about the tax credit, including tax tips, guides and answers to frequently asked questions, is available on the IRS website.

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