Most people in the United States receive health insurance coverage through their employers.  As the Patient Protection and Affordable Care Act (healthcare reform law) is implemented over the next five years, business owners will need to carefully analyze how the law impacts the coverage they offer (or don’t offer) employees.  Some changes, such as the 2010 heath care spending tax credit, are already active. 

The 2010 Small Business Health Care Tax Credit for Small Employers

The purpose of the 2010 small business healthcare tax credit is to encourage small employers to provide healthcare coverage for their employees if they don’t already do so.  If your company already offers healthcare coverage but is thinking of discontinuing it, the goal is to get you to change your mind (or at least postpone the decision).   Whether or not your business should offer, continue to offer or discontinue heath care benefits for employees is a very complex decision with many factors to consider.  This credit is just one of those factors.

Which businesses are eligible for the 2010 Health Care Tax Credit?

There are several qualification requirements for the health care tax credit:

Your company must pay at least 50 percent of the cost of the premium and these payments must be done under a qualifying arrangement.  A “qualifying arrangement” basically means that the employer pays a uniform percentage of the health insurance premiums for all enrolled employees. 

In order to help more companies qualify, this requirement is being relaxed for 2010 through 2013. As long as companies pay at least 50 percent of the premium cost for all participating employees, the percentage paid does not have to be uniform for the company to qualify.  Secondly, the company only has to pay at least 50 percent of the premiums for a “single-person” policy per employee.  If some employees use more expensive family coverage, the employer only has to cover the equivalent of 50 percent of what the employee plan would cost if they signed up as a single person to qualify.

Your company must employ less than “25 full time equivalent employees” to qualify for the credit.  Don’t confuse this with “25 employees”. They are not the same.  The term “full time equivalent employee” is used to take into account part-time employees.  To calculate the number of full time equivalent employees or FTEs at your company, you simply divide the total number of work hours of all employees for the year by 2,080. If the result isn’t a whole number you simply round down.  So if you have five employees with 1,600 work hours and six employees with 2,000 work hours, then the number of FTEs would be 9, calculated as follows:

[ (1,600 x 5) + (2,000 x 6) ] / 2,080
=
[ 8,000 + 12,000 ] / 2,080 
=
9.615, rounded down to 9

Keep in mind the following points when calculating the number of FTEs:

• Seasonal employee hours are generally not included unless they work at least 120 days during the year.

• Sole proprietors, partners, shareholders with more than 2 percent of the company or 5 percent owners in any company are not considered employees and therefore their hours worked do not count towards the FTE calculation.

• The hours worked by family members of the business owner do not count towards the FTE calculation.  The IRS states that “[f]or this purpose, a family member is defined as a child (or descendant of a child); a sibling or step-sibling; a parent (or ancestor of a parent); a step-parent; a niece or nephew; an aunt or uncle; or a son-in-law, daughter- in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law”.

If that wasn’t tricky enough, you also have to make sure you calculate the number of hours correctly for each employee.  The hours for each employee consist of the sum of:

• Hours worked and paid for during the year
• Hours worked that should have been paid during the year
• Hours of paid leave (up to a maximum of 160 hours for each continuous period of paid leave)

The average annual wages per FTE must be less than $50,000.  To calculate this number, simply divide the total wages paid to employees used in the FTE calculation by the number of FTEs and round the result down to the nearest thousand.  So if your company has paid $380,000 in wages and has 9 FTEs, then the average annual wage would be: 

$380,000 / 9
=
$42,222.22 rounded down to $42,000

The IRS offers a worksheet for determining company eligibility for the 2010 health care tax credit.  The worksheet is rather simplified, so the “best” answer it can give you is that your business “may qualify”.  It’s really meant to weed out the businesses that clearly don’t qualify.

How big of a tax credit is my business eligible for?

The credit is based on the amount of money your company spends on health care premiums for employees.  Even though the law was not enacted until March 23, 2010, companies can calculate the credit based on premiums paid since January 1, 2010.  The maximum credit is equal to 35 percent of the employer’s qualified premium expenses up to a certain cap. 

A cap on the premium amount used to calculate the credit

The premium amount used to calculate the credit cannot be great than the “average premium for the small group market in the state (or an area within the state) in which the employer offers coverage”.  These average premiums are determined by the Department of Health and Human Services.  You can download them here.

A cap on the maximum credit your company can earn

The credit cannot exceed the sum of the following three items:

• Total amount of income (profits) generated by the company
• Total employee contribution of Medicare taxes withhold by the employer
• Total employer contribution of Medicare taxes for the year.

Other reductions to the credit

If your company employs between 10 and 25 full time equivalent employees, the credit is reduced by a certain percentage.  Use this formula to calculate the reduction:  

(total full time equivalent employees – 10) / 15  

So if your company has 13 FTEs, your credit would be reduced by (13-10) / 15 = 20 percent.

If the average annual wage exceeds $25,000, the credit is reduced by a certain percentage as well.  Use this formula to calculate the reduction:

(average annual wage – 25,000) / 25,000  

If the average annual wage is $29,000, your credit would be reduced by (28,000 – 25,000) / 25,000 = 12 percent.

It’s important to note that the reductions for total number of employees and average annual wages are cumulative.  So you must deduct both from the maximum credit in order to determine your actual credit. In this example, the credit would be reduced by 20 percent + 12 percent = 32 percent.

As you can see, this tax credit is complex!  Make sure that your company’s accountant is on top of it. For the full details, read IRS Notice 2010-44.