How the Tax Credit Works
The purpose of the tax credit is to help small businesses transition to the new system that will be in place once ACA is fully enacted. It provides a dollar-for-dollar discount on your company’s income tax return equivalent to a percentage of what you spend on healthcare premiums.
If your company didn’t earn enough money to take advantage of the credit—for example if you lost money or made very little profits—you can apply the credit to your tax year 2010 or tax year 2011 returns if you did better during one of those years. If not, you also have the option of saving the tax credit amount for future use for up to 20 years. For example, if your credit is for $20,000 but your tax liability without the credit is only $5,000, then you can apply $5,000 this year and carry forward the remaining $15,000 in credit to future years.
Which Companies Qualify?This is where things get tricky. There are three main criteria for determining if your company qualifies for the tax credit.
1. Your company must have less than 25 full-time equivalent employees (FTEs) during the tax year for which you are requesting the credit. A FTE includes full-time employees and part-time employees. The number is calculated by dividing the total number of hours worked per employee (up to a maximum of 2,080 hours per employee) by 2,080. If the result is not a whole number then you round down. For example, if you have:
- 1 employee who worked 2,300 hours: 1 x 2,080 = 2,080/2,080 = 1 FTE
- 4 employees that worked 2,080 hours: 4 x 2,080 = 8,320/2,080 = 4 FTE
- 50 employees that worked 520 hours: 50 x 520 = 26,000/2,080 = 12.5 FTE
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There are also some people your company can employ who don’t count toward this limit. Shareholders owning more than 5 percent of the stock of a corporation (2 percent for sub-chapter S corporations) are exempt. Partners in a partnership and sole proprietors are exempt. For tax purposes, a Limited Liability Company is a disregarded entity so the sole proprietorship and partnership exemption applies. Family members, like parents and children of exempt persons, are also exempt from the FTE calculation. Even though spouses are not specifically mentioned under exempt employees, the spouses of owners are usually exempt.
2. Your company’s average annual wage per FTE must be less than $50,000. For determining average compensation, you must include the total wages paid for the hours counted in the FTE calculation. Wages in this case refer to compensation on which you pay FICA (payroll) taxes.
3. The employer must pay at least 50 percent of the health insurance premium for qualifying coverage. The payment must also be uniform, meaning the employer must pay the same percentage of premium across different plans and for different employees. If you pay 60 percent of the premium for your single employees, you must also pay the same percentage of the premiums for your married employees.
How Much is the Credit Worth?
The amount of the credit depends on the number of FTEs and the average wages you pay. The smaller your total payroll, the larger the credit you qualify for. The credit is currently set at 35 percent of the health insurance premiums you pay for your employees unless the premiums you pay are above average for your state. In that case, it's 35 percent of the average premium paid per employee in your state. Starting in 2014, the maximum value of the credit increases from 35 to 50 percent of eligible premiums and continues through 2015. At that point, the credit sunsets, as in theory small businesses have transitioned to the new healthcare marketplaces.
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Is it Worth the Effort?Based on the number of companies applying for the credit, the likely answer is no. To achieve the maximum value of the credit, which is 35 percent of the employer portion of the health insurance premium, a company must have less than 10 FTEs with an average wage below $25,000. Companies that pay so little are unlikely to offer benefits like health insurance.
For companies that claim the full or a partial credit, by claiming it, you lose part of your deduction for the health insurance expense you incur. While a credit is better than a deduction, the value of the credit relative to just keeping the full deduction for the expense is diminished. For example, by claiming a $2,500 credit, you may lose $500 in deduction, so the net benefit of claiming the credit would be closer to $2,300.
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Mike Periu is the founder of Proximo, a leading provider of training and educational programs in finance, entrepreneurship and information technology. He is a nationally recognized speaker, blogger and writer on small-business finance.
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