IRS Provides Guidance on Small Business Health Care Tax Credit

The IRS website now includes a fact sheet, examples, and Q&As on the tax credit available to small employers offering health insurance coverage.

New IRC §45R, which was included in the Patient Protection and Affordable Care Act, provides a sliding scale income tax credit, effective beginning in tax years after Dec. 31, 2009, to small employers with fewer than 25 employees and average annual wages of less than $50,000 who offer health insurance coverage to their employees. The IRS notes that a qualifying employer must pay at least 50% of the cost of health care coverage for some of its workers based on the rate for an employee who has single coverage (as opposed to family coverage). The fewer than 25 employees requirement may still be met by an employer with fewer than 50 half-time workers.

Amount of the credit. The credit is equal to 35% of a small business employer's premium costs in 2010. On Jan. 1, 2014, the credit increases to 50% (35% for tax-exempt employers). The credit phases out gradually for firms with average wages between $25,000 and $50,000, and for firms with the equivalent of between 10 and 25 full-time workers. The credit applies against an employer's income tax liability, rather than its employment tax liability. An employer may not reduce employment tax payments (i.e., withheld income tax, Social Security tax, and Medicare tax) during the year in anticipation of the credit [Q&A #21].

Qualification for the credit. The IRS fact sheet includes what the Service calls "Three Simple Steps" to determine if an employer qualifies for the credit. First, an employer must calculate the total number of employees in its organization. Owners or family members should not be included in the calculation. An employee who works at least 40 hours per week is considered a full-time employee. For other employees, the employer should add their total annual hours and divided this figure by 2,080. These employees are considered "full-time equivalent or part-time employees." The "total number of employees" is the sum of the full-time employees and the "full-time equivalent or part-time employees."

Next (Step 2), the employer must calculate the average annual wages of employees (not counting owners or family members). The employer should take the total annual wages paid to employees and divide that figure by the total number of employees computed in Step 1. If an employer's average annual wages are less than $50,000 (Step 3), it may be able to qualify for the credit.

Examples. The IRS website includes the example of an auto repair shop that has 10 employees, pays $250,000 in total annual wages ($25,000 average wages per worker) and $70,000 of employee health care costs. This employer will be able to claim a $24,500 income tax credit in the 2010 tax year (i.e., $70,000 × 35%). Using the same facts, the credit would be $35,000 in the 2014 tax year (i.e., $70,000 × 50%).

In another example, a diner has 40 half-time employees (the equivalent of 20 full-time workers). It pays $500,000 in total annual wages (or $25,000 per full-time equivalent worker) and $240,000 of employee health care costs. This employer will be able to claim a $28,000 income tax credit in the 2010 tax year (35% credit with phase-out). Using the same facts, the credit would be $40,000 in the 2014 tax year (50% credit with phase-out).

Q&As. There are Q&As on: (1) employers eligible for the credit; (2) calculation of the credit; (3) determining full-time equivalent (FTE) employees and average annual wages; (4) how to claim the credit; and (5) anticipated transition relief for tax years beginning in 2010.