In March the Patient Protection and Affordable Care Act and the Health Care & Education Reconciliation Act of 2010 (together, "PPACA") were signed into law by President Obama. Among other sweeping changes to health care, PPACA contains a small business Federal income tax credit (the "Tax Credit") for certain small employers that provide health care coverage to their employees, effective for tax years beginning in 2010. The IRS recently released guidance on the Tax Credit in a question and answer format. The guidance discusses which employers are eligible for the Tax Credit, how to calculate the Tax Credit, how to claim the Tax Credit, as well as provides information on transition relief for employers claiming the Tax Credit in 2010.
Small employers that provide health care coverage to their employees and that meet certain requirements ("Qualified Employers") generally are eligible for a Federal income tax credit for health insurance premiums they pay for certain employees. In order to be a Qualified Employer, (1) the employer must have fewer than 25 full-time equivalent employees ("FTEs") for the tax year, (2) the average annual wages of its employees for the year must be less than $50,000 per FTE, and (3) the employer must pay the premiums under a qualifying arrangement ("Qualifying Arrangement"). Additionally, tax-exempt employers may qualify as Qualified Employers for purposes of the Tax Credit; however, different rules for calculating the Tax Credit apply to tax-exempt employers, as discussed below.
Counting FTEs. The number of an employer's FTEs is determined by dividing the total hours for which the employer pays wages to employees during the year (but not more than 2,080 hours for any employee) by the number 2,080 (i.e., total hours paid to employees/2,080). The result, if not a whole number, is then rounded to the next lowest whole number. The final number is the employer's FTEs. This use of the formula, instead of just counting the number of employees an employer has on its payroll means that employers with more than 25 employees may qualify for the Tax Credit if some of the employees are part-time employees.
Determining Average Annual Wages. The amount of average annual wages is determined by first dividing the total wages paid by the employer to employees during the employer's tax year by the number of the employer's FTEs for the year (i.e., total amount of wages paid/total number of employer's FTEs). The result is then rounded down to the nearest $1,000 (if not otherwise a multiple of $1,000) and the resulting number is the amount of average annual wages. For purposes of this calculation, wages means wages as defined for FICA purposes (without regard to the wage base limitation).
What Constitutes a Qualifying Arrangement. The IRS defines a Qualifying Arrangement as a situation where the employer pays premiums for each employee enrolled in health care coverage offered by the employer in an amount equal to a uniform percentage (not less than 50%) of the premium cost of the coverage.
The IRS guidance makes clear that only premiums paid by the employer under Qualifying Arrangement are counted in calculating the Tax Credit. If an employer pays only a portion of the premiums for the coverage provided to employees under Qualifying Arrangement (with employees paying the rest), the amount of premiums counted in calculating the Tax Credit is only the portion paid by the employer. For example, if an employer pays 60% of the premiums for employees' coverage (with its employees paying the other 40%), only the 60% premium amount paid by the employer counts in calculating the Tax Credit. For purposes of the Tax Credit (including the requirement that at least 50% of the premium is paid by the employer), any premium paid pursuant to a salary reduction arrangement under a section 125 cafeteria plan is not treated as paid by the employer.
In addition, the amount of an employer's premium payments that counts for purposes of the Tax Credit is capped by the premium payments the employer would have made under the same arrangement if the average premium for the small group market in the state (or an area within the state) in which the employer offers coverage were substituted for the actual premium. The IRS has stated that the average premium for the small group market in a state (or an area within the state) will be determined by the Department of Health and Human Services and is expected to be posted on the IRS website by the end of April.
For tax years beginning in 2010 through 2013, the maximum Tax Credit is 35% of a Qualified Employer's premium expenses that count towards the Tax Credit. For tax years beginning in 2010 through 2013, the maximum Tax Credit for a tax-exempt Qualified Employer is 25% of the employer's premium expenses that count towards the Tax Credit. However, for tax-exempt Qualified Employers, the amount of the Tax Credit cannot exceed the total amount of income and Medicare (i.e., hospital insurance) tax the employer is required to withhold from employees' wages for the year and the employer share of Medicare tax on employees' wages.
Finally, the IRS stated that it intends to provide transition relief for Qualified Employers claiming the Tax Credit in 2010. This relief is intended to help those Qualified Employers who pay at least 50% of the premium for each of its employees, but not at uniform amounts and to help those Qualified Employers claiming the Tax Credit who pay an amount equal to 50% of the employee premium for individual coverage.
This new IRS guidance on the Tax Credit may provide small employers who provide their employees with health coverage an income tax credit for the 2010 tax year. Since this portion of PPACA is effective for this tax year, small employers should begin to review their cost-sharing policies and other relevant records to determine if they may qualify for and take advantage of the Tax Credit this year. The IRS guidance may be found here: http://www.irs.gov/newsroom/article/0,,id=220839,00.html.