Highlights of the Small Employer Tax Credit
Originally posted September 18, 2013 by United Benefit Advisors
Very small employers with a high percentage of employees who earn low wages are eligible for a tax credit for employer contributions made to purchase health insurance. Non-profit organizations also are eligible – they will receive the credit as an offset to their payroll taxes. Governmental entities are not eligible unless they qualify as 501(c) organizations.
The tax credit is only available to employers if they satisfy all of these requirements:
- They have 25 or fewer full-time equivalent employees
- The average wage per employee is $50,000 (indexed) or less
- The employer makes a uniform contribution for covered employees of at least 50 percent of the cost of single coverage (the employer does not need to contribute anything to the cost of dependent coverage, or even offer that coverage)
- Starting in 2014, coverage must be purchased through the SHOP exchange
Eligible health insurance includes medical, dental, vision, long term care, specified disease, hospital indemnity, and Medicare supplement policies. Because only health insurance is eligible for the credit, contributions toward self-funded plans, health reimbursement arrangements, health savings accounts, flexible spending accounts, or flex credits are not included.
The controlled group rules apply, so all employees employed by employers in a controlled group or an affiliated service group must be considered both when determining the number of full-time equivalent employees the employer has and the average wage.
For the rest of 2013, the maximum credit for businesses is 35 percent of the employer’s contribution for health insurance. For tax-exempt organizations, the maximum credit is currently 25 percent. Starting January 1, 2014, the credit will increase to 50 percent for businesses and 35 percent for exempt organizations. However, the employer premium on which the credit is determined may not exceed the average cost of coverage in the small group market of the employee’s rating area.
The credit is only available for two consecutive years once 2014 begins. A partial year counts as a full year toward the two-year limit. Under a special rule, a non-calendar year plan may use the increased credit percentage for all of 2014.
The credit phases out for employers with more than 10 full-time equivalent employees, or whose employees have average wages of $25,000 or more.
The credit also discounts any state-provided tax credit or subsidy.
Common-law employees employed during the year must be counted, including part-time employees, former employees terminated during the year and employees who do not enroll in the health insurance plan (whether or not they are covered under another plan). Seasonal workers are not taken into account unless they work more than 120 days during the tax year. Leased employees are counted only if they have worked for the employer for at least one year. Sole proprietors, partners, more than two percent shareholders of an S-corporation, more than five percent shareholders of an organization that is not an S-corporation, and their family members and tax dependents are not considered employees.
An employer may count hours of includable employees using any of three methods – actual hours worked (including overtime, but not more than 2,080 hours per year), crediting an employee with a full day (eight hours) for each day the employee works one hour, or crediting an employee with a full workweek (40 hours) for each week in which the employee works one hour. Employees must be credited both with hours actually worked and hours for which the employee was paid (such as for vacation, holidays and sick days). An employer may use different methods of calculating hours for different classifications of employees.
The number of full-time equivalent employees (FTEs) is generally calculated by dividing the total hours worked by all includable employees during the year by 2,080 and rounding down to the nearest whole number (but not less than 1).
Example: For the 2014 taxable year, Acme Co. pays five employees wages for 2,080 hours each, three employees wages for 1,040 hours each, and one employee wages for 2,300 hours. Acme uses a method that counts hours actually worked. The employer’s FTEs would be calculated as follows:
10,400 hours for the five employees paid for 2,080 hours (5 x 2,080)
3,120 hours for the three employees paid for 1,040 hours (3 x 1,040)
2,080 hours for the one employee paid for 2,300 hours (lesser of 2,300 and 2,080)
The total hours counted is 15,600 hours. Acme has seven FTEs (15,600 divided by 2,080 = 7.5, rounded to the next lowest whole number).
When calculating the average annual wages, the employer must use wages subject to Social Security payroll taxes (FICA), but without the Social Security wage base limitation. To calculate the average wages paid, the total annual wages paid to employees taken into account in the FTE calculation is divided by the number of FTEs, and rounded down to the nearest $1,000.
Example: For the 2014 taxable year, Case Bros. pays a total of $224,000 in wages to employees and has 10 FTEs. Case Bros.’ average annual wages are $22,000 ($224,000 / 10 = $22,400, rounded down to the nearest $1,000).
The employer must make a “uniform” contribution on behalf of each employee who is enrolled in health insurance. Employers with only one plan option and a composite rate must contribute at least 50 percent of the cost of single coverage. Employers that list bill may either contribute the same percentage (not less than 50 percent) of each employee’s premium, or determine a composite premium and contribute at least 50 percent of the composite premium for each participating employee. Employers that offer family coverage must contribute the same amount for each employee in the tier. The rules provide several ways to meet the uniform contribution requirement if the employer offers more than one plan.
Although a seasonal employee who works fewer than 120 days is disregarded when calculating the number of full-time equivalent employees and the average wage, if the employer provides coverage to a seasonal employee, it is entitled to a credit on that contribution.
Claiming the Credit
For-profit employers must file IRS Form 8941 with their tax return to claim the credit. The credit may be used toward their regular or the alternative minimum tax. Tax-exempt organizations must file Form 990-T and attach the Form 8941. Their credit will be applied against their payroll taxes.