Posted on April 11th, 2014

THE NUTS AND BOLTS OF THE CREDIT FOR SMALL EMPLOYERS’ HEALTH INSURANCE PREMIUMS

The Patient Protection and Affordable Care Act of 2010 provides a general business credit for small employers to help offset up to 50% of the cost incurred in funding employees’ health insurance premiums. Businesses are allowed to take the credit for two consecutive years beginning after 12/31/13.  It is nonrefundable, but can be carried back one year and carried forward 20 years.

According to Prop. Reg. 1.45R-2(a), to be eligible for the credit, an employer must meet the following criteria:

• The business employs less than 25 non-seasonal,  full-time equivalent employees 
  
• The average annual wages  paid to FTEs (full time employees) are less than $50,000. 
  
• The business provides at least one qualified health plan (QHP) option through the small business health options program (SHOP) exchanges.
• The employer contribution, plus any state subsidies or credits, covers at least 50% of the premium of a qualified health plan (self-only option) for each enrolled employee.
• The employer contribution meets the uniform percentage requirement for each enrolled employee.

The credit is subject to phase-out rules and a number of limitations that are covered below. It is calculated and claimed on Form 8941, “Credit for Small Employer Health Insurance Premiums,” which is attached to the employer’s federal income tax return.

Limitations to the credit

The credit can be as high as 50% of the premium cost of the QHP contributed by the employer, including any state subsidies or credits, if applicable, granted to the employer for providing this benefit. There are two limitations that may reduce the amount that can be claimed by an employer. First, the cost of premiums used to determine the credit cannot exceed the average premium cost for the small group market in the rating area where the employees are enrolled.  So, if a business chooses to offer a QHP that is more expensive than the average cost plan in that rating area, the credit will be based on the average premium cost rather than the actual cost of the offered plan.

Second, in the event that a particular state offers a health insurance subsidy or state tax credit to assist businesses in providing health insurance, the amount of the federal small employer health insurance premium credit will be limited to the employer’s actual contribution to the plan. This limitation can be confusing because the amount of the subsidy is added to the employer’s contribution when calculating the maximum credit available to the employer (at a rate of 50% of the cost). The actual amount of the credit taken, however, cannot exceed the employer contribution not including the subsidy.

Phase-out rules

The credit is subject to two phase-out provisions. The credit begins to phase-out once the company employs more than ten FTEs and when the average annual wage for the FTEs exceeds $25,000. To calculate the number of FTEs, the company divides the total number of hours of service for all employees by 2,080.  For employers with more than ten FTEs, the maximum credit is reduced by a fraction of the credit, in which the numerator is the number of employees exceeding ten and the denominator is 15. So, if a business employs 18 FTEs the credit would be reduced by 8/15. Once a business employs 25 FTEs, the entire credit is eliminated.

A similar method is used to calculate the phase-out due to the average annual wage. If a company’s average annual wage for FTEs exceeds $25,000, the credit is reduced by a fraction consisting of the amount of the average annual wages above $25,000 divided by $25,000. For instance, if a company’s average annual wages for FTEs is $35,000, the credit will be reduced by 10,000/25,000 or 2/5 of the maximum credit. When the average wages reach $50,000, the credit is reduced by 25,000/25,000 and is zero.

Both phase-outs can apply in the same year if a company employs more than ten employees and the average annual wage is above $25,000. Therefore, the credit can be reduced to zero long before the company reaches 25 FTEs or average wages of $50,000.

Available years for taking the credit

The credit is available to an employer only for two consecutive tax years beginning after 12/31/13. It becomes available in the first year the employer offers a QHP through a SHOP Exchange. There are transition rules for employers who have a tax year beginning 1/1/14, but whose benefit packages are effective later in the calendar year (but prior to 1/1/15). 

If the employer uses the credit for tax year 2014, the eligible years for taking the credit will be 2014 and 2015. If the employer waits to use the credit until 2015, the eligible years for taking the credit will be 2015 and 2016. If 2014 is a transition year for a small employer who did not contribute toward employees’ health insurance coverage or did not offer plans that would have qualified for a credit before 1/1/14, the employer may receive a larger benefit by postponing the credit to the first tax year in which the employees are covered by a QHP for the entire year.

Nonelective contribution requirements

To be eligible for the credit in tax years beginning in or after 2014, the business is required to contribute “an amount equal to a uniform percentage” of the premium cost for each employee enrolled in a qualified health program offered through a SHOP Exchange. The uniform percentage cannot be less than 50% of the cost of a self-only plan. As discussed earlier, any available state subsidies or credits are included as part of the nonelective contribution paid by the employer. However, salary reduction amounts through Section 125 cafeteria plans and amounts provided to an employee’s FSA, HAS, or HRA are not considered to be premium payments made by the employer.

Employers offering only one QHP.

Employers may offer plans with different tiers of coverage (self-only, employee plus one, and family plans). They also may offer more than one QHP from the SHOP Exchanges to give employees a greater choice. For employers offering only one QHP, the requirement that nonelective contributions made on behalf of each enrolled employee be at least 50% of the premium cost may be met in one of two ways. First, as long as the employer is contributing at least 50% of the cost of the self-only plan per enrolled employee, regardless of in which tier plan the employee(s) have enrolled, the requirement is met. Therefore, if an employee is enrolled in a family plan with a premium cost of $6,000 per year while the cost to the same employee for a self-only plan would have been $4,000 per year, as long as the employer is contributing at least $2,000 per year per enrolled employee, the requirement is met. The business does not have to contribute 50% of the cost of insuring the other family members.

A second option for meeting this requirement is for the employer to contribute a uniform percentage of at least 50% of the cost of the selected tier coverage for each employee. This option allows employers to subsidize a portion of the insurance covering other family members if they want to provide a larger benefit. Using the example above, the employer would need to cover at least $2,000 for employees enrolled in a self-only plan and at least $3,000 for employees enrolled in a family plan.

Regardless of the method chosen, the employer must contribute a uniform percentage on behalf of each employee. For instance, the employer cannot choose to cover certain employees at 75% of the premium and other employees at only 50%.

The uniform percentage requirement can be met in different ways for different billing methods. For plans with composite billing, the calculations of the uniform percentage are as stated above as each enrolled individual is charged the same rate. For plans with list billing, individuals enrolled in the plan may have premiums assessed at different rates. For instance, younger employees may be charged a lower premium than older employees. When computing the uniform percentage for plans with list billing, the employer has two options. The first option involves simply applying a uniform percentage of at least 50% to the premium cost on behalf of each enrolled employee based on that employee’s particular cost. Thus, the dollar amount of the contribution per employee may vary because the premium cost may vary. As discussed above, the percentage can either be applied to the self-only rate for all enrolled employees regardless of the tier of coverage chosen or it can be applied to the actual premium for the tier that is chosen.

Another option is for the employer to calculate an “employer-computed composite rate”  for self-only coverage and contribute an amount equal to or greater than 50% of the composite rate per enrolled employee. For employers offering more than one tier of coverage, the uniform percentage can either be applied to the self-only employer-computed composite rate for all employees regardless of the tier of coverage chosen or a composite rate can be calculated for each tier of coverage and the uniform percentage can be applied based on the tier of coverage chosen by the employee.

Special considerations for tax-exempt eligible small employers

Tax-exempt small employers are eligible for the same credit at a reduced rate. The credit for taxable entities is up to 50% of the nonelective contributions toward the cost of QHP premiums, while the credit for tax-exempt employers is up to 35% of the employer-provided portion of the premium. The eligibility requirements, limitations, and phase-out calculations for tax-exempt entities are the same as other entities with one additional limitation: Prop. Reg. 1.45-3(e)(1) states that “the amount of the credit claimed cannot exceed the total amount of payroll taxes (as defined in §1.45-1(a)(13)) of the employer during the calendar year in which the taxable year begins.”

Planning considerations

Employers should take the following issues into account when considering the health care credit:

• Employers should be conscious of the cost of the company’s chosen QHP compared to the average cost for a QHP for the small group market in that rating area. The credit will be calculated on the lower of the two amounts.
• If a business is considering a change to its staffing model—either expanding or reducing its workforce, consideration should be given to the impact of the phase-out on the eligible credit when choosing which year to begin taking the credit. There may be an advantage to taking the credit in the two years in which the phase-out would have the least impact on the credit. However, the higher cost and, consequently, the higher available credit that is incurred with having more employees enrolled in a QHP may provide for a higher dollar value to the credit even with some reduction due to the phase-out. In years in which there are more than ten FTEs, all else being equal (i.e. the cost of the premiums per individual and the employer contribution percentage), the actual dollar amount of the credit will likely be larger than the credit available with only ten employees up until employment reaches 15 FTEs. For employment above 15, the dollar amount will be less than what was available with only ten employees.  This relationship will not necessarily hold true if all employees do not enroll in the QHP.
• The two-consecutive-tax year limit states that successor companies are not eligible for additional years of the credit. Once the credit is used for two consecutive tax years, neither the business nor successor companies formed from the business are eligible for the credit in the future as the provision is now written.
• The credit can be reflected in determining a company’s estimated tax payment for the year or years in which the credit will be used. The credit, however, cannot be used to offset deposits or payments of employment taxes. The credit can reduce the alternative minimum tax (AMT) liability in most instances.