The mere mention of the Affordable Care Act of 2010 can still make employers wince all these years later, but there might be a silver lining for some woven into its terms. One of the provisions of the ACA is the Small Employer Health Care Tax Credit.
This credit allows certain small businesses to whittle away at their tax bills when they pay at least half the health insurance premiums for their employees. Some tax-exempt organizations might even get a refund.
The Basics of the Small Employer Health Care Tax Credit
The Small Employer Health Care Tax Credit got off to a rough start. It's somewhat difficult to calculate, and some employers found that their credits were miniscule, at least in the beginning. Some employers even found that they didn't get a credit at all.
Then the maximum credit was increased in 2014, taking some of the sting out of laboring over all those calculations. The Small Employer Health Care Tax Credit is equal to up to 50% of employer-paid health insurance premiums as of 2019. It was only 35% of eligible health insurance premiums from 2010 through 2013, and non-profit employers can still only claim up to 35%.
There are other rules and limitations as well.
Qualifying for the Small Business Health Insurance Credit
A three-pronged test determines which small businesses qualify for the health care tax credit.
- The business must have less than 25 full-time equivalent (FTE) employees.
- The average wage paid to employees must be less than $54,200 as of the 2019 tax year. This limit has been adjusted annually for inflation since 2014.
- Health insurance premiums must be paid through a "qualifying arrangement."
Add up the total you paid in wages and divide it by the number of your FTE employees to find the average wage.
A "Qualifying Arrangement"
The Internal Revenue Service defines a qualifying arrangement as one that is:
"Generally, an arrangement that requires you to pay a uniform percentage not less than 50% of the premium cost for each enrolled employee's health insurance coverage."
The IRS has clarified that this 50% rule applies just to employee-only health coverage.
A scenario in which the employer pays half the employee-only coverage and the employee pays all the premiums for covering his spouse and children would still qualify.
No Tax Credit for Owners of the Business
Small businesses can't take the tax credit for insurance premiums paid on behalf of their owners. This includes owners of corporations, partners in partnerships, and sole proprietors. No tax credit is available for employees who own more than 5% of a business structured as a C corporation, or for employees who own more than 2% of an S corporation.
Partners, members of LLCs that are treated as partnerships, owners of single-member LLCs, S corporation shareholders with more than 2% ownership, and sole proprietors are all treated as self-employed persons for health insurance purposes. They're not entirely left out in the cold, however. They're eligible for the self-employed health insurance deduction instead of this tax credit.
It's a Flexible Credit
A prime advantage of this credit is that it can be carried forward or back to other tax years. This can be beneficial if your business doesn't owe tax in a particular year, so claiming the credit won't do you any good because you don't have an income tax liability for it to offset.
But if you owe tax for the previous year, you can apply your credit to that balance. Likewise, you can elect to carry the credit forward if you expect to have a tax liability next year.
Some small employers might not qualify for the full amount of the credit. The 50% amount represents the maximum tax credit available, but the credit is reduced or phased out in the following circumstances:
- The number of your FTE employees exceeds 10.
- Your average annual wages exceed $25,800 per FTE employee for years 2015 and later.
- Actual health insurance premiums exceed the average premiums paid for health coverage in the employer's geographical area.
Claiming the Health Care Tax Credit
The health care tax credit can be calculated and claimed using Form 8941. The form must be attached to the business's tax return. The credit then reduces any income tax the business owes.
Tax-exempt organizations should file Form 990-T. Generally, this tax credit is non-refundable, although it can be carried backward or forward to other tax years. But tax-exempt organizations that have no taxable income can qualify for a refund of the credit, provided it doesn't exceed their Medicare tax liability and income tax withholding.
The credit cannot offset payroll tax or self-employment tax liabilities for small business owners.
Can Businesses Take a Deduction for Premiums?
Small businesses can take both a deduction for health insurance premiums and the health care tax credit as well, but the amount of the deduction is reduced by the amount of the tax credit.
- Small businesses should review their accounting systems to make sure they're accurately keeping track of employer-paid and employee-paid health insurance premiums. This can be vitally important because employers must report the value of health insurance benefits on employees' W-2 forms.
- Business owners might also want to review how they structure their health benefits. For example, owners might want to revise what percentage of health insurance premiums they pay so as to be eligible for the tax credit. This can be offset by adjustments in salary, particularly for new hires.