IRS FAQs: Small Business Health Care Tax Credit

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[nbox type=”notice”]Federal law gives a tax credit to eligible small employers who provide health care coverage to their employees. These questions and answers provide information on the credit for tax years beginning in 2014. Page Last Reviewed or Updated: June 26, 2014.[/nbox]

Effect of Sequestration on Small Business Health Care Tax Credit – Tax-Exempt Employers Only

Due to sequestration, refund payments issued to certain small tax-exempt employers claiming the refundable portion of the Small Business Health Care Tax Credit under Internal Revenue Code section 45R, are subject to sequestration. This means that refund payments processed on or after Oct. 1, 2014, and on or before Sept. 30, 2015, issued to a tax-exempt taxpayer claiming the Small Business Health Care Tax Credit under section 45R will be reduced by the fiscal year 2015 sequestration rate of 7.3 percent (regardless of when the original or amended tax return was received by the IRS). The sequestration reduction rate will be applied unless and until a law is enacted that cancels or otherwise impacts the sequester, at which time the sequestration reduction rate is subject to change. Sequestration only affects the refundable portion of the Small Business Health Care Tax Credit filed by tax-exempt employers. Sequestration does not impact Small Business Health Care Tax Credit claims by non-tax-exempt employers, as the credit is not a refundable credit for non-tax-exempt employers.

Affected taxpayers will be notified through correspondence that a portion of their requested payment was subject to the sequester reduction and the amount.


Who Gets the Tax Credit

Q1. Who is eligible?

A1. A small employer is eligible for the credit if (a) it has fewer than 25 full-time equivalent employees, (b) the average annual wages of its employees are less than $50,000 (adjusted for inflation beginning in 2014), and (c) it pays a uniform percentage for all employees that is equal to at least 50% of the premium cost of employee-only insurance coverage. Each part-time employee counts as a fraction of a full-time equivalent employee (for example, two half-time employees equal one full-time equivalent employee for purposes of the credit). For tax years beginning in 2014 or later, the employer generally must contribute toward premiums on behalf of each employee enrolled in a qualified health plan (QHP) offered by the eligible small employer through a Small Business Health Options Program (SHOP Marketplace) established as part of the Affordable Care Act to qualify for the credit.

Q2. Can a tax-exempt organization be eligible?

A2. Yes. A tax-exempt organization described in section 501(c) of the Internal Revenue Code (Code) and exempt from tax under section 501(a) of the Code that otherwise meets the definition of an eligible small employer may qualify for the credit. The credit is refundable for tax-exempt employers but is limited to the amount of the tax-exempt employer’s payroll taxes withheld during the calendar year in which the taxable year begins. See the “What is the maximum credit for a tax-exempt qualified employer?” question on the Calculating the Credit page.

Q3. How does the credit change in 2014?

A3There are a few statutory changes to the credit for tax years beginning in 2014 and forward.

  • Employers generally must enroll in a QHP through their designated SHOP Marketplace (or through a direct enrollment process if available).
  • The maximum credit amount increases from 35% to 50% of premiums paid for eligible small employers and from 25% to 35% of employer premiums paid for tax-exempt eligible small employers.
  • An employer must contribute a uniform percentage of premiums (at least 50%) on behalf of each employee enrolled in a QHP offered by the small employer through a SHOP Marketplace.
  • An employer may claim the credit for no more than two-consecutive taxable years, beginning with the first taxable year in or after 2014 in which the eligible small employer attaches a Form 8941, Credit for Small Employer Health Insurance Premiums, to its income tax return, or in the case of a tax-exempt eligible small employer, attaches a Form 8941 to the Form 990-T, Exempt Organization Business Income Tax Return.
  • Cost-of-living adjustments are made to the average annual wage phaseout amounts. (The credit is phased out gradually when average annual wages exceed certain amounts.)

Q4. Are there exceptions to the requirement to offer health coverage through the SHOP Marketplace to be eligible to claim the credit?

A4. Yes, in some circumstances, an employer whose plan year and tax year do not match may still claim the 2014 credit, as may eligible small employers located in specific counties where QHPs are not available through a SHOP Marketplace in 2014. See questions 5 and 6 below.

Q5. What if an eligible small employer’s health plan year is not the same as its 2014 taxable year and the employer does not switch to SHOP coverage until the beginning of its 2014 plan year? Can the employer still claim the credit for the entire 2014 taxable year?

A5. Yes. For the 2014 taxable year, an eligible small employer does not need to switch plans mid-year to comply with the requirement that an employer offer coverage to its employees through a SHOP Marketplace. If, as of August 26, 2013, the employer has a plan year that begins after the start of its taxable year, the employer may claim the credit for premiums paid for the entire 2014 taxable year at up to the maximum 50% rate (up to 35% for tax-exempt employers) if (1) the employer begins offering coverage through a SHOP Marketplace on the first day of the plan year; (2) the employer offers coverage during the period before the first day of the plan year that would have qualified the employer for the credit under the rules applicable to years prior to  2014, and (3) the employer begins offering coverage through a SHOP Exchange as of the first day of its plan year that begins in 2014.

Example: The employer is an eligible small employer and a calendar year taxpayer. As of Aug. 26, 2014, the employer’s health plan year runs from July 1 through June 30. The employer offers a QHP to its employees through the SHOP Marketplace on July 1, 2014. If, from Jan. 1, 2014, through June 30, 2014, the employer has been offering coverage to its employees under the rules applicable to years before 2014, then the employer may claim the credit for premiums paid on behalf of each employee enrolled in coverage for the entire 2014 taxable year at up to the 50% rate (up to 35% for tax-exempt employers), even though the employer did not offer coverage through a SHOP Marketplace for the first six months of 2014.

For a detailed description of transition rule applicable to the SHOP Marketplace, see §1.45R-3(i) of the final regulations.

Q6. If my principal place of business is in Washington or Wisconsin and QHPs are not available through a SHOP Marketplace in the county where my business is located, can I still qualify for the credit?

A6. A small employer with a principal business address in one of the counties listed below, where QHPs are not available through the SHOP Marketplace in 2014, may claim the credit under the pre-tax year 2014 rules. The credit will be calculated at the maximum 50% rate (35% rate for tax-exempt eligible small employers) for the entire 2014 taxable year, and the 2014 taxable year will be the first year of the two consecutive taxable year credit period.

Washington:

Adams, Asotin, Benton, Chelan, Clallam, Columbia, Douglas, Ferry, Franklin, Garfield, Grant, Grays Harbor, Island, Jefferson, King, Kitsap, Kittitas, Klickitat, Lewis, Lincoln, Mason, Okanogan, Pacific, Pend Oreille, Pierce, San Juan, Skagit, Skamania, Snohomish, Spokane, Stevens, Thurston, Wahkiakum, Walla Walla, Whatcom, Whitman, and Yakima counties.

Wisconsin:

Green Lake, Lafayette, Marquette, Florence, and Menominee counties.

For a detailed description of this transition relief, see Notice 2014-6.

Q7.  What if an employer already claimed the credit for prior years? Can the employer still take advantage of the credit in 2014?

A7. Yes, if an eligible small employer takes the credit for tax years beginning in 2010 through 2013, those years do not count toward the two-consecutive taxable year period. Starting in 2014, an employer may claim the credit for two-consecutive taxable years, beginning with the first taxable year in or after 2014 in which the eligible small employer attaches a Form 8941 to its income tax return, or in the case of a tax-exempt eligible small employer, attaches a Form 8941 to the Form 990-T.

Q8. Is a household employer eligible for the credit, even if he or she has employees who are not performing services in a trade or business?

A8. Yes, a household employer may be eligible for the credit.

Q9. Is an employer outside the U.S. eligible for the credit?

A9. An employer located outside the United States (including a U.S. territory) may be an eligible small employer if the employer has income effectively connected with the conduct of a trade or business in the United States, and otherwise meets the requirements for claiming the credit.

Q10. How are employer contributions to a multiemployer plan treated for purposes of the credit?

A10. For taxable years 2010 through 2013, contributions by an employer to a multiemployer plan (but not self-insured health coverage offered through a multi-employer plan) are treated as premiums paid by the employer for purposes of the credit. However, 100 percent of the cost of coverage must be paid from employer contributions, not by employee contributions to satisfy the uniform percentage requirement for premiums paid on behalf of each employee covered by the multiemployer plan. See Notice 2010-82 for more guidance. For tax years 2014 and forward, eligibility for the credit depends on employers contributing on behalf of employees enrolled in a QHP offered to employees by the employer through a SHOP Marketplace.

Q11. Can a section 521 farmers cooperative be eligible?

A11. Yes. A section 521 farmers cooperative subject to tax under section 1381 may be eligible for the credit if it otherwise meets the definition of an eligible small employer. See the “Who is eligible?” question on this page.

Calculating the Credit

Q12. What expenses count toward the credit?

A12. Beginning in 2014, only premiums paid by the employer for employees enrolled in a qualified health plan (QHP) offered through a Small Business Health Options Program (SHOP Marketplace) are counted when calculating the credit. For taxable years 2010 through 2013, the employer may count premiums paid by the employer for health insurance coverage under a qualifying arrangement. See the “What is a qualifying arrangement?” question on this page. Employer contributions to health reimbursement arrangements (HRAs), health flexible spending arrangements (FSAs) and health savings accounts (HSAs) are not taken into account for purposes of determining premium payments by the employer. In SHOP Marketplaces where employers have the option of paying for some or all of any employee tobacco surcharges , these amounts are not included in premiums for purposes of calculating the uniform percentage requirement, nor are they treated as premium payments for purposes of the credit.

Q13. What if the employer only pays a portion of the premiums?

A13. If the employer pays a portion of the premiums and the employees pay the rest, only the portion paid by the employer is counted in calculating the credit. For example, if an employer pays 80 percent of the premiums, and employees have the other 20 percent taken out of their pay, only the 80 percent paid by the employer counts. Premiums paid through a salary reduction arrangement under a section 125 cafeteria plan are not treated as employer-paid premiums for purposes of the credit. Premiums paid with employer-provided flex credits that employees may elect to receive as cash or as a taxable benefit are treated as paid pursuant to a salary reduction arrangement under a section 125 cafeteria plan (and so are not treated as employer-paid premiums for purposes of the credit).

Q14. Is there a limit on the premiums that may be counted? 

A14. Yes, in certain situations. In calculating the credit, the employer’s premium payments are limited to the premium payments the employer would have made if the average premium for the small group market in the rating area in which the employee enrolls for coverage were substituted for the actual premium paid by the employer. This means that an employer must compare the actual premiums paid against the average premium table provided by HHS for their rating area and use the lesser of the two amounts. If an employer pays only a percentage of the premiums and employees pay the rest, the amount compared against the average premium is the percentage paid by the employer. For example, if an employer pays 80% of the premiums and employees have the other 20% taken out of their pay, the 80% paid by the employer is compared against 80% of the amount listed in the average premium table. The lesser amount is used in calculating the credit.

Example: An eligible small employer offers a health insurance plan with employee-only and family coverage. The employer has nine FTEs with average annual wages of $23,000. Four employees are enrolled in employee-only coverage and five are enrolled in family coverage. The employer pays 50% of the premiums for all employees enrolled in employee-only coverage and 50% of the premiums for all employees enrolled in family coverage. The employee is responsible for the remainder in each case. The premiums are $6,000 a year for employee-only coverage and $14,000 a year for family coverage. The average premium for the small group market in the employer’s state is $5,000 for employee-only coverage and $12,000 for family coverage

The employer’s premium payments for each employee ($3,000 for employee-only coverage and $7,000 for family coverage) exceed 50% of the average premium for the small group market in the employer’s rating area ($2,500 for employee-only coverage and $6,000 for family coverage).

Number of employees

4

5

Type of coverage

Employee-only

Family

Total premiums

6,000

14,000

State Average Premium

5,000

12,000

Employer pays 50%

3,000

7,000

50% of State Average Premium

2,500

6,000

The amount of premiums paid by the employer for purposes of computing the credit equals $40,000 [(4 x $2,500) plus (5 x $6,000)].

Q15. How is the average premium for the small group market determined, and where can employers find a listing of the average premiums each year?

A15. The IRS works with the Department of Health and Human Services (HHS) to obtain the average premium figures for the Small Employer Health Care Tax Credit each year. For years 2010 through 2013, the IRS publishes this information in the Instructions for Form 8941, Credit for Small Employer Health Insurance Premiums. For years beginning in 2014, the average premium figures will be found on the HHS website.

Q16. What if an employer has employees in multiple states?

A16. Beginning in 2014, the employer applies the average premium for each employee based on the rating area where the employee enrolls for coverage in a SHOP Exchange. For years 2010 through 2013, the employer applies the average state premium for each employee based on the state where the employee works.

Q17. What is the maximum credit for an eligible small employer who is not a tax-exempt organization?

A17. For taxable years beginning in 2014 and forward, the maximum credit is 50% of the employer’s premium payments made on behalf of its employees under a qualifying arrangement for a QHP offered through a SHOP Marketplace. For taxable years beginning in 2010 through 2013, the maximum credit is 35% of the employer’s premium payments made on behalf of its employees for health insurance coverage under a qualifying arrangement. See the “What is a qualifying arrangement?” question on this page.

Q18. What is the maximum credit for a tax-exempt eligible small employer?

A18. For taxable years beginning in 2014 and forward, the maximum credit is 35% of the tax-exempt employer’s premium payments made on behalf of its employees under a qualifying arrangement for a QHP offered through a SHOP Marketplace. For taxable years beginning in 2010 through 2013, the maximum credit is 25% of the employer’s premium payments made on behalf of its employees for health insurance coverage under a qualifying arrangement. See the “What is a qualifying arrangement?” question on this page. The credit is refundable for tax-exempt employers. However, the amount of the credit cannot be more than the total amount of income and Medicare tax (i.e., hospital insurance) the employer is required to withhold from employees’ wages for the year and the employer share of Medicare tax on employees’ wages for the year.

Q19. What is a qualifying arrangement?

A19. A qualifying arrangement is one where an eligible small 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. See the “How is the uniform percentage requirement satisfied?” question on this page.

Q20. How is the uniform percentage requirement satisfied?

A20. To satisfy the requirements for the credit, an eligible small employer must generally pay an amount equal to least 50% of the premium for each employee enrolled in coverage. The rules are different depending on whether the premium established is based upon list billing or composite billing. The rules may also be different for employee-only coverage, dependent coverage and family coverage, and whether the employer offers just one plan or more than one plan. See the “What is composite and list billing?” question on this page.

Q21. What is composite and list billing?

A21. Composite billing is a system of billing under which a health insurer charges a uniform premium for each of the employer’s employees or charges a single aggregate premium for the group of covered employees that the employer may then divide by the number of covered employees to determine the uniform premium. In contrast, the term list billing is a billing system under which a health insurer lists a separate premium for each employee based on the age of the employee or other factors.

Q22. If an employer offers just one plan to its employees using composite billing, how can the uniform percentage requirement be met?

A22. For an employer offering one plan under a composite billing system with only employee-only coverage, the uniform percentage requirement is met if an eligible small employer pays the same amount for each employee and that amount is equal to at least 50% of the premium for employee-only coverage for each employee enrolled in coverage.

If the employer offers one plan under a composite billing system with different tiers of coverage, for example, both employee-only and family coverage, for which different premiums are charged, the uniform percentage requirement is satisfied if the eligible small employer either: (1) pays the same amount for each employee enrolled in that tier of coverage and that amount is equal to at least 50% of the premium for that tier of coverage, or (2) pays an amount for each employee enrolled in the more expensive tiers of coverage that is the same for all employees and is no less than the amount that the employer would have contributed toward employee-only coverage for that employee.

Example: For the 2014 taxable year, Employer has nine FTEs with average annual wages of $23,000. Employer offers one plan under a composite billing system with different tiers of coverage. Six employees are enrolled in employee-only coverage ($8,000 per year) and three employees are enrolled in family coverage ($14,000 per year). Employer pays 50 percent of the premium for employee-only coverage for each employee enrolled in employee-only or family coverage (50 percent x $8,000 = $4,000 for each employee).

Number of employees

6

3

Type of coverage

Employee-only

Family

Total premiums

8,000

14,000

Employer pays

4,000

4,000

Employer pays $4,000 toward the premium for each of the six employees enrolled in employee-only coverage and $4,000 of the premium for each of the three employees enrolled in family coverage. Employer satisfies the uniformity requirement.

Q23. If an employer offers just one plan to its employees using list billing, how can the uniform percentage requirement be met?

A23. For an employer offering one plan under a list billing system with only employee-only coverage, the eligible small employer may convert the different individual premiums into a composite rate, referred to as an employer-computed composite rate. This is an average rate determined by adding the premiums for that tier of coverage for all employees eligible to participate in the employer’s plan (whether or not the eligible employee enrolls in coverage under the plan or in that tier of coverage under the plan) and dividing by the total number of such eligible employees. The uniform percentage requirement is met if the eligible small employer either:  (1) pays an amount equal to a uniform percentage (not less than 50%) of the premium charged for each employee, or (2) if any employee contribution is required, each enrolled employee pays a uniform amount toward the employee-only premium that is no more than 50% of the employer-computed composite rate for employee-only coverage.

If the employer offers one plan under a list billing system with different tiers of coverage, for example both employee-only and family coverage, for which different premiums are charged, the uniform percentage requirement is satisfied if the eligible small employer pays toward the premium for each employee covered under each tier of coverage an amount equal to or exceeding the amount the employer would have contributed with respect to that employee for employee-only coverage, calculated either based on the actual premium that would have been charged by the insurer for that employee for employee-only coverage, or based on the employer-computed composite rate for employee-only coverage, and the employer premium payments within the same tier are uniform in percentage or amount. Alternatively, the eligible small employer may satisfy the uniform percentage requirement by meeting the uniform percentage requirement separately for each tier of coverage and substituting the employer-computed composite rate for that tier of coverage for the employer-computed composite rate for employee-only coverage.

Example: For the 2014 taxable year, Employer has four FTEs with average annual wages of $23,000. Employer offers one plan under a list billing system with different tiers of coverage. Employer receives a list billing quote for each of the four employees. For Employee A, the employee-only premium is $3,000 per year, and the family premium is $8,000. For Employees B, C and D, the employee-only premium is $5,000 per year and the family premium is $10,000. Employer computes an employer-computed composite employee-only rate of $4,500 ($18,000 / 4). Employer offers to make contributions such that each employee would need to pay $2,000 of the premium for employee-only coverage. Under this arrangement, Employer would contribute $1,000 toward employee-only coverage for Employee A and $3,000 for employee-only coverage for Employees B, C and D. The total employee-only premium for the four employees is $18,000 ($3,000 + (3 x $5,000). In the event an employee elects family coverage, Employer would make the same contribution ($1,000 for Employee A or $3,000 for Employees B, C and D) toward the family premium and satisfy the uniform percentage requirement.

Q24: Are employer premiums paid toward dependent coverage included in the calculation?  Is the employer required to pay at least 50% of dependent coverage to be eligible to claim the credit?

A24:  An employer may include amounts paid toward dependent coverage when determining employer premiums paid.   To get the credit, an employer is not required to pay for all or even a portion of dependent coverage, but to the extent the employer pays these amounts, they may be included in employer premiums paid when calculating the credit.  Additionally, the employer will not fail to satisfy the uniform percentage requirement by contributing different amounts toward dependent coverage under I.R.C. § 45R.

Q25:  How do wellness programs or tobacco surcharges affect the uniformity requirement?

A25. If an employer’s plan provides a wellness program, for purposes of meeting the uniform percentage requirement any increase in the employer contribution that may occur due to an employee’s participation in the wellness program is not taken into account in calculating the uniform percentage requirement.  However, for purposes of computing the credit, the final regulations provide the employer contributions are taken into account, including those contributions made due to an employee’s participation in a wellness program.   In SHOP Marketplaces where employers have the option of paying for some or all of any employee tobacco surcharges, these amounts are not included in premiums for purposes of calculating the uniform percentage requirement (nor are they treated as premium payments for purposes of the credit).  If employers do not have the option of paying for any portion of employee tobacco surcharges through the SHOP Exchange, the uniform percentage requirement is applied without regard to any tobacco surcharges imposed upon the employee.

Q26. If an employer offers more than one plan to its employees, how can the uniform percentage requirement be met?

A26. If an employer offers more than one plan to its employees, the uniform percentage requirement may be satisfied in one of two ways. The first is on a plan-by-plan basis, meaning that the employer’s premium payments for each plan must individually satisfy the uniform percentage requirement. The amounts or percentages of premiums paid toward each plan do not have to be the same, but they must each satisfy the uniform percentage requirement if each plan is tested separately.

The other permissible method to satisfy the uniform percentage requirement is through the reference plan method. Under the reference plan method, the employer designates one of its plans as a reference plan. Then the employer determines a level of employer contributions for each employee such that, if all eligible employees enrolled in the reference plan, the contributions would satisfy the uniform percentage requirement as applies to that reference plan, and the employer allows each employee to apply the minimum amount of employer contribution determined necessary to meet the uniform percentage requirement toward the reference plan or toward coverage under any other available plan.

Example: Employer has four FTEs with average annual wages of $23,000. Employer offers two plans under a composite billing system with different tiers of coverage. Plan X is $4,000 per year for employee-only coverage and $10,000 for family coverage, and Plan Y is $7,000 per year for employee-only and $12,000 for family coverage. Employer designates Plan X as the reference plan. Employer offers to pay 50% of the premium for employee-only coverage under Plan X, which is $2,000. In the event that an employee elects family coverage under Plan X or either employee-only or family coverage under Plan Y, Employer would make the same contribution ($2,000) toward that coverage and satisfy the uniform percentage requirement.

Q27. What effect do state credits and state subsidies for health insurance have on the amount of the federal health care tax credit?

A27. Some states offer tax credits or a premium subsidy to certain small employers who provide health insurance to their employees. Generally, the premium subsidy is in the form of direct payments to the employer or to the employer’s insurance company. The effect these credits and subsidies on an employer’s federal health care tax credit depends on whether the direct payment goes to the employer or the insurance company.

If a state tax credit or a premium subsidy is paid directly to the employer, the effect on calculation of the federal health care tax credit in general is zero. If a state makes payments directly to an insurance company, the state is treated as making these payments on behalf of the employer for purposes of the uniform percentage requirement and the premium payments made by the state are treated as paid by the employer for purposes of calculating the credit. Note, however, that the amount of the federal health care tax credit cannot exceed the amount of the premiums actually paid by the employer.

A state-administered program (such as Medicaid) may make payments directly to a health care provider or insurance company on behalf of eligible individuals and their families. Those payments are not taken into account in determining the employer’s federal health care tax credit.

Q28. Do church welfare benefit plans qualify?  

A28. For taxable years 2014 and forward, employers are required to offer a QHP to its employees through a SHOP Marketplace to claim the credit.

Determining FTEs and Average Annual Wages

 

Q29. What is an FTE?

A29. A full-time equivalent employee (FTE). See the “How is the number of FTEs determined?” question for more information on how to calculate the number of FTEs.

Q30. Who is an employee for purposes of determining FTEs and average annual wages?

A30. In general, all employees of the eligible small employer are taken into account when determining FTEs and average annual FTE wages, including employees who terminated employment during the tax year, employees covered under a collective bargaining agreement, and employees who are not enrolled in health care coverage. The following individuals are not considered employees for purposes of the credit: owners of the small business, such as sole proprietors, partners, shareholders owning more than 2% of an S corporation or more than 5% of a C corporation; spouses of these owners; and family members of these owners, which include a child, grandchild, sibling or step-sibling, parent or ancestor of a parent, a step-parent, niece or nephew, aunt or uncle, son-in-law or daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law. A spouse of any of these family members should also not be counted as an employee.

Q31. Can I be counted as an employee if I own my small business?

A31. No. See “Who is an employee for purposes of determining FTEs and average wages” for information on who may be counted in the FTE and average annual wage calculation.

Q32. What about family members of the small business owner?

A32. Family members who work for the small employer are not counted as employees in calculating the credit. See “Who is an employee for purposes of determining FTEs and average wages” for information on who may be counted in the FTE and average annual wage calculation.

Q33. Do seasonal workers count in FTEs and average annual wages?

A33. Generally, no. Seasonal workers are workers who perform labor or services on a seasonal basis as defined by the Secretary of Labor, and  retail workers employed exclusively during holiday seasons. For this purpose, employers may apply a reasonable, good faith interpretation of the term “seasonal worker.” Seasonal workers are not employees for purposes of the credit unless the seasonal worker provides services to the employer on more than 120 days during the taxable year; however, premiums paid on behalf of a seasonal worker are counted in determining the amount of the credit.

Q34. Do part-time employees count in FTEs and average annual wages?

A34. Yes, part-time employees are counted in FTEs and average annual wages. If an employee works part-time throughout most of the year, he or she is not a seasonal worker and the employer must count the employee’s hours of service during the year in its FTE and average annual wage calculation.

Q35. Are leased employees counted in FTEs and average annual wages?

A35. Yes, leased employees (as defined in section 414(n)) are counted in the FTE and average annual wage calculation. A leased employee is a person who is not an employee of the service recipient and who provides services to the service recipient pursuant to an agreement with the leasing organization.

Q36.  Are ministers included in a church’s FTE calculation?

A36. The answer depends on whether, under the common law test for determining worker status, the minister is considered an employee of the church or self-employed. If the minister is an employee, the minister is taken into account in determining an employer’s FTEs, and premiums paid on behalf of the minister can be taken into account in computing the credit. If the minister is self-employed, the minister is not included in the employer’s FTE calculation and premiums paid on behalf of the minister are not taken into account.

Q37. Are ministers’ compensation taken into account in the average annual wage calculation?

A37. No. Compensation paid to a minister performing services in the exercise of his or her ministry is not subject to FICA tax and is not wages as defined in section 3121(a). It is not taken into account in the average annual wage calculation.

Q38.  What are the permissible ways to count hours of service?

A38. An employee’s hours of service for a year include hours for which the employee is paid, or entitled to payment, for the performance of duties for the employer during the employer’s tax year. Hours of service also include hours for which the employee is paid for vacation, holiday, illness, incapacity (including disability), layoff, jury duty, military duty or leave of absence. Hours of service do not include the hours of seasonal employees who work for 120 or fewer days during the taxable year, nor do they include hours worked for a year in excess of 2,080 by a single employee.

There are three methods for calculating the total number of hours of service for a single employee for the taxable year: actual hours worked; days-worked equivalency; and weeks-worked equivalency. Employers do not need to use the same method for all employees and may apply different methods for different classifications of employees if the classifications are reasonable and consistently applied. For example, an employer may use the actual hours worked method for all hourly employees and the weeks-worked equivalency method for all salaried employees.

(1) Actual Hours Worked: An employer may determine actual hours of service from records of hours worked and hours for which payment is made or due, including hours for paid leave. For example, if payroll records indicate an employee worked 2,000 hours and was paid for an additional 80 hours on account of vacation, holiday and illness, the employee must be credited with 2,080 hours of service (2,000 hours worked + 80 hours for which payment was made or due).

(2) Days-Worked Equivalency: An employer may use a days-worked equivalency whereby the employee is credited with 8 hours of service for each day the employee would be required to be credited with at least one hour of service, including hours for paid leave. For example, if an employer uses the days-worked equivalency for an employee who works from 8:00a.m.–12:00p.m. every day for 200 days, the employee must be credited with 1,600 hours of service (8 hours for each day the employee would otherwise be credited with at least one hour of service x 200 days).

(3) Weeks-Worked Equivalency: An employer may use a weeks-worked equivalency whereby the employee is credited with 40 hours of service for each week for which payment is made or due including weeks of paid leave. For example, if an employee worked 49 weeks, took two weeks of vacation with pay, and took one week of leave without pay, the employee must be credited with 2,040 hours of service (51 weeks x 40 hours per week).

Q39. How is the number of FTEs determined?

A39. Add up the total hours of service for which the employer pays wages to employees during the year (but not more than 2,080 hours for any employee), and divide that amount by 2,080. If the result is not a whole number, round to the next lowest whole number. (If the result is less than one, however, round up to one FTE.) In some circumstances, an employer with 25 or more employees may qualify for the credit if some of its employees work less than full-time. For example, an employer with 48 employees that are each half-time has 24 FTEs and, therefore may qualify for the credit. See the “Who is an employee for purposes of determining FTEs and average annual wages?” and the “What are the permissible ways to count hours of service?” questions on this page for information on how to compute an employee’s hours of service and determining which employees are counted.

Example: For the 2014 taxable year, an employer 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. The employer uses a method that counts hours actually worked. The employer’s FTEs would be calculated as follows:

(1) 10,400 hours for the five employees paid for 2,080 hours (5 x 2,080)

(2) 3,120 hours for the three employees paid for 1,040 hours (3 x 1,040)

(3) 2,080 hours for the one employee paid for 2,300 hours (lesser of 2,300 and 2,080)

(4) The total hours counted is 15,600 hours. The employer has seven FTEs (15,600 divided by 2,080 = 7.5, rounded to the next lowest whole number).

Q40. How are an employer’s average annual wages determined?

A40. All wages paid to employees (including overtime pay) are taken into account in computing an eligible small employer’s average annual wages. Add up the total wages paid by the employer during the taxable year to its employees (see the “Who is an Employee for Purposes of Determining FTEs and Average Annual Wages” question on this page), and divide that number by the number of FTEs for the year. The result is then rounded down to the nearest $1,000 (if not otherwise a multiple of $1,000). Include only wages paid for hours of service (see the “What are the Permissible Ways to Count Hours of Service?” question on this page). Use wages as defined for purposes of the Federal Insurance Contributions Act (FICA) (without regard to the social security wage base limitation).

Example: For the 2014 taxable year, an employer pays a total of $224,000 in wages to employees and has 10 FTEs. The employer’s average annual wages are $22,000 ($224,000 / 10 = $22,400, rounded down to the nearest $1,000).

Q41. How are average annual wages and FTEs calculated when the employer has a short taxable year?

A41. In accordance with general accounting principles, average annual wages and FTEs must be pro-rated or annualized in calculating the credit. For example, if a small employer has only been in business and paying premiums for 6 months during its first taxable year, it must pro-rate or annualize the employee hours worked and wages earned to reflect the 6 months the employer has been in operation.

Q42. How is the credit reduced if the number of FTEs exceeds 10 or average annual wages exceed $25,000?

A42. The credit phases out for eligible small employers if the number of FTEs exceeds 10, or if the average annual wages for FTEs exceed $25,400 (as adjusted for inflation beginning in 2014). If the number of FTEs exceeds 10, the reduction is determined by multiplying the otherwise applicable credit amount by a fraction, the numerator of which is the number of FTEs in excess of 10, and the denominator of which is 15. If average annual FTE wages exceed $25,400, the reduction is determined by multiplying the otherwise applicable credit amount by a fraction, the numerator of which is the amount by which average annual FTE wages exceed $25,400 and the denominator of which is $25,400. The credit will be reduced based on the sum of the two reductions. This may reduce the credit to zero for some employers with fewer than 25 FTEs and average annual FTE wages of less than $50,800 (as adjusted for inflation).

Example 1: For the 2014 taxable year, Employer has 12 FTEs and average annual wages of $30,000. Employer pays $96,000 in employee premiums, which does not exceed the average premium for the small group market in the employer’s rating area.

(1) Credit determined before any reduction: (50 percent x $96,000) = $48,000

(2) Credit reduction for FTEs in excess of 10: ($48,000 x 2/15) = $6,400

(3) Credit reduction for average annual wages in excess of $25,400: ($48,000 x $5,000/$25,400) = $9,449

(4) Total credit reduction: ($6,400 + $9,449) = $15,849

(5) Total 2014 tax credit: ($48,000 – $15,849) = $32,151

Example 2 (Tax-Exempt Eligible Small Employer): Same facts as Example 1, but Employer is a tax-exempt eligible small employer and the total amount of Employer’s payroll taxes equals $30,000 for calendar year 2014.

(1) Credit determined before any reduction: (35 percent x $96,000) = $33,600

(2) Credit reduction for FTEs in excess of 10: ($33,600 x 2/15) = $4,480

(3) Credit reduction for average annual wages in excess of $25,400: ($33,600 x $5,000/$25,400) = $6,614

(4) Total credit reduction: ($4,480 + $6,614 = $11,094)

(5)  Employer’s payroll taxes:  $30,000

(6) Total 2014 tax credit: ($33,600 – $11,094) = $22,506 (the lesser of $22,506 and $30,000).

Q43. How is eligibility for the credit determined if the employer is a member of a controlled group or an affiliated service group?

A43. Members of a controlled group (e.g., businesses with the same owners) or an affiliated service group (e.g., related businesses where one performs services for the other) are treated as a single employer for purposes of the credit. For example, all employees of the controlled group or affiliated service group, and all wages paid to employees by the controlled group or affiliated service group, are counted in determining whether any member of the controlled group or affiliated service group is a qualified employer. Rules for determining whether an employer is a member of a controlled group or an affiliated service group are provided under sections 414(b), (c), (m) and (o) of the Code.

Example: A taxpayer owns 100% of a sole proprietorship and files a Schedule C. The taxpayer also owns at least 80% of the voting power or value of the shares of an S Corporation. Even if the sole proprietorship and the S Corporation individually meet the requirements for the small business health care tax credit, section 414 of the Code and related regulations provide that there is common control under section 1563(a) of the code and when there is common control, the taxpayer must calculate their credit including the employees, their wages and premiums paid for all entities as one entity.|

How to Claim the Credit

Q44. How does an employer claim the credit?

A44. An employer (other than a tax-exempt employer) claims the credit on the employer’s annual income tax return, with an attached Form 8941, Credit for Small Employer Health Insurance Premiums, showing the calculation of the credit.

Q45. How does a tax-exempt employer claim the credit?

A45. An employer that is described in section 501(c) and exempt from tax under section 501(a) claims the credit by filing the Form 990-T, Exempt Organization Business Income Tax Return, with an attached Form 8941 showing the calculation of the claimed credit. Filing Form 990-T with an attached Form 8941 is required for a tax-exempt eligible small employer to claim the credit, even if it is not otherwise required to file Form 990-T. See the question, “Can a tax-exempt organization be eligible?” on the Who Gets the Tax Credit page.

Q46. May an employer use the credit to offset its alternative minimum tax (AMT) liability?

A46. Yes. The credit can be used, subject to certain limitations based on the amount of an employer’s regular tax liability, AMT liability and other allowable credits. See section 38(c)(1) of the Internal Revenue Code (Code), as modified by section 38(c)(4)(B)(vi).

Q47. Can an employer (other than a tax-exempt employer) claim the credit if it has no taxable income and no AMT liability for the year?

A47. Generally, no. The credit offsets only an employer’s actual income tax liability or AMT liability for the year, subject to certain limitations. However, under the general business credit rules, as amended by section 2012 of the Small Business Jobs Act of 2010, the taxable year 2010 unused credit may be carried back five years or forward up to 20 years. For other years, normal carryback and carry forward rules apply.

Q48. Can a tax-exempt employer claim the credit if it has no taxable income for the year?

A48. Yes. For a tax-exempt employer, the credit is refundable, so even if the employer has no taxable income, the employer may receive a refund (so long as it does not exceed the employer’s income tax withholding and Medicare tax liability, as discussed in the “What is the maximum credit for a tax-exempt qualified employer?” question on the Calculating the Credit page.

Q49. Can the credit be reflected in determining estimated tax payments for a year?

A49. Yes.

Q50. Does taking the credit affect an employer’s deduction for health insurance premiums?

A50. Yes. In determining the employer’s allowable deduction for health insurance premiums, the amount of premiums that can be deducted is reduced by the amount of the credit. Thus, the employer may claim both a credit and a partial deduction for the same premium payments.

Q51. May an employer reduce employment tax payments — withheld income tax, Social Security tax and Medicare tax — during the year in anticipation of the credit?

A51. No. The credit applies against income tax, not employment taxes.


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