December 6, 2010 | last updated March 25, 2012 5:56 am

Knowhow: Tax Time | The basics of a new health insurance tax credit for small businesses

The Patient Protection and Affordable Care Act, passed by Congress and signed by President Barack Obama on March 23, 2010, has vastly changed health care in this country. To ease the burden on small employers who provide health insurance for their employees, new tax credits are available for tax years beginning in 2010.

Who is eligible?

Employers who contribute at least 50 percent of the health insurance premiums for their employees at the single (employee-only) coverage rate. The number of full-time equivalent (FTE) employees must be fewer than 25. The average annual wages of employees must be less than $50,000.

What is a full-time equivalent employee?

The total hours worked by all employees during the year, divided by 2,080, rounded down to the nearest whole number. For employees who work more than 2,080 hours per year, only the first 2,080 hours are counted.

A company has 50 part-time employees. Since it has more than 25 employees, is it still eligible for the credit?

Yes, if the total number of hours worked divided by 2,080 is less than 25, the company is still eligible for the credit.

How are the average annual wages calculated?

The total wages that the employer pays is divided by the number of its FTE employees and that number is rounded down to the nearest $1,000.

How much is the credit?

For taxable entities, during tax years beginning in 2010 to 2013, the amount of the credit is 35 percent of the employer's contributions toward the employees' health insurance premiums. During tax years beginning after 2013, the credit is 50 percent of the employer's contributions.

Is there a phase out of the credit?

Yes, the full amount of the credit is only available to an employer with 10 or fewer FTE employees and whose employees have average annual wages of less than $25,000. An employer with exactly 25 FTE employees or average annual wages exactly equal to $50,000 is not eligible for the credit.

Are tax-exempt organizations eligible for the credit?

Yes, but the maximum credit for the first four years is 25 percent of the employer's premium payments and 35 percent for tax years beginning after 2013. In addition, their credit cannot exceed the amount of employee federal tax withholding and the employee and employer portion of Medicare taxes. The other rules are the same.

Is there a restriction on where the employer purchases the health insurance?

Yes, during the first 4 years, it must be purchased from an insurance company licensed under state law. During the second phase, beginning in 2014, it must be purchased through a state exchange.

How does the employer get the credit?

Employers file Form 8941. The credit will be taken as a business tax credit on the annual tax return of the company or on the owner's returns of a pass-through entity. For tax-exempt organizations, the credit will be taken on a revised Form 990-T.

Are all employees counted in the number of FTEs?

No. Self-employed individuals, including partners and sole proprietors, 2 percent or greater shareholders of an S corporation, and 5 percent owners of the employer and certain relatives of these individuals are not treated as employees. There are also special rules that apply to seasonal workers and leased employees.

Example for a taxable entity:

  • Number of FTEs 10
  • Average annual wages $20,000
  • Health insurance premiums $50,000
  • paid by employer
  • Tax credit at 35% $17,500

As always, see your professional tax advisor to determine how this new tax credit applies to your individual situation.

Joy C. Child is a partner and vice-president at the Worcester-based accounting firm of Alexander, Aronson, Finning & Co. PC. She can be reached at jchild@aafcpa.com.

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