The Small Business Health Care Tax Credit

What it is and how to access it

As a small business owner, you have many decisions to make regarding employee perks and benefits. Offering the right benefits may entice experienced individuals to apply for jobs while encouraging current employees to stay with your company longer than expected.

One of the most important employee benefits to consider is health insurance. And if you're worried about the cost, there's a tax credit that can help you as long as your business or organization qualifies. Here's what you need to know about the tax credit to help offset the cost of providing health insurance to your employees. Remember that it's also available to small tax-exempt organizations.

Key Takeaways

  • Health insurance is one of the perks that you may offer your employees.
  • Covering health insurance premiums can be costly, especially for small businesses.
  • The small business health care tax credit can offset the costs if a business meets certain thresholds, offers a qualified health plan through the SHOP Marketplace, and pays at least 50% of the cost of employee-only health plans.
  • Eligible small businesses may carry the credit backward or forward.
  • Eligible small tax-exempt organizations may claim a refundable credit.

What Is the Small Business Health Care Tax Credit?

Certain provisions of the Affordable Care Act (ACA) apply only to small businesses. For example, special insurance options are available only to employers of fewer than 50 employees through the Small Business Health Options Program.

The small business health care tax credit is another feature of the ACA, but it is limited to employers of fewer than 25 employees. It is a sliding-scale credit that is based on the size of the employer. The larger the employer, the smaller the tax credit and vice versa. The maximum credit is 50% of premiums paid for small business employers or 35% of premiums paid for small tax-exempt employers.

The small business health care tax credit is available to eligible businesses for two consecutive tax years. If you have an eligible small business, and your business does not owe tax during any one year, the credit can be carried back or forward to other tax years. The excess amount you paid for employer health insurance premiums over the allowable credit can be claimed as a business expense deduction.

In order to claim the tax credit, you need to fill out Internal Revenue Service (IRS) Form 8941.

Who Qualifies for the Small Business Health Care Tax Credit?

According to the IRS, an employer with fewer than 25 full-time-equivalent (FTE) employees qualifies for the small business health care tax credit so long as it does all of the following three things:

  • Pays average wages of less than $56,000 per year for each FTE employee (indexed annually for inflation starting in 2014)
  • Offers a qualified health plan to its employees through the SHOP Marketplace (there are rare exceptions to this rule)
  • Pays at least 50% of the cost of the employee-only option for each employee

As mentioned above, the credit works on a sliding scale based on the size of the employer. The maximum credit is reduced if you have more than 10 FTE employees or if your average wage is more than $27,000 (also indexed annually for inflation).

Tax-exempt organizations are also eligible for the tax credit. If you have a tax-exempt business, the credit is refundable to the extent that it does not exceed your income tax withholding and Medicare tax liability. Refunds to tax-exempt organizations are subject to sequestration, which means the refundable amount will be reduced by the current fiscal year sequestration rate.

Employers don't have to cover 50% of the dependent or family health insurance options to qualify.

How to Calculate the Small Business Health Care Tax Credit

Calculating FTEs

One FTE employee equals 2,080 hours per year for the purpose of the tax credit. This is in contrast to other provisions in the ACA that consider 30 hours per week to be one FTE employee. Any number of part-time employees that adds up to 2,080 hours per year is equivalent to one FTE employee.

Hours worked by a single employee over 2,080 hours per year do not count toward FTE and are, therefore, excluded from the calculation. Any seasonal employees who worked fewer than 120 days per year should also be excluded from the calculation. However, the health insurance premiums paid by the employer for seasonal workers may still be included in the calculation of the credit amount.

The following should also be excluded from the calculation of FTE employees, and any premiums paid for these individuals should be excluded from the calculation of the credit amount:

  • Owner of a sole proprietorship
  • Partner in a partnership
  • Shareholder of an S Corporation owning more than 2%
  • Owner of more than 5% of a business
  • Family members of the above

Calculating Average Annual Wages

The total annual wages you pay to all of your eligible employees is divided by your total FTE employees to arrive at your average annual wage. For example, if you paid a total of $240,000 to your 10 FTE employees, you divide $240,000 by 10 to arrive at a $24,000 average annual wage.

Limit on Premiums

When calculating the small business health care tax credit, the employer-paid premiums are limited to the premium payment that would have been made if the employer paid the average premium for the small group market in the rating area. This means the tax credit is limited to the lesser of the actual premiums paid by the employer or the average premium that would have been paid for the small group market in the rating area in which the employee enrolls for coverage.

Let’s assume an employer has 10 total employees. The employer covers 50% of all employee-only and family options. Five employees are on an employee-only plan, and each one has a total premium of $4,000. Five employees are on a family plan, and each one has a total premium of $10,000. The total premiums paid were equal to $70,000 ((5 × $4,000) + (5 × $10,000)).

Half of that was paid by the employer for a total of $35,000 ($70,000 × 50%) in premiums on behalf of the employees. The average premium in the employer’s small group market was $6,000 for employee-only plans and $12,000 for family plans. Because the employer paid less than average for its area, it is able to use the full amount of premiums paid on behalf of employees in the calculation of the tax credit.

The average premium table for a given area is published by the Department of Health and Human Services annually.

The Bottom Line

Health insurance is a benefit that some small business owners think is beyond their economic grasp, even though it is attractive to both prospective and current employees. Governmental incentives such as the small business health care tax credit are there to help bridge the gap, allowing more Americans access to decent healthcare. Take a good look at the tax implications to see if it can help your small business.

Article Sources

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  1. HealthCare.gov. "The Small Business Health Care Tax Credit." Accessed Dec. 21, 2021.

  2. Internal Revenue Service. "Small Business Health Care Tax Credit and the SHOP Marketplace." Accessed Dec. 21, 2021.

  3. Internal Revenue Service. "Small Business Health Care Tax Credit Questions and Answers: Calculating the Credit." Accessed Dec. 21, 2021.

  4. Internal Revenue Service. "Affordable Care Act Tax Provisions for Small Employers." Accessed Dec. 21, 2021.

  5. Internal Revenue Service. "About Form 8941, Credit for Small Employer Health Insurance Premiums." Accessed Dec. 21, 2021.

  6. Internal Revenue Service. "Effect of Sequestration on State & Local Government Filers of Form 8038-CP." Accessed Dec. 21, 2021.