Here's what you need to know about the tax credit that can help owners of small businesses offset the cost of providing health insurance to their employees. It's also available to small tax-exempt organizations.

As a small business owner, you have many decisions to make regarding employee perks and benefits. Offering the right kind of benefits may entice experienced individuals to apply for open positions. Additionally, it can encourage current employees to stay with the company longer than they would otherwise. One of the most important employee benefits to consider is health insurance and this tax credit can help you do it, if your business or organization qualifies.

Key Takeaways

  • Your business may qualify for the small business health care tax credit if you have fewer than 25 employees, pay average wages less than $50,000 per employee, offer a qualified health plan through the SHOP Marketplace, and pay 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 employee through the Small Business Health Options Program (SHOP).

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. Additionally, the excess amount you paid for employer health insurance premiums over the allowable credit can still 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 $50,000 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

Please note, the employer does not have to cover 50% of the dependent or family health insurance options to qualify.

As mentioned above, the credit works on a sliding scale based on the size of the employer. If you have more than 10 FTE employees, or if your average wage is more than $25,000 (also indexed annually for inflation), the maximum allowed credit will be reduced.

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.

How to Calculate the Small Business Health Care Tax Credit

Calculating FTEs

For the purpose of the tax credit, one FTE employee equals 2,080 hours per year. 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.

Exclude from the calculation of FTE employees any hours worked by any one employee over 2,080 hours per year. 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 the 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 had paid the average premium for the small group market in the rating area. In other words, 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.  The average premium table for a given area is published by the Department of Health and Human Services annually.

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 x $4,000) + (5 x $10,000)).

Half of that was paid by the employer, so it paid $35,000 ($70,000 x 50%) in premiums on behalf of its employees. According to the DHHS table, 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 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 health care. Take a good look at the tax implications to see if it can help your small business.