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The Small Business Health Care Tax Credit

This credit is designed to help you offset the costs of providing health insurance to your employees.

Beginning in 2014, if you're a small employer and meet certain requirements, the credit can be up to 50% (35% for eligible tax exempt employers) of the premiums you pay for providing health insurance.

This information is only an overview to help you understand the credit and how it can benefit you.

You can find more details about the credit and its requirements from the IRS at Affordable Care Act Tax Provisions and from the Instructions for Form 8941.

Eligible Small Employers

There are three basic requirements to be eligible for the Small Business Health Care Tax Credit. They are:

  1. You paid premiums for employee health insurance coverage under a qualifying arrangement.
  2. You had fewer than 25 full-time equivalent employees (FTEs) for the tax year.
  3. You paid average annual wages for the tax year of less than $52,000 per FTE in 2015.

Employers treated as a single employer

The following employers are treated as a single employer to figure the credit:

  • Employers who are corporations in a controlled group of corporations.
  • Employers who are members of an affiliated service group.
  • Employers who are partnerships, proprietorships, etc., under common control. See Regulations sections 1.414(c)-2, 1.414(c)-3, and 1.414(c)-4.
  • Tax-exempt employers under common control. See Regulations section 1.414(c)-5.
For details, see section 45R(e)(5)(A) and Regulations section 1.45R-2(b).

Unless an exception applies, only one Form 8941 can be filed with a tax return. See the instructions for Form 8941 for additional information.

Credit Period

Beginning in 2014, the credit period during which the credit can be claimed is a 2 consecutive tax year period beginning with the first tax year in which:

  • An eligible small employer (or any predecessor) files an income tax return with an attached Form 8941, or
  • A tax-exempt eligible small employer (or any predecessor) files Form 990-T with an attached Form 8941.

Example

If you claimed the credit for 2013 and 2014, the first year of your credit period is 2014. If you meet the requirements, you can claim the credit again for 2015. However, for 2016 and forward you may no longer claim the credit.

Eligible Employees

In general, all employees who perform services for you during the tax year are taken into account in determining your FTEs, average annual wages, and premiums paid.

You can generally calculate your FTEs by adding up the hours of service for all of your employees (but not more than 2,080 hours per employee) and then dividing that by 2,080 (which is a full time employee - 40 hours a week at 52 weeks per year).

Former Employees

Premiums paid on behalf of a former employee with no hours of service may be treated as paid on behalf of an employee for purposes of figuring the credit provided that, if so treated, the former employee is also treated as an employee for purposes of the uniform percentage requirement.

Leased Employees

Do not use premiums paid by the leasing organization to figure your credit. Also, a leased employee who is not a common law employee is considered an employee for credit purposes if he or she does all the following:

  • Provides services to you under an agreement between you and a leasing organization,
  • Has performed services for you (or for you and a related person) substantially full time for at least 1 year, and
  • Performs services under your primary direction or control.

But do not use hours, wages, or premiums paid with respect to the initial year of service on which leased employee status is based.

Seasonal Employees

Employees who perform labor or services on a seasonal basis and perform labor or services for you 120 or fewer days during the tax year are not considered employees in determining FTEs and average annual wages. But premiums paid on their behalf are counted in determining the amount of the credit.

Seasonal workers include retail workers employed exclusively during holiday seasons. Seasonal workers also include workers employed exclusively during the summer.

Household and Other Nonbusiness Employees

Household employees and other employees who are not performing services in your trade or business are considered employees if they otherwise qualify as discussed above. A sole proprietor must include both business and nonbusiness employees to determine FTEs, average annual wages, and premiums paid.

Ministers

A minister performing services in the exercise of his or her ministry is treated as self-employed for Social Security and Medicare purposes.

However, for credit purposes, whether a minister is an employee or self-employed is determined under the common law test for determining worker status. Self-employed ministers are not considered employees.

Excluded Employees

The following individuals are not considered employees when you figure this credit. Hours and wages of these employees and premiums paid for them are not counted when you figure your credit.

  • The owner of a sole proprietorship.
  • A partner in a partnership.
  • A shareholder who owns (after applying the section 318 constructive ownership rules) more than 2% of an S corporation.
  • A shareholder who owns (after applying the section 318 constructive ownership rules) more than 5% of the outstanding stock or stock possessing more than 5% of the total combined voting power of all stock of a corporation that is not an S corporation.
  • A person who owns more than 5% of the capital or profits interest in any other business that is not a corporation.
  • Family members or a member of the household who is not a family member but qualifies as a dependent on the individual income tax return of a person listed above. Family members include:
    • A child (or descendant of a child),
    • A sibling or step-sibling,
    • A parent (or ancestor of a parent),
    • A step-parent,
    • A niece or nephew,
    • An aunt or uncle,
    • A son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law.
    A spouse is also considered a family member for this purpose.

Counting Employee Hours of Service

Count both the time your employees worked for you and for the time that you paid (and were supposed to pay) them for time off, such as vacation, holidays, illness, incapacity (including disability), layoff, jury duty, military duty, or leave of absence.

Also, if any of your employees took more than 160 hours of continuous paid time off (as described above) you only need to count the first 160 hours. If your employees have more than 2,080 hours, only count the first 2,080.

You can count your employees' time by one of three methods:

  1. Actual Hours: Determine actual hours of service from records of hours worked and hours for which payment is made or due.
  2. Days-worked equivalency: Your employee is credited with 8 hours of work each day he or she worked (and received paid time off) for you at least one hour.
  3. Weeks-worked equivalency: Your employee is credited with 40 hours of work for each week he or she worked (and received paid time off) for you at least one hour.

Your credit will begin to phase out if you have more than 10 FTEs and completely phases out if you have 25 or more.

Qualifying Arrangement

A qualifying arrangement 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.

An arrangement that offers different tiers of coverage (for example, self-only, self-plus one, and family coverage) is generally a qualifying arrangement if it requires you to pay a uniform percentage (not less than 50%) separately for each tier of coverage you offer.

Beginning in 2014, to be a qualifying arrangement you must also purchase your employees' insurance through a SHOP Marketplace.

Example

You pay 50% of the cost of self-coverage for all your employees. This leaves your employees who are enrolled in more expensive coverage - such as self plus one or family - to pay the additional cost.

Then, even though you pay less than 50% of the cost of self plus one and family coverage, you may still be eligible because you paid 50% of what would have been charged for self-coverage.

Average Annual Wages

You can find the average annual wages you paid to your FTEs by dividing the total wages you paid to all your employees (other than the employees that aren't counted) by the number of your FTEs.

However, only count the wages subject to Social Security and Medicare withholding, disregarding the wage base limit.

The wage phaseout is indexed to inflation. For 2015, the credit will begin to phase out when the average annual wages are more than $25,000 and falls to zero when the wages reach $52,000. This phaseout is in addition to the FTE phase out.

Premiums You Pay

You can claim the credit only for premiums you paid for health insurance coverage under a qualifying arrangement, and only for people counted as employees for credit purposes.

Wellness programs.

A wellness program is generally an insurance program of health promotion or disease prevention. If you pay part or all of the cost of an employee's participation in a wellness program, use the amount you paid to figure your employer premiums paid.

Tobacco surcharges.

A tobacco surcharge is generally an additional amount charged for insurance for a tobacco user. If you pay part or all of an employee's tobacco surcharge, you cannot use the amount you paid to figure your employer premiums paid.

Dependent coverage.

Dependent coverage is generally coverage offered separately to an individual who is or may become eligible for coverage under the terms of a group health plan because of a relationship to a participant-employee, whether or not a dependent of the participant-employee. Dependent coverage does not include coverage, such as family coverage, which includes coverage of the participant-employee.

If you pay part or all of the cost of an employee's dependent coverage, use the amount you paid to figure your employer premiums paid.

Portion of premiums paid.

If you pay only a portion of the premiums and your employees pay the rest, only the portion you pay is taken into account. For this purpose, any premium paid through a salary reduction arrangement under a section 125 cafeteria plan is not treated as an employer paid premium. For more information on cafeteria plans, see section 1 of Publication 15-B, Employer's Tax Guide to Fringe Benefits.

Limitations on the Credit

State Average Premium Limitation

The amount of your premium payments that are taken into account in calculating the credit is limited to the premium payments you would have made under the same arrangement if the average premium for the small group market in the rating area in which your employees enroll for coverage were substituted for the actual premium.

State Premium Subsidy and Tax Credit Limitation

Your credit may be reduced if you are entitled to a state tax credit or a state premium subsidy for the cost of health insurance coverage you provide under a qualifying arrangement to individuals considered employees. The state tax credit may be refundable or nonrefundable and the state premium subsidy may be paid to you or directly to your insurance provider.

Although a state tax credit or premium subsidy paid directly to you does not reduce the amount of your employer premiums paid, and a state premium subsidy paid directly to an insurance provider is treated as an employer premium you paid, the amount of your credit cannot be more than your net premium payments. Net premium payments are employer premiums paid minus the amount of any state tax credits you received or will receive and any state premium subsides paid either to you or directly to your insurance provider for premiums for health insurance coverage you provide under a qualifying arrangement to individuals considered employees.

Payroll Tax Limitation for Tax-Exempt Small Employers

If you are an eligible tax-exempt small employer, the credit cannot exceed the amount of certain payroll taxes. For tax years beginning in 2015, payroll taxes, for this purpose, mean only the following taxes:

  • Federal income taxes you were required to withhold from employees' wages in calendar year 2015.
  • Medicare taxes you were required to withhold from employees' wages in calendar year 2015.
  • Medicare taxes you were required to pay for calendar year 2015.

The Small Business Health Options Program Marketplace

The SHOP Marketplace is an online health insurance marketplace where you can shop for and purchase insurance to offer to your employees.

You may be able to purchase health insurance for your employees through the SHOP Marketplace if you have fewer than 50 full time (or equivalent) employees (FTEs). For purposes of the SHOP Marketplace, a full time employee is an employee that is employed, on average, either:

  • 30 hours of service per week or
  • 130 hours of service per calendar month

For your other employees, determine the full time equivalents by adding their hours worked for each month (not more than 120 for each employee), and dividing that amount by 120.

SHOP eligibility is based on many factors, including your FTEs, but the requirements can vary from state to state. For more information about the eligibility requirements for SHOP, visit Healthcare.gov.

KEY TERMS

Eligible Employees

In general, all employees who perform services for you during the tax year are taken into account in determining your FTEs, average annual wages, and premiums paid.

You can generally calculate your FTEs by adding up the hours of service for all of your employees and then dividing that by 2,080 (which is a full time employee - 40 hours a week at 52 weeks per year).

Former Employees

Premiums paid on behalf of a former employee with no hours of service may be treated as paid on behalf of an employee for purposes of figuring the credit provided that, if so treated, the former employee is also treated as an employee for purposes of the uniform percentage requirement.

Leased Employees

Do not use premiums paid by the leasing organization to figure your credit. Also, a leased employee who is not a common law employee is considered an employee for credit purposes if he or she does all the following:

  • Provides services to you under an agreement between you and a leasing organization,
  • Has performed services for you (or for you and a related person) substantially full time for at least 1 year, and
  • Performs services under your primary direction or control.

But do not use hours, wages, or premiums paid with respect to the initial year of service on which leased employee status is based.

Seasonal Employees

Employees who perform labor or services on a seasonal basis and perform labor or services for you 120 or fewer days during the tax year are not considered employees in determining FTEs and average annual wages. But premiums paid on their behalf are counted in determining the amount of the credit.

Seasonal workers include retail workers employed exclusively during holiday seasons. Seasonal workers also include workers employed exclusively during the summer.

Household and Other Nonbusiness Employees

Household employees and other employees who are not performing services in your trade or business are considered employees if they otherwise qualify as discussed above. A sole proprietor must include both business and nonbusiness employees to determine FTEs, average annual wages, and premiums paid.

Ministers

A minister performing services in the exercise of his or her ministry is treated as self-employed for Social Security and Medicare purposes.

However, for credit purposes, whether a minister is an employee or self-employed is determined under the common law test for determining worker status. Self-employed ministers are not considered employees.

Excluded Employees

The following individuals are not considered employees when you figure this credit. Hours and wages of these employees and premiums paid for them are not counted when you figure your credit.

  • The owner of a sole proprietorship.
  • A partner in a partnership.
  • A shareholder who owns (after applying the section 318 constructive ownership rules) more than 2% of an S corporation.
  • A shareholder who owns (after applying the section 318 constructive ownership rules) more than 5% of the outstanding stock or stock possessing more than 5% of the total combined voting power of all stock of a corporation that is not an S corporation.
  • A person who owns more than 5% of the capital or profits interest in any other business that is not a corporation.
  • Family members or a member of the household who is not a family member but qualifies as a dependent on the individual income tax return of a person listed above. Family members include:
    • A child (or descendant of a child),
    • A sibling or step-sibling,
    • A parent (or ancestor of a parent),
    • A step-parent,
    • A niece or nephew,
    • An aunt or uncle,
    • A son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law.
    A spouse is also considered a family member for this purpose.

Eligible Tax Exempt Employers

A tax-exempt small employer is an eligible small employer described in section 501(c) that is exempt from taxation under section 501(a). A tax-exempt employer not described in section 501(c) is generally not eligible to claim this credit. However, a tax-exempt farmers' cooperative subject to tax under section 1381 may be able to claim it as a general business credit.

Hours of Service

Count both the time your employees worked for you and for the time that you paid (and were supposed to pay) them for time off, such as vacation, holidays, illness, incapacity (including disability), layoff, jury duty, military duty, or leave of absence.

Also, if any of your employees took more than 160 hours of continuous paid time off (as described above) you only need to count the first 160 hours. If your employees have more than 2,080 hours, only count the first 2,080.

Net Premium Payments

In the case of an employer receiving a State tax credit or State subsidy for providing health insurance to its employees, net premium payments are the excess of the employer’s actual premium payments over the State tax credit or State subsidy received by the employer.

In the case of a State payment directly to an insurance company (or another entity licensed under State law to engage in the business of insurance), the employer’s net premium payments are the employer’s actual premium payments.

If a State-administered program (such as Medicaid or another program that makes payments directly to a health care provider or insurance company on behalf of individuals and their families who meet certain eligibility guidelines) makes payments that are not contingent on the maintenance of an employer-provided group health plan, those payments are not taken into account in determining the employer’s net premium payments.

Payroll Tax Limitation for Tax-Exempt Small Employers

If you are an eligible tax-exempt employer, your credit cannot exceed the amount of certain payroll taxes. Payroll taxes, for this purpose, mean only the following:

  • Federal income taxes and Medicare taxes you were required to withhold from employees’ wages during the calendar year.
  • Medicare taxes you were required to pay for the calendar year.

State

The state is where your employee is enrolled in coverage. It is used in determining whether the State Average Premium Limitation applies.

State Average Premium Limitation

The amount of your premium payments that are taken into account in calculating the credit is limited to those you would have made under the same arrangement if the average premium for the small group market in the rating area in which your employees enroll for coverage were substituted for the actual premium.

State Subsidies and Tax Credits

Your credit may be reduced if you are entitled to a state tax credit or a state premium subsidy for the cost of health insurance coverage you provide under a qualifying arrangement to individuals considered employees. The state tax credit may be refundable or nonrefundable and the state premium subsidy may be paid to you or directly to your insurance provider.

Although a state tax credit or premium subsidy paid directly to you does not reduce the amount of your employer premiums paid, and although a state premium subsidy paid directly to an insurance provider is treated as an employer premium you paid, the amount of your credit cannot be more than your net premium payments. Net premium payments are employer premiums paid minus the amount of any state tax credits you received or will receive and any state premium subsides paid either to you or directly to your insurance provider for premiums for health insurance coverage you provide under a qualifying arrangement to individuals considered employees.

Total Wages

Wages, for this purpose, mean wages subject to Social Security and Medicare tax withholding determined without considering any wage base limit. If an individual is not considered an employee or is an excluded employee, his or her wages do not count. This includes:

  • Wages paid to any seasonal employees who worked 120 or fewer days during the tax year; and
  • Wages paid with respect to the initial year of service on which leased employee status is based.

Wages or compensation paid to ministers who are common-law employees for duties performed in the exercise of their ministry are not subject to FICA taxes and are not wages as defined in § 3121(a). So the wages of a minister who is a common law employee are not taken into account.

Short Taxable Year If an employer has a short taxable year, wages must be pro-rated (or annualized) in calculating the credit. For example, if a small employer has been in business (and paying premiums) for 6 months during its first taxable year, it must pro-rate the wages earned to reflect the 6 months the employer has been in operation.