Welcome to the second post in our series: "ACA Essentials: Does ACA Compliance for Small Businesses Apply to Me?"
In the last post, I focused on the major components of the ACA and the general health care reforms in place and in this post I'll talk about the health care tax credits for small businesses — formally known as the Small Business Health Care Tax Credit (HCTC).
Certain small employers that provide health coverage to employees may be eligible for a premium tax credit. The credit is designed to encourage small employers to offer, and maintain, group health insurance.
Eligible small employers may receive a tax credit of up to 50% of the employer's premium expenses. Note: For tax exempt employers, the maximum credit is 35%.
Basic Eligibility Requirements
To be eligible, the employer must have fewer than 25 full-time equivalent employees (FTEs) for the taxable year with average annual wages of less than $51,600 per FTE for the 2015 tax year. In addition, health insurance premium payments must be made under a "qualifying arrangement." Small employers must also purchase coverage online through the Small Business Health Options Program (SHOP) Marketplace in order to qualify for the credit.
Note: The total credit amount is reduced if the number of FTEs exceeds 10, or if the average annual wages exceed $25,800 for the 2015 tax year.
In order for an employer's premium payments to count for purposes of the credit, they must be made under a "qualifying arrangement." This means that for each employee enrolled in the health plan, the employer must pay the same percentage towards his or her premium expenses and the percentage must be at least 50%.
There are five steps for determining eligibility for the health care tax credits for small businesses:
- Determine Employees to Take into Account: With a few limited exceptions, all employees who perform service for the employer during the taxable year are to be considered when calculating the number of FTEs. Exceptions include sole proprietors, partners in business, shareholders owning more than 2% of an S corporation, owners of more than 5% of other businesses, and family members of these individuals. Seasonal workers are also excluded, unless the seasonal employee works more than 120 calendar days during the taxable year. However, premiums paid on their behalf may be counted in determining the amount of the credit.
- Determine Hours of Service: The IRS has defined hours of service to be each hour for which an employee is paid or entitled to payment for the performance of duties. Hours of service also includes paid time off for vacation and several other types of paid leave. The maximum number of hours that may be credited per employee is 2,080. To calculate the total hours of service, employers may refer to records of hours worked or use a days-worked equivalency (8 hours per day) or a weeks-worked equivalency (40 hours per week).
- Determine Number of FTEs: To determine the number of FTEs, divide the total hours of service credited during the year to employees taken into account (a maximum of 2,080 hours for each employee) by 2,080. Round down to the next lowest whole number. In some cases, an employer with 25 or more employees may qualify for the credit if some of its employees work part-time.
Note: The method used to determine the number of FTEs for purposes of the health care tax credit is different than the method used for determining whether the business has 50 or more FTEs for purposes of the employer mandate.
- Determine Average Annual Wages: To determine the average annual wages paid to FTEs, divide the total wages paid to employees taken into account during the taxable year by the number of FTEs. The result is rounded down to the nearest $1,000.
- Determine Premiums Paid: Determine the employer's portion of the premiums paid for the taxable year. For purposes of calculating the credit, employer-paid premiums are capped at the average premium for the small group market in the state that the employer offers coverage. The amount that exceeds the state average is excluded from the calculation of the credit. The list of average premiums for the small group market in each state for the taxable year is available on the IRS Form 8941 instructions.
Claiming the Credit
The credit is a general business credit and is claimed on the eligible employer's annual income tax return. For tax years 2014 and beyond, eligible employers can only claim the credit for two consecutive years. IRS Form 8941 can be used by both small businesses and tax-exempt organizations to calculate the credit. A small business can then include the amount of the credit as part of the general business credit on its income tax return. Tax-exempt organizations can claim the credit on a revised Form 990-T.
In the next installment we'll talk about the SHOP marketplace – where small employers must purchase health insurance in order to qualify for the health care tax credit.
In the meantime, I invite you to subscribe to ADP's Eye on Washington to help you stay on top of ACA guidelines and deadlines.
Read the rest of the series.
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