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Health Care Tax Credit for Small Businesses

Federal tax credit of up to 35% of employer-paid health insurance premiums

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Small businesses may be eligible for a federal tax credit based on health insurance premiums paid for employees. As part of the health care reform effort, the federal government is providing an incentive for small businesses to provide health insurance coverage for their employees. The Small Business Health Care Tax Credit provides a federal tax credit of up to 35% of employer-paid health insurance premiums. As with all tax credits, there are rules and limitations.

Health Care Tax Credit Amounts

  • 35% of eligible premiums -- for 2010 through 2013
  • 50% of eligible premiums -- beginning in 2014

Qualifying for the Health Care Tax Credit

There's a three-part test for see if a small business qualifies for the health care tax credit:
  • The business must have less than 25 full-time equivalent employees
  • The average wage of employees must be less than $50,000 per full-time equivalent employee
  • Health insurance premiums must be paid through a "qualifying arrangement"

No Tax Credit for Owners of the Business

Small businesses cannot take a tax credit for insurance premiums paid for owners of the business. This means that owners of corporations, partners in a partnership, and sole proprietors. For small businesses structured as a C-corporation, no tax credit is available for employees who own 5% or more of the corporation. For S-corporations, no tax credit is available for employees who own 2% or more of the S-corporation. Source: Internal Revenue Code, section 45R, paragraph (e)(1).

Partners, members of LLC treated as a partnership, owners of a single-member LLC, S-corporation shareholders owning 2% or more of an S-corporation, and sole proprietors are all treated as self-employed persons for health insurance purposes, and are eligible for the self-employed health insurance deduction instead of the tax credit.

Employer Must Pay at Least Half of the Insurance Premiums

So far the IRS is applying the term "qualifying arrangement" to any scenario in which the small business pays at least half of the health insurance premiums for its employees. In a set of frequently asked questions, the IRS clarified that this 50% test applies only to employee-only health coverage. So a scenario is which the employers pays half of the employee-only coverage, and the employee pays all the premiums for covering spouse and children would still qualify for the tax credit.

3 Limitations That Reduce the Health Care Tax Credit

Small employers may not qualify for the full amount of the credit. The 35% credit amount represents a maximum amount for the tax credit. The credit must be reduced (or phased out) in the following circumstances:
  • The number of full-time equivalent employees exceeds ten,
  • Average annual wages exceeds $25,000 per full-time equivalent, or
  • Actual health insurance premiums exceed average premiums paid for health coverage in the employer's area.
In Revenue Ruling 2010-13 (pdf, 4 pages), the IRS has set forth average health insurance premiums by state that can be used for 2010. Average health insurance premiums will be determined by the Department of Health and Human Services and published by the IRS.

Claiming the Health Care Tax Credit

The Health Care Tax Credit will be claimed using Form 8941 and attached to the business's tax return. The health care credit will reduce any income tax for the business. The credit is non-refundable (in other words, it can reduce income tax to at most zero). The credit cannot offset payroll tax or self-employment tax liabilities for small business owners. The IRS has also published some frequently asked questions about the health care credit and simplified worksheet (pdf) for seeing if a business might be eligible for the tax credit.

Can Businesses Take a Deduction for Health Insurance Premiums?

Small businesses can take both a deduction for health insurance premiums as the health care tax credit. However, the amount of the deduction must be reduced by the amount of the tax credit.

Planning Tips for the Health Care Tax Credit

Small businesses should review their accounting systems to make sure they are keeping track of employer-paid and employee-paid health insurance premiums. This will become vitally important as employers will need to report the value of health insurance benefits on employees' W-2 Forms starting in 2011.

Additionally, business owners will want to review how they structure their health benefits. For example, owners may want to revise what percentage of health insurance premiums they want to pay so as to be eligible for the tax credit.

Business may also want to calculate different scenarios such as paying 50% of the insurance premiums, or 60%, or 100%, or taking only the deduction instead of the tax credit. This could help reveal the most cost-efficient way to structure health benefits for employees.

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