Second wave of detailed guidance on new small business health care credit

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1 Page 1 of 5 Checkpoint Contents Federal Library Federal Editorial Materials Federal Taxes Weekly Alert Newsletter Preview Documents for the week of 12/09/ Volume 56, No. 49 Articles Second wave of detailed guidance on new small business health care credit (12/09/2010) Federal Taxes Weekly Alert, Second wave of detailed guidance on new small business health care credit Notice , IRB ; IR IRS has issued the second wave of detailed guidance on the small employer health insurance credit created by the Patient Protection and Affordable Care Act (Affordable Care Act, P.L ). The guidance sheds further light on this complex new credit, including which employers qualify for the credit and which employees may be counted for credit purposes. It includes new rules for satisfying the Code Sec. 45R uniformity requirement. IRS also issued the final version of Form 8941 (Credit for Small Employer Health Insurance Premiums) and its Instructions. Health Care Credit Essentials Background. Under the Affordable Care Act, effective for tax years beginning after Dec. 31, 2009, an eligible small employer (ESE) may claim a tax credit for nonelective contributions to purchase health insurance for its employees. ( Code Sec. 45R ) An ESE is an employer with no more than 25 full-time equivalent employees (FTEs) employed during its tax year, and whose employees have annual full-time equivalent wages that average no more than $50,000. ( Code Sec. 45R(d) ) However, the full credit is available only to an employer with 10 or fewer FTEs and whose employees have average annual fulltime equivalent wages from the employer of not more than $25,000. ( Code Sec. 45R(c) ) Aggregation rules apply in determining the employer. ( Code Sec. 45R(b) ) The contributions must be provided under a qualifying arrangement, i.e., one requiring the ESE to make a nonelective contribution for each employee who enrolls in certain defined qualifying health insurance offered by the ESE equal to a uniform percentage (not less than 50%) of the premium cost of the qualifying health plan. ( Code Sec. 45R(d)(4) ) The credit is a general business credit, can be carried back for one year and carried forward for 20 years, and can offset alternative minimum tax. ( Code Sec. 38(b), Code Sec. 39(a) ), Code Sec. 38(c) (4)(B)(vi) ) Qualifying health insurance during initial credit phase. For any tax year beginning in 2010, 2011, 2012, or 2013, qualifying health insurance is health insurance coverage within the meaning of Code Sec. 9832(b)(1) (generally health insurance coverage bought from a State licensed insurance company). ( Code Sec. 45R(g)(2) ) Calculation of credit amount. For tax years beginning before 2014, the credit is equal to the lesser of the following two amounts multiplied by an applicable tax credit percentage: (1) Total nonelective contributions the ESE made on behalf of the employees during the tax year for the qualifying health coverage. (2) Total nonelective contributions the ESE would have paid if each employee were enrolled in a

2 Page 2 of 5 plan that had a premium equal to the average premium for the small group market in the State (or in an area in the State) in which the employer is offering health insurance coverage. Health and Human Services (HHS) determines whether separate average premiums apply for areas within a State and also determines the average premium for a State or sub-state area. ( Code Sec. 45R(b) ) RIA observation: In Rev Rul , IRB, IRS released a state-by-state table of average health insurance premiums for the small group market for the 2010 tax year; see Weekly Alert 4 05/06/2010. The applicable percentage is 35% for tax years beginning after 2009 and before 2014 (25% for tax exempts) and is 50% for tax years beginning after 2013 (35% for tax-exempts). For exempts, the credit is a refundable tax credit limited to the amount of the employer's payroll taxes (income tax and Medicare tax withheld from employees' wages and the employer share of Medicare tax on employees' wages) during the calendar year in which the tax year begins. The credit is reduced for an ESE if: (1) It has more than 10 FTEs but not more than 25 FTEs. Find the number of FTEs by dividing (1) the total hours for which the ESE pays wages to employees during the year (but not more than 2,080 hours for any employee) by (2) 2,080. (2) Average wages per employee are between $25,000 and $50,000. ( Code Sec. 45R(c) ) Find average annual wages by dividing (a) total wages (as defined for FICA purposes, without regard to the wage base limitation) paid to employees during the ESE's tax year by (2) the number of the FTEs for the year. Round the result down to the nearest $1,000 (if not otherwise a multiple of $1,000). ( Code Sec. 45R(d)(3)(A), Code Sec. 45R(e)(4) ) If an ESE has more than 10 FTEs and average annual wages exceed $25,000, the credit reduction is the sum of the amount of the two reductions above. The Code Sec. 45R credit reduces the employer's Code Sec. 162 deduction for contributions to employees' health insurance coverage. ( Code Sec. 45R (e)(5) ) A sole proprietor, a partner in a partnership, a shareholder owning more than 2% of an S corporation, any owner of more than 5% of other businesses, a family member of any of these individuals, or a member of such a business owner's or partner's household: (1) are not considered employees for Code Sec. 45R purposes, (2) their wages or hours are not counted in determining either the number of FTEs or the amount of average annual wages, and (3) premiums paid on their behalf are not counted in determining the amount of the credit. ( Code Sec. 45R(e) ) Earlier Guidance on Health Care Credit In April, IRS issued preliminary guidance on the Code Sec. 45R credit in the form of frequently asked questions (FAQs) posted on its website; see Weekly Alert 1 04/08/2010. Notice , IRB 717, issued in May, formalized much of the guidance in April's FAQs, but also contained new guidance as well as clarification of points raised in the FAQs. The guidance in Notice covered: how to determine hours of service worked; finding the number of FTEs; how health insurance coverage is defined for purposes of Code Sec. 45R, and how to treat state credits or subsidies for health insurance (see Weekly Alert 4 05/20/2010 ). Notice , also provided transition relief for the uniformity requirement. For a tax year beginning in 2010, an employer that pays an amount equal to at least 50% of the premium for single (employeeonly) coverage for each employee enrolled in coverage is deemed to satisfy the uniformity requirement for a qualifying arrangement, even if the employer does not pay the same percentage of the premium for each employee. Thus, an employer meets the uniformity requirement if it pays at least 50% of single-coverage premiums for each employee receiving single coverage, and, if the employer offers

3 Page 3 of 5 more-expensive coverage (e.g., family or self-plus-one coverage), if it pays an amount for each employee receiving that more expensive coverage that is no less than 50% of the premium for single coverage for that employee (even if it is less than 50% of the premium for the more expensive coverage the employee is actually receiving). ( Notice , Sec. V. ) New Guidance on Health Care Credit New Notice expands on guidance in Notice , and provides new rules as well. Here's a summary. Who may claim the credit. IRS says that:... Tax-exempt organizations are ineligible for the Code Sec. 45R credit if they are not both described in Code Sec. 501(c) and exempt from taxation under Code Sec. 501(a). But a Code Sec. 521 farmers cooperative that is subject to tax under Code Sec may be eligible.... An employer otherwise qualifying for the Code Sec. 45R credit does not fail to be an ESE merely because his employees are not performing services in a trade or business. For example, a household employer that otherwise satisfies the requirements of Code Sec. 45R is eligible for the credit.... An ESE located outside the U.S. (including one located in a U.S. territory), which has income effectively connected with the conduct of a trade or business in the U. S., may claim the Code Sec. 45R credit only if it pays premiums for an employee's health insurance coverage that is issued in and regulated by one of the 50 States or the District of Columbia. A similar rule applies to tax-exempt ESEs.... Solely for Code Sec. 45R purposes, an arrangement under which a small church employer pays premiums for employees receiving medical care provided through a church welfare benefit plan may be a qualifying arrangement and a small church employer paying for employees' medical coverage under such a plan may be a tax-exempt eligible small employer. Employees taken into account. Notice sheds light on the following points: For purposes of Code Sec. 45R, an employee-spouse of any of the following is not taken into account: (1) a more-than-2% S shareholder; (2) a more-than-5% owner of a business; (3) a partner owning more than a 5% interest in a partnership; and (4) a sole proprietor. Leased employees are counted in figuring an employer's FTEs and average annual wages, but premiums for health insurance coverage paid by a leasing organization for a leased employee are not taken into account by the service recipient in computing the service recipient's Code Sec. 45R credit. In general, all employees of the employer during the year for which the credit is being claimed are counted when computing FTEs and annual average wages, including, for example, former employees who terminated employment during the year for which the credit is being claimed, employees covered under a collective bargaining agreement, and employees who don't enroll in their employer's health insurance plan (whether or not they have other coverage). A minister who is an employee under the common law test is taken into account in determining an employer's FTEs, and premiums paid for the minister's health insurance coverage can be taken into account in computing the credit, subject to limitations on the credit. But because compensation of a minister performing services in the exercise of his or her ministry is not subject to Social Security or Medicare tax under the Federal Insurance Contributions Act (FICA), a minister has no wages as defined under Code Sec. 3121(a) for purposes of computing an employer's average annual wages. Finding average annual wages. Under Notice , average annual wages may be computed by way of three different methods (actual hours worked, days-worked equivalency, weeks-worked equivalency). Notice , explains that employers need not use the same method for all employees, but may apply different methods for different classifications of employees, if the classifications are reasonable and consistently applied. For example, an employer may use the actual

4 Page 4 of 5 hours worked method for all hourly employees and the weeks-worked equivalency method for all salaried employees. Also, employers may change the method for calculating employees' hours of service for each tax year. What qualifies as a health insurance plan. Employer contributions to a multiemployer plan that are used to pay premiums for employee health insurance coverage (but not for welfare-type benefits, such as disability) are treated as payment of health insurance premiums by the employer. Moreover, if 100% of the cost of coverage under the multiemployer plan is paid from nonelective employer contributions, and not by employees, each employer in the multiemployer plan is considered to be contributing a uniform percentage of 100% of the premium on behalf of each employee covered by the plan. An employer's self-insured plan, including a health reimbursement arrangement (HRA) or health flexible spending arrangement (health FSA), or self-insured coverage provided through a multiemployer plan, isn't a health insurance plan for Code Sec. 45R purposes. Health savings accounts (HSAs) are also not health insurance coverage. Meeting the uniformity requirement. Notice carries comprehensive rules for applying the uniformity requirement for tax years beginning after 2009 and before 2014, but for tax years beginning in 2010, taxpayers may instead use the transition rules carried in Notice (see above). An employer offering only one health insurance plan will satisfy the uniformity requirement as follows: (a) If its health insurer uses composite billing (charges a uniform premium for each employee, or charges a single aggregate premium for the group of covered employees that the employer may then divide by the number of covered employees to determine the uniform premium), an employer providing self-only coverage must pay the same amount for the premium for each employee receiving self-only coverage, so long as that amount is equal to at least 50% of the self-only premium. (b) If its health insurer uses composite billing, an employer that provides tiers of coverage other than self-only coverage (i.e., self plus one, or family coverage) must pay an amount for each employee enrolled in that more expensive tier of coverage that is the same for all employees and that is no less than the amount that the employer would have contributed toward self-only coverage for that employee. Alternatively, an employer that offers a tier of coverage that is more expensive than self-only coverage may meet the requirements of (a), above, for each tier of coverage that it offers. (c) If its health insurer uses list billing (i.e., it lists a separate premium for each employee based on age or other factors), the employer must with respect to self-only coverage either: (1) pay toward the premium an amount equal to a uniform percentage (not less than 50%) of the premium charged for each employee or (2) convert the individual premiums for self-only coverage into an employer-computed composite rate (total premiums divided by total number of eligible employees) for self-only coverage, and, if an employee contribution is required, each employee receiving coverage pays a uniform amount toward the self-only premium that is no more than 50% of the employer-computed composite rate for self-only coverage. (d) If its health insurer uses list billing, an employer that offers a more expensive tier of coverage than individual coverage must pay toward the premium for each employee covered under that tier of coverage an amount equal to the amount that the employer would have contributed with respect to that employee for self-only coverage (based on the actual premium that would have been charged by the insurer for that employee for self-only coverage or on the employer-computed composite rate for self-only coverage). Alternatively, the employer may meet the requirements of (b), above, for each tier of coverage that it offers and substitute the employer-computed composite rate for that tier of coverage for the employer-computed composite rate for self-only coverage. Other rules. A separate set of uniformity rules applies to employers offering more than one health insurance plan (i.e., more than one benefit package), and an anti-abuse rule applies to certain employers offering more than one plan. Additionally, Notice provides guidance for how employers should calculate the credit under Code Sec. 45R(b)(2) for the tax year beginning after Dec.

5 Page 5 of 5 31, 2009, if they have employees in multiple states. How to claim the health care credit. The Code Sec. 45R credit is claimed on Form 8941 (Credit for Small Employer Health Insurance Premiums), which was released in final form on Dec. 2, along with its Instructions. Eligible small businesses use Form 8941 to figure the credit and then include the amount of the credit as part of the general business credit on its income tax return. Tax-exempt organizations use Form 8941 to figure their refundable credit, and then claim the credit on Line 44f of Form 990-T (Exempt Organization Business Income Tax Return). Though primarily filed by those organizations liable for the tax on unrelated business income, Form 990-T is also be used by any eligible tax-exempt organization to claim the Code Sec. 45R credit, regardless of whether they are subject to this tax. References: For small employer health insurance credit, see FTC 2d/FIN L ; United States Tax Reporter 45R4 ; TG END OF DOCUMENT Thomson Reuters/RIA. All rights reserved.

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