# Small Employer Health Care Tax Credit: Questions & Answers (Q&A)

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5 Q. How is the credit reduced if the number of FTEs exceeds 10 or average annual wages exceed \$25,000? A. Formulas help determine the effect of having more than 10 FTEs or average annual wages that exceed \$25,000. For each FTE above 10 the credit is reduced by 1/15. For each \$1,000 above \$25,000 in average annual wages the credit is reduced by 1/25. Example 1 (for qualified employers that are NOT tax-exempt organizations): For the 2010 tax year, the employer has 12 FTEs and average annual wages of \$30,000. The employer pays \$96,000 in health care premiums for those employees, which does not exceed the average premium for the small group market in the employer's state. For eligible employers that are NOT tax-exempt organizations, the credit is calculated as follows: 1. Initial amount of credit determined before any reduction: (35 percent x \$96,000) = \$33, Credit reduction for FTEs in excess of 10: (\$33,600 x 2/15) = \$4, Credit reduction for average annual wages in excess of \$25,000: (\$33,600 x \$5,000/\$25,000) = \$6, Total credit reduction: (\$4,480 + \$6,720) = \$11, Total 2010 tax credit: (\$33,600 \$11,200) = \$22,400 Example 2 (For qualified employers that ARE tax-exempt organizations): For the 2010 tax year, the employer has 12 FTEs and average annual wages of \$30,000. The employer pays \$96,000 in health care premiums for those employees, which does not exceed the average premium for the small group market in the employer's state. The total amount of the employer s income tax and Medicare tax withholding plus the employer s share of the Medicare tax equals \$30,000 in For eligible employers that ARE tax-exempt organizations the credit is calculated as follows: 1. Initial amount of credit determined before any reduction: (25 percent x \$96,000) = \$24, Credit reduction for FTEs in excess of 10: (\$24,000 x 2/15) = \$3, Credit reduction for average annual wages in excess of \$25,000: (\$24,000 x \$5,000/\$25,000) = \$4, Total credit reduction: (\$3,200 + \$4,800 = \$8,000) 5. Employer s withholding and Medicare taxes: \$30, Total 2010 tax credit: (\$24,000 \$8,000) = \$16,000 (the lesser of \$16,000 and \$30,000). Q. Do premiums count if they were paid by the employer in 2010 before the new health reform legislation was enacted? A. Yes. In computing the credit for a tax year beginning in 2010, employers may count all qualified premiums for that tax year. Q. What effect do state credits and state subsidies for health insurance have on the amount of the federal health care tax credit? A. Some states offer tax credits or a premium subsidy to certain small employers who provide health insurance to their employees. Generally, the premium subsidy is in the form of direct payments to the employer or to the employer s insurance company. The effect these credits and subsidies on an employer s federal health care tax credit depends on whether the direct payment goes to the employer or the insurance company. 5

7 The employer s net premium payment is \$20 (the amount actually paid by the employer excluding the state subsidy). After applying the limit for the employer s net premium payment, the federal health care tax credit is \$20 per month (the lesser of \$24.50 or \$20). Q. Do church welfare benefit plans qualify? A. When a small church employer that is qualified in other respects pays premiums for employees under a church welfare benefit plan, that may be a qualifying arrangement for purposes of the credit. DETERMINING FTEs AND AVERAGE ANNUAL WAGES Q. How is the number of FTEs determined? A. Add up the total hours of service for which the employer pays wages to employees during the year (but not more than 2,080 hours for any employee). Divide by 2,080. If the result is not a whole number, round to the next lowest whole number. (If the result is less than one, round up to one FTE). See questions below for information on which employees are counted. An employee s hours of service include each hour for which he or she is paid, or entitled to payment, during the employer s tax year. Add each hour of paid leave (no more than 160 hours of service are required to be counted for an employee on account of any single continuous period of paid leave). Three ways to calculate: 1. Determine actual hours of service from records of hours worked and hours for which payment is made or due, including hours for paid leave; 2. Use a days-worked equivalency whereby the employee is credited with 8 hours of service for each day for which payment is made or due including days of paid leave; or 3. Use a weeks-worked equivalency whereby the employee is credited with 40 hours of service for each week for which payment is made or due including weeks of paid leave. Employers may apply different methods for different classifications of employees, if the classifications are reasonable and consistently applied. For example, it is permissible for an employer to use method 1 for all hourly employees and method 3 for all salaried employees. Employers may change the method for calculating employees hours of service for each taxable year. Example 1: For the 2010 tax year, an employer s payroll records indicate that an employee worked 2,000 hours and was paid for an additional 80 hours on account of vacation, holiday and illness. In calculating hours of service, the employer uses a method that counts hours actually worked. Employee A must be credited with 2,080 hours of service (2,000 hours worked and 80 hours for which payment was made or due). Example 2: For the 2010 tax year, an employee worked 49 weeks, took two weeks of vacation with pay, and took one week of leave without pay. In calculating hours of service, the employer uses the weeks-worked equivalency method. Employee B must be credited with 2,040 hours of service (51 weeks multiplied by 40 hours per week). Example 3: For the 2010 tax year, an employer pays five employees wages for 2,080 hours each, three employees wages for 1,040 hours each, and one employee wages for 2,300 hours. The employer uses a method that counts hours actually worked. The employer s FTEs would be calculated as follows: 7

8 Total hours not exceeding 2,080 per employee is 15,600 hours: 10,400 hours for the five employees paid for 2,080 hours each (5 x 2,080) 3,120 hours for the three employees paid for 1,040 hours each (3 x 1,040) 2,080 hours for the one employee paid for 2,300 hours (lesser of 2,300 and 2,080) Based on 15,600 hours of service, the employer has seven FTEs (15,600 divided by 2,080 = 7.5, rounded to the next lowest whole number). Example 4: For the 2010 tax year, an employer has 26 FTEs with average annual wages of \$23,000 each. Only 20 of the employees are enrolled in the employer s health insurance plan. The hours of service and wages of all employees are taken into consideration to determine whether the employer is qualified for the credit. Because the employer does not have fewer than 25 FTEs for the tax year, the employer is not qualified. Q. How is the amount of average annual wages determined? A. Add up the total wages paid by the employer during the tax year. Divide by the number of FTEs for the year. Round down the result to the nearest \$1,000 (if not a multiple of \$1,000). Include only wages paid for hours of service (see the question, How is the number of FTEs determined? under this section). Use wages as defined for purposes of the Federal Insurance Contributions Act (FICA) (without regard to the wage base limitation). See questions below for information on which employees are counted. Example 1: For the 2010 tax year, an employer pays a total of \$224,000 in wages to employees and has 10 FTEs. The employer s average annual wages are \$22,000 (\$224,000 divided by 10 = \$22,400, rounded down to the nearest \$1,000). Q. How are average annual wages and FTEs calculated when the employer has a short taxable year? A. In accordance with general accounting principles, average annual wages and FTEs may be pro-rated (or annualized) in calculating the section 45R credit. For example, if a small employer has been in business (and paying premiums) for 6 months during its first taxable year, it may pro-rate the employee hours worked and wages earned to reflect the 6 months the employer has been in operation. Q. Can an employer with 25 or more employees qualify for the credit if some of its employees are parttime? A. Yes. Because the limitation on the number of employees is based on FTEs, an employer with 25 or more employees could qualify for the credit if some of its employees work part-time. For example, an employer with 46 half-time employees (meaning each employee is paid wages for 1,040 hours) has 23 FTEs and therefore may qualify for the credit. Q. Do seasonal workers count? A. Generally, no. Seasonal workers are not included in the FTE and wage calculation unless they work for the employer more than 120 days during the tax year. However, premiums paid by the employer on behalf of seasonal employees may be counted in determining the amount of the employer s credit. 8

10 by the employer for the health insurance coverage of a minister who is an employee can be taken into account in computing the credit, subject to limitations on the credit. If the minister is self-employed, he or she is not taken into account in determining an employer s FTEs or premiums paid. Q. Are the wages of a minister taken into account when computing average annual wages for purposes of determining eligibility for the credit? A. No. Compensation paid to ministers who are common law employees for duties performed in the exercise of their ministry is not subject to FICA taxes and is not a wage as defined in section 3121(a). Thus, the wages of a minister who is a common law employee are not taken into account. HOW TO CLAIM THE CREDIT Q. How does an employer (other than a tax-exempt employer) claim the credit? A. An employer (other than a tax-exempt employer) claims the credit on the employer s annual income tax return, with an attached Form 8941 showing the calculation of the credit. Q. How does a tax-exempt employer claim the small business health care tax credit? A. An employer that is described in section 501(c) and exempt from tax under section 501(a) claims the refundable credit by filing Form 990-T with an attached Form 8941 showing the calculation of the claimed credit. See the question, Can a tax-exempt organization be eligible? under the Who Gets the Tax Credit section. Q. May an employer use the credit to offset its alternative minimum tax (AMT) liability? A. Yes. The credit can be used, subject to certain limitations based on the amount of an employer s regular tax liability, AMT liability and other allowable credits. See IRC section 38(c)(1), as modified by section 38(c)(4)(B)(vi). Q. Can an employer (other than a tax-exempt employer) claim the credit if it has no taxable income and no AMT liability for the year? A. Generally, no. The credit offsets only an employer s actual income tax liability or AMT liability for the year, subject to certain limitations. However, under the general business credit rules, as amended by section 2012 of the Small Business Jobs Act of 2010, the tax year 2010 unused credit may be carried back five years or forward up to 20 years. For other years, normal carryback and carry forward rules apply. Q. Can a tax-exempt employer claim the credit if it has no taxable income for the year? A. Yes. For a tax-exempt employer, the credit is refundable, so even if the employer has no taxable income, the employer may receive a refund (so long as it does not exceed the employer s income tax withholding and Medicare tax liability, as discussed in the question, What is the maximum credit for a tax-exempt qualified employer?," under the Calculating the Credit section. Q. Can the credit be reflected in determining estimated tax payments for a year? A. Yes. Q. Does taking the credit affect an employer s deduction for health insurance premiums? A. Yes. In determining the employer s allowable deduction for health insurance premiums, the amount of premiums that can be deducted is reduced by the amount of the credit. Q. May an employer reduce employment tax payments withheld income tax, Social Security tax and Medicare tax during the year in anticipation of the credit? A. No. The credit applies against income tax, not employment taxes. 10

11 Q. How is the credit applied for an employer with a fiscal tax year? A. If the employer has a tax year beginning, for example, on July 1, 2010, the credit first applies for the taxable year beginning on July 1, 2010, and ending on June 30, TRANSITION RELIEF FOR TAX YEARS BEGINNING IN 2010 Q. Is relief available to make it easier for small employers to meet the requirements for a qualifying arrangement? A. Yes. In Notice , the IRS and Treasury issued guidance providing that, for tax years beginning in 2010, certain transition relief applies. Specifically, an employer will be deemed to satisfy the uniformity requirement if it pays at least 50 percent of the premium for single coverage for each enrolled employee, even if it does not pay the same percentage of the premium for each employee. For example, if the employer offers more expensive coverage (such as family), the employer will have satisfied the uniformity requirement if it pays at least 50 percent of the premium for single coverage for that employee (even if it is less than 50 percent of the family coverage). Also, Notice further clarifies ways for a small employer to meet the requirements for a qualifying arrangement. For tax years beginning in 2010, an employer can use the transition rule above or the rules in Notice Q. Can employers who do not satisfy the 2010 transition rule still meet the qualifying arrangement requirement for the tax year beginning in 2010? A. Yes. Certain employers who do not satisfy the 2010 transition rule (because they contribute less than 50 percent of the employee-only premium for some enrolled employees) may still qualify for the credit for the tax year beginning in 2010 under other rules for qualifying arrangements set forth in Notice Employers who may be able to take advantage of these rules include, for example, employers who offer more than one type of health insurance coverage or whose insurance provider does not charge the same premium for all employees enrolled in single (employee-only) coverage. For details on these additional rules, see Notice Source: Internal Revenue Service 11

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