SMALL BUSINESS. 1 NATP TAXPRO Journal Fall 2010 www.natptax.com

SMALL BUSINESS 1 NATP TAXPRO Journal Fall 2010 www.natptax.com

PPACA and the small business Health Insurance Credit By Cherie J. Hennig, Ph.D, and Bob Thompson The Patient Protection and Affordable Care Act (Affordable Care Act, P.L. 111-148) that became law on March 23, 2010, will significantly alter the way Americans pay health care costs. One of the many provisions in the bill is a new health insurance (HI) credit that encourages small businesses to either keep their existing health insurance coverage or begin offering health insurance to their employees. Whether this new tax credit will significantly increase health insurance coverage by small businesses remains to be seen. Because of its complexity, the HI credit may be overlooked by the many small businesses that it is intended to benefit. This article offers a discussion of the new credit, including an explanation of how the credit works and an illustration of its benefits using two hypothetical case studies. A subsequent article will discuss additional IRS guidance issued on the HI credit and Treasury regulations issued on grandfathered plans, preexisting condition exclusions, restrictions on annual and lifetime benefit caps, plan rescissions, and patient protections including the years in which the various provisions of the Act take effect. NATP TAXPRO Journal Fall 2010 www.natptax.com 2

How Does the New HI Credit Work? Effective for tax years beginning after December 31, 2009, an eligible small employer (ESE) who has an existing health insurance plan or who begins offering health insurance coverage in 2010 may claim a tax credit for its nonelective contributions for health insurance for its employees. An ESE is an employer with no more than 25 full-time equivalent employees (FTEs) employed during its tax year, and whose employees have average annual full-time equivalent wages of less than $50,000 [IRC 45R (d)]. Members of a controlled group (businesses with the same owners) or an affiliated service group (related businesses of which one performs services for the other) are treated as a single employer for purposes of the credit. A controlled group of corporations within the meaning of 1563(a) and all trades or businesses (whether or not incorporated) that are under common control shall be treated as a single employer. All employees of these groups and all wages paid to them are counted in determining whether any member of the controlled group or affiliated service group is a qualified employer. Example: Corporation AB and Corporation CD are owned by shareholders R and S. S also has a 60% interest in the EF partnership. R also conducts business as RW, LLC, a single-member LLC, which is treated as a disregarded entity. AB, CD, EF, and RW are treated as a single employer for purposes of computing the credit. The full credit is available only when an employer has 10 or fewer FTEs and average annual full-time equivalent wages of $25,000 or less [IRC 45R(c)]. The credit The Department of Health and Human Services will determine annually the average premium for a State or sub-state area. is claimed on Form 8941, Small Employer Health Insurance Premiums (IR 2010-96, 9/7/2010). The premium payments must be made under a qualifying arrangement in which the ESE is required to make a nonelective contribution for each employee who enrolls in a qualifying health insurance plan equal to a uniform percentage (but not less than 50%) of the premium cost [IRC 45R(d)(4)]. The HI credit is a general business credit that can be carried back for one year (starting in 2011) and carried forward for 20 years [IRC 38(b)(36),(c)(4)(B) (vi)]. It can also be used to reduce the alternative minimum tax [IRC 38(c)(4)(ii)(I)]. All health insurance premiums paid during 2010 qualify for the credit even if the premiums were paid before the new law was enacted (Rev. Rul. 2010-13, 2010-21 IRB). Qualifying health insurance also includes coverage for limited scope dental or vision, long-term care, nursing home care, home health care, community-based care, coverage for a specified disease or illness, and medical supplemental health insurance. The employer must separately satisfy the requirements with respect to each type of coverage (Notice 2010-44, 2010-22 IRB, 5/17/2010, II-G). For the insurance to qualify, it must be purchased from a State-licensed insurance company [IRC 45R(g)(2)]. Example: An employer pays 50% of the premium cost for health insurance and 40% of the cost of the dental insurance. When computing the HI credit, the employer cannot take into consideration premiums paid for the dental insurance. For the 2010 tax year, an employer who pays an amount equal to at least 50% of the premium for single (employee-only) 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. An employer will meet the uniformity requirement if it pays at least 50% of single-coverage premiums for each employee receiving single coverage, and if more expensive coverage is offered (e.g., family or selfplus-one coverage) pays an amount for the more expensive coverage that is not less than 50% of the premium for single coverage even if it is less than 50% of the premium for the more expensive coverage (Notice 2010-44, 2010-22 IRB, Sec. V). Example: The employer pays 70% of the single health insurance premium, 60% of family coverage and 50% of vision and dental coverage. This plan satisfies the uniformity requirement. Who Is and Who Isn t an Eligible Employee? A sole proprietor, a more than 2% partner in a partnership or a more than 2% shareholder in an S corporation, or any owner of more than 5% of any other business, or 3 NATP TAXPRO Journal Fall 2010 www.natptax.com

a family member of any of these individuals, or a member of the business owner s or partner s household are not considered employees for IRC 45R purposes even though they provide valuable services. A family member is defined as a child or descendant of a child, a sibling or step-sibling, a parent, grandparent or step-parent, a niece or nephew, an aunt or uncle, a son-in-law or daughter-in-law, a father-in-law or mother-in-law, a brother-in-law or sister-in-law (Notice 2010-44, 2010-22 IRB, 5/17/2010). Owners and family members wages or hours are not counted in determining either the number of FTEs or the amount of average annual wages. Nor are premiums paid on their behalf counted in determining the amount of the credit [IRC 45R(e)]. How to Calculate the HI Credit The credit is equal to the lesser of the following two amounts multiplied by an applicable percentage: Total nonelective contributions the ESE made on behalf of qualifying employees during the tax year for the qualifying health coverage. Total nonelective contributions the ESE would have paid if each qualifying employee were enrolled in a plan that had a premium equal to the average premium for the small group market in the State in which the ESE is offering health insurance coverage. The Department of Health and Human Services (HHS) will determine annually the average premium for a State or sub-state area [IRC 45R(b)]. On May 3, 2010, the IRS released a state-by-state table of average health insurance premiums for the small group market for the 2010 tax year (Rev. Rul. 2010-13, 2010-21 IRB. These amounts are listed in the chart on page 8). The following example illustrates application of the average premium limits. Example: The ABC Corporation, an ESE, offers employee-only health insurance to its employees and pays 50% of the premium. ABC is located in a state that has an annual small group premium of $4,469. ABC has two eligible employees. Since the monthly premium for employee A is $425, the HI credit will be based on 50% of $372.42 ($4,469/12) which is less than the monthly premium actually paid. The monthly premium for employee B is $325 and the HI credit will be based on this amount since it is less than the small group premium amount of $372.42. The maximum applicable percentage for the HI credit for forprofit firms is 35% for tax years 2010 through 2013 (25% for not-forprofit firms) provided the ESE has 10 or fewer employees whose average annual wage is $25,000 or less. In 2014 the maximum credit increases to 50% for for-profit firms (35% for not-for-profit firms) and will be allowed only for health insurance coverage purchased through a State exchange and only for a maximum of two consecutive tax years [IRC 45R(d) (4)]. The IRS has not yet issued any guidance defining who is an eligible employee for not-for-profit firms. The credit is reduced when: There are more than 10 FTEs but not more than 25 FTEs. The number of FTEs is determined by dividing 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 2,080. That number is rounded down to the nearest whole number. The average annual wage per employee is between $25,000 and $50,000. The average annual wage is determined by dividing total wages (as defined for FICA purposes, without regard to the wage base limitation, including overtime pay) paid to employees during the ESE s tax year by the number of the FTEs for the year. That amount is rounded down to the nearest $1,000 [IRC 45R(d) (3)(A) and (e)(4)]. If an ESE has more than 10 FTEs and average annual wages exceed $25,000, the credit is reduced by the sum of the two above reductions. Note that the IRC 45R credit reduces the employer s IRC 162 health insurance premium deduction [IRC 45R(e)(5)]. Thus, the actual after-tax savings will be less. Since notfor-profit employers do not pay income tax, they have an additional limitation: the NATP TAXPRO Journal Fall 2010 www.natptax.com 4

Equivalent Average Wage 10 or fewer amount of their HI credit cannot exceed the total amount of income and Medicare tax, but not social security tax the not-for-profit is required to withhold from employees wages for the year plus the not-for-profit s share of Medicare tax on employees wages. To date, there is no guidance on how to treat health insurance premiums paid on behalf of ministers, since they are not subject to withholding for either Small Business Tax Credit Percentages, for-profit firms for 2010 2013 and not-for-profit firms for 2014+ Number of employees 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 $25,000 35% 33% 30% 28% 26% 23% 21% 19% 16% 14% 12% 9% 7% 5% 2% 0% $26,000 34% 31% 29% 27% 24% 22% 20% 17% 15% 13% 10% 8% 6% 3% 1% $27,000 32% 30% 28% 25% 23% 21% 18% 16% 14% 11% 9% 7% 4% 2% 0% $28,000 31% 28% 26% 24% 21% 19% 17% 14% 12% 10% 7% 5% 3% 0% $29,000 29% 27% 25% 22% 20% 18% 15% 13% 11% 8% 6% 4% 1% $30,000 28% 26% 23% 21% 19% 16% 14% 12% 9% 7% 5% 2% 0% $31,000 27% 24% 22% 20% 17% 15% 13% 10% 8% 6% 3% 1% $32,000 25% 23% 21% 18% 16% 14% 11% 9% 7% 4% 2% 0% $33,000 24% 21% 19% 17% 14% 12% 10% 7% 5% 3% 0% $34,000 22% 20% 18% 15% 13% 11% 8% 6% 4% 1% $35,000 21% 19% 16% 14% 12% 9% 7% 5% 2% 0% $36,000 20% 17% 15% 13% 10% 8% 6% 3% 1% $37,000 18% 16% 14% 11% 9% 7% 4% 2% 0% $38,000 17% 14% 12% 10% 7% 5% 3% 0% $39,000 15% 13% 11% 8% 6% 4% 1% $40,000 14% 12% 9% 7% 5% 2% 0% $41,000 13% 10% 8% 6% 3% 1% $42,000 11% 9% 7% 4% 2% 0% $43,000 10% 7% 5% 3% 0% $44,000 8% 6% 4% 1% $45,000 7% 5% 2% 0% $46,000 6% 3% 1% $47,000 4% 2% 0% $48,000 3% 0% $49,000 1% income or Medicare tax. Hopefully, $50,000 0% guidance will be issued soon. The applicable HI tax credit percentage can be found using the tables on pages 5 7. Conclusion Employers currently offering health insurance should begin gathering the necessary records to compute their 2010 HI credit and make this information available to their tax professional. Employers considering adopting an HI plan should also gather the necessary information to determine whether they may be eligible for the credit. They should also work with a qualified tax professional and a qualified Employee Benefit Consultant to make sure the maximum credit possible is received. Each benefit plan offered by the employer should be reviewed to confirm it meets the requirements outlined in IRS Notice 2010-44, 2010-22 IRB, especially if maintaining grandfathered plan status is important. Consult the National Association of Health Underwriters at www.nahu.org for a list of benefit professionals in your area who can assist in implementing and maintaining a qualified HI plan. According to a survey of more than 650 mid- to senior-level benefit professionals by Towers Watson, a benefit specialist firm, most employ- 5 NATP TAXPRO Journal Fall 2010 www.natptax.com

Equivalent Average Wage 10 or fewer Small Business Tax Credit Percentages, not-for-profit firms for 2010-2013 Number of employees 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 $25,000 25% 23% 22% 20% 18% 17% 15% 13% 12% 10% 8% 7% 5% 3% 2% 0% $26,000 24% 22% 21% 19% 17% 16% 14% 12% 11% 9% 7% 6% 4% 2% 1% $27,000 23% 21% 20% 18% 16% 15% 13% 11% 10% 8% 6% 5% 3% 1% 0% $28,000 22% 20% 19% 17% 15% 14% 12% 10% 9% 7% 5% 4% 2% 0% $29,000 21% 19% 18% 16% 14% 13% 11% 9% 8% 6% 4% 3% 1% $30,000 20% 18% 17% 15% 13% 12% 10% 8% 7% 5% 3% 2% 0% $31,000 19% 17% 16% 14% 12% 11% 9% 7% 6% 4% 2% 1% $32,000 18% 16% 15% 13% 11% 10% 8% 6% 5% 3% 1% 0% $33,000 17% 15% 14% 12% 10% 9% 7% 5% 4% 2% 0% $34,000 16% 14% 13% 11% 9% 8% 6% 4% 3% 1% $35,000 15% 13% 12% 10% 8% 7% 5% 3% 2% 0% $36,000 14% 12% 11% 9% 7% 6% 4% 2% 1% $37,000 13% 11% 10% 8% 6% 5% 3% 1% 0% $38,000 12% 10% 9% 7% 5% 4% 2% 0% $39,000 11% 9% 8% 6% 4% 3% 1% $40,000 10% 8% 7% 5% 3% 2% 0% $41,000 9% 7% 6% 4% 2% 1% $42,000 8% 6% 5% 3% 1% 0% $43,000 7% 5% 4% 2% 0% $44,000 6% 4% 3% 1% $45,000 5% 3% 2% 0% $46,000 4% 2% 1% $47,000 3% 1% 0% $48,000 2% 0% $49,000 1% $50,000 0% ers anticipate that the health care reform legislation will increase health benefit costs and that these increased costs will be either passed on to employees or the employer will reduce health benefits and programs (www. towerswatson.com/united-states/ research/1935). Mercer Co., a benefit specialist firm, surveyed 791 employers about whether they expect the new Act to increase premium costs. One-fourth of the respondents indicated that the new law will increase the cost of health insurance coverage between 3 5%. Another 41% indicated the increase would be less than 2% (www.mercer.com/referencecontent.htm?idcontent=1380755). The Small Employer Health Insurance Credit is a carrot encouraging qualifying small businesses to offer or to continue health insurance coverage to their employees. Whether the tax savings are sufficient remains to be seen. The stick portions of the law will be implemented in 2014, when individuals without health insurance will face a monetary penalty that will ultimately be as high as 2.5% of their income, and in 2018, when employers will be faced with an excise tax on highcost plans. There are many unanswered questions and complex issues remaining to be resolved prior to implementing this complex and far-reaching legislation. In a followup article, we ll discuss IRS and Treasury guidance on provisions of the Patient Protection and Affordable Care Act, including when they will take effect. Editor s Note: The authors have developed two case studies to illustrate the HI credit. The first case study illustrates the tax benefits to a firm that currently does not offer health insurance coverage. It also NATP TAXPRO Journal Fall 2010 www.natptax.com 6

Equivalent Average Wage 10 or fewer Small Business Tax Credit Percentages, For-profit firms for 2014+ Number of employees 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 $25,000 50% 47% 43% 40% 37% 33% 30% 27% 23% 20% 17% 13% 10% 7% 3% 0% $26,000 48% 45% 41% 38% 35% 31% 28% 25% 21% 18% 15% 11% 8% 5% 1% $27,000 46% 43% 39% 36% 33% 29% 26% 23% 19% 16% 13% 9% 6% 3% 0% $28,000 44% 41% 37% 34% 31% 27% 24% 21% 17% 14% 11% 7% 4% 1% $29,000 42% 39% 35% 32% 29% 25% 22% 19% 15% 12% 9% 5% 2% 0% $30,000 40% 37% 33% 30% 27% 23% 20% 17% 13% 10% 7% 3% 0% $31,000 38% 35% 31% 28% 25% 21% 18% 15% 11% 8% 5% 1% $32,000 36% 33% 29% 26% 23% 19% 16% 13% 9% 6% 3% 0% $33,000 34% 31% 27% 24% 21% 17% 14% 11% 7% 4% 1% $34,000 32% 29% 25% 22% 19% 15% 12% 9% 5% 2% 0% $35,000 30% 27% 23% 20% 17% 13% 10% 7% 3% 0% $36,000 28% 25% 21% 18% 15% 11% 8% 5% 1% $37,000 26% 23% 19% 16% 13% 9% 6% 3% 0% $38,000 24% 21% 17% 14% 11% 7% 4% 1% $39,000 22% 19% 15% 12% 9% 5% 2% 0% $40,000 20% 17% 13% 10% 7% 3% 0% $41,000 18% 15% 11% 8% 5% 1% $42,000 16% 13% 9% 6% 3% 0% $43,000 14% 11% 7% 4% 1% $44,000 12% 9% 5% 2% 0% $45,000 10% 7% 3% 0% $46,000 8% 5% 1% $47,000 6% 3% 0% $48,000 4% 1% $49,000 2% 0% $50,000 0% discusses the potential tax benefits to the employees, especially to those who qualify for the earned income tax credit. The second case illustrates the importance of maintaining grandfathered plan status for existing health insurance plans and how the state annual group premium limits are applied to a firm currently offering health insurance coverage. To review the case studies, refer to pages 9 11. Cherie J. Hennig, Ph.D. is a professor of accounting at the University of North Carolina, Wilmington. She is a member of the American Taxation Association and the American Institute of CPAs. Cherie has published numerous tax articles and AICPA continuing professional education courses and has presented numerous continuing professional education programs. She is a co-author of Contemporary Tax Practice, Research, Planning and Strategies published by CCH, a Wolters Kluwer business. Bob Thompson is the President of Better Benefit Specialists, a Westminster Colorado Employee Benefit Consulting firm. Founded by Bob in 1986, his company helps businesses design and maintain high quality benefit plans for their employees. Bob is a member of the local Colorado chapter as well as the National Association of Health Underwriters. Bob can be reached at Bob@BetterBenefitSpecialists.com. 7 NATP TAXPRO Journal Fall 2010 www.natptax.com

The following examples illustrate how to determine the HI credit using the applicable table percentages shown in columns (b) and (c) Employer A has 4 employees with an average annual wage of $12,500 and pays annual qualifying health care premiums of $8,000. The maximum credit is allowed since the employer has 10 or fewer employees with an annual wage of $25,000 or less. The annual HI tax credit for 2010 13 is $2,800 and $4,000 for 2014+. Employer B has 8 employees with an average annual wage of $41,250 and pays annual qualifying health care premiums of $38,000. The equivalent average wage is $41,000 ($41,250 is rounded down to the next lowest $1,000 increment). The HI tax credit for 2010 13 is $4,940 and $6,840 for 2014+. Employer C has 13 employees with an average annual wage of $41,250 and pays annual qualifying health care premiums of $39,000. The equivalent average wage is $41,000 ($41,250 is rounded down to the next lowest $1,000 increment). The HI tax credit for 2010 13 is $2,340 and $3,120 for 2014+. Employer D has 19 employers with an average annual wage of $35,050 and pays annual qualifying health care premiums of $72,000. The equivalent average wage is $35,000. D is not eligible for the HI credit. Employer E has 5 employees who worked full-time, 3 employees who worked half-time, and one employee who worked full-time and also received 220 hours of overtime pay. The total hours not exceeding 2,080 is 15,600 (6 x 2,080 + 3 x 1,040). The employer has 7 FTEs (15,600/2,080 = 7.5, which is rounded to the next lowest whole number. The employer paid $260,000 in wages, including overtime pay. The average annual wages are $37,000 ($260,000/7 = $37,143, which is rounded down to the nearest $1,000). E pays annual qualifying health care premiums of $24,000. The HI tax credit for 2010 13 is $4,320 and $6,240 for 2014+. Employer F has 16 full-time employees with an average annual wage of $36,000 and pays annual health care premiums of $80,000. Four of these employees are classifi ed as either owners or family members. The average annual wage for 12 of the non-owner/family members is $28,000 and the qualifying annual health care premiums paid on their behalf is $48,000. The HI tax credit for 2010 13 is $12,480 and $17,760 for 2014+. Employer G, a qualifi ed tax-exempt employer, has 10 FTEs with average annual wages of $16,000. The employer pays qualifying health care premiums of $80,000. The total income tax and Medicare tax withheld from the employees wages and paid by the employer is $25,000 per year. The HI tax credit for 2010 2013 is $20,000, the lesser of $20,000 ($80,000 x 25%) or $25,000. The HI tax credit for 2014+ is $25,000, the lesser of $28,000 ($80,000 x 35%) or $25,000. HI Credit % (b) 2010 2013 (c) 2014+ 35% 50% 13% 18% 6% 8% 0% 0% 18% 26% 26% 37% 25% 35% 2010 Annual Small Group Premiums by State State Employee-only Coverage Family Coverage Alaska $6,204 $13,723 Alabama 4,441 11,275 Arkansas 4,329 9,677 Arizona 4,495 10,239 California 4,628 10,957 Colorado 4,972 11,437 Connecticut 5,419 13,484 District of Columbia 5,355 12,823 Delaware 5,602 12,513 Florida 5,161 12,453 Georgia 4,612 10,598 Hawaii 4,228 10,508 Iowa 4,652 10,503 Idaho 4,215 9,365 Illinois 5,198 12,309 Indiana 4,775 11,222 Kansas 4,603 11,462 Kentucky 4,287 10,434 Louisiana 4,829 11,074 Massachusetts 5,700 14,138 Maryland 4,837 11,939 Maine 5,215 11,887 Michigan 5,098 12,364 Minnesota 4,704 11,938 Missouri 4,663 10,681 Mississippi 4,533 10,501 Montana 4,772 10,212 North Carolina 4,920 11,583 North Dakota 4,469 10,506 Nebraska 4,715 11,169 New Hampshire 5,519 13,624 New Jersey 5,607 13,521 New Mexico 4,754 11,404 Nevada 4,553 10,297 New York 5,442 12,867 Ohio 4,667 11,293 Oklahoma 4,838 11,002 Oregon 4,681 10,890 Pennsylvania 5,039 12,471 Rhode Island 5,887 13,786 South Carolina 4,899 11,780 South Dakota 4,497 11,483 Tennessee 4,611 10,369 Texas 5,140 11,972 Utah 4,238 10,935 Virginia 4,890 11,338 Vermont 5,244 11,748 Washington 4,543 10,725 Wisconsin 5,222 12,819 West Virginia 4,986 11,611 Wyoming 5,266 12,163 NATP TAXPRO Journal Fall 2010 www.natptax.com 8

CASE STUDIES Case Study #1 A sole proprietorship (Schedule C) adopts a health insurance plan on July 1, 2010. The business has 10 FTEs with annual equivalent average wages of less than $25,000. The owner has net income before paying health insurance premiums of $100,000, has other income equal to the standard deduction and personal exemption deductions, and is in the 25% marginal tax bracket. The business will pay 50% of the single annual premium cost of $2,400. Each employee will pay 50% of the single premium cost and any additional premium cost for family coverage. Assume an annual increase in the premiums of 10% and that the premiums do not exceed the State small group market premium. The total income and SE tax savings from the Health Insurance deduction plus the reduction in the regular tax liability from the HI credit, shown in the table on page 10, reduces the employer s cost of offering health insurance coverage by an average of 62% over the 6-year period. The employees will also receive a tax benefit if their health insurance premiums are made through a salary reduction agreement. A single employee who is in the 10% marginal tax bracket would save $120 in the first year, making the aftertax cost of health insurance $1,080, or $90 per month. For those employees who have one or more one dependent children, there is an additional tax savings for employees eligible for the EITC since the salary reduction reduces their earned income which increases their EITC. Employees with one (2 or more) qualifying child(ren) would have an additional tax saving of $320 ($380), making their after-tax cost of health insurance $880 ($820) or $73 ($68) per month. Case Study #2 A closely-held corporation (Form 1120) has a health insurance plan in effect on January 1, 2010. The corporation has ten full-time employees, none of which are related to A, the sole shareholder. The corporation pays various percentages of its employees single-coverage health insurance costs, including vision and dental coverage. The employer does not pay any portion of the premium for family coverage. The maximum allowable premium is the lesser of the actual monthly premium or $414.33 which is the monthly maximum small group premium for a firm located in Colorado. The premiums paid by the employees are withheld from their pay under a salary-reduction agreement. This is a grandfathered plan, since it was in effect on March 23, 2010. As a result, payment of 85% of the HI cost of the two management employees and only 75% for the non-management employees will not be considered a discriminatory plan. Although A s HI premiums are not eligible for the credit since A owns more 5% of the stock, the corporation s payment of 99% of A s premiums is permitted as long as the plan maintains its grandfathered plan status. For the two employees who are over age 45, the monthly HI premium exceeds the maximum small group premium for Colorado so the HI credit must be computed on the lesser amount. As shown in the table below, the equivalent average wage of the ten employees of $39,000 results in a 15% HI credit of approximately $5,000 ($32,383 x.15). If the corporation s marginal tax rate is 25%, the net tax savings is only $3,750 ($5,000 x (1.25)), because the corporation s health insurance deduction is reduced by the HI credit. In this case, the after-tax cost of the employer s share of the health insurance premiums for 2010 declines from 75% to 64%. (See chart on page 11.) Conclusion As these two case studies illustrate, computation of the HI credit can be a time-consuming and complex process. To claim the HI credit, the employer must maintain detailed records for each employee indicating the total wages paid and the total annual hours worked during the year. The total hours worked for part-time, seasonal, and new and retiring employees must be converted to FTE s. The employer must also identify which employees are related to the business owners so that their hours and wages can be excluded from the computations. Employers who have more than 25 employees throughout the year should not automatically assume they are not eligible for the HI credit, because their FTE may be less than their actual number of employees. In certain geographic areas, the phase-out of the credit as the equivalent annual wage exceeds $25,000 may preclude many small employers from receiving a benefit from the credit that is greater than the cost incurred to compute the credit. The HI credit offers no additional tax incentives for employers to pay a portion of the additional premiums for family coverage leaving this additional cost to be borne by the employee. Many low-income employees may be unable to afford the additional premium cost for family coverage and may not qualify for assistance under their state s Children s Health Insurance Program (CHIP). (Information about CHIP is available at: www.insurekidsnow. gov.) Whether the federal government will offer additional tax incentives to plug this family coverage hole is problematic. 9 NATP TAXPRO Journal Fall 2010 www.natptax.com

Small Business Health Insurance Credit Facts Baseline 2010 2011 2012 2013 2014 2015 Net Income before health insurance $100,000 $100,000 $100,000 $100,000 $100,000 $100,000 $100,000 Health insurance deduction $ $6,000 $13,200 $14,520 $15,972 $17,569 $19,326 Less:Credit $ $2,100 $4,620 $5,082 $5,590 $8,785 $9,663 Net Income from Self Employment $100,000 $96,100 $91,420 $90,562 $89,618 $91,215 $90,337 AGI deduction for 1/2 SE tax $7,065 $6,789 $6,459 $6,398 $6,331 $6,444 $6,382 Taxable Income $92,935 $89,311 $84,961 $84,164 $83,287 $84,771 $83,955 Income Tax $23,234 $22,328 $21,240 $21,041 $20,822 $21,193 $20,989 SE Tax $14,130 $13,578 $12,917 $12,796 $12,663 $12,888 $12,764 HI Tax Credit $ $2,100 $4,620 $5,082 $5,590 $8,785 $9,663 Total Tax with HI $33,806 $29,538 $28,755 $27,894 $25,297 $24,090 Total Tax without HI $37,363 $37,363 $37,363 $37,363 $37,363 $37,363 $37,363 Tax Savings $3,557 $7,826 $8,608 $9,469 $12,067 $13,274 % Tax Savings 59% 59% 59% 59% 69% 69% Cost of Health Insurance $6,000 $13,200 $14,520 $15,972 $17,569 $19,326 after-tax cost of health insurance $2,443 $5,374 $5,912 $6,503 $5,502 $6,053 NPV of 6-year cost of providing HI $22,378 % After-tax cost 41% 41% 41% 41% 31% 31% After-tax cost per employee, per year After-tax cost per employee, per month $244 $537 $591 $650 $550 $605 $20 $45 $49 $54 $46 $50 # of children 1 2 3 or more Before-tax Cost to Employee, year 1 $1,200 $1,200 $1,200 Income Tax Savings from Salary Reduction Agreement $120 $120 $120 Additional EITC $200 260 260 After-tax cost to employee, per year $880 $820 $820 Monthly after-tax cost $73 $68 $68 NATP TAXPRO Journal Fall 2010 www.natptax.com 10

# Employee Age Annual Salary Monthly Total Premium Monthly Maximum Small Group Premium Employer % Paid Employer $ Paid Per Month Employer $ Paid Per Year Employer Maximum $ Per Year Employee $ Paid Per Year 1 B 38 $55,000 $380.05 $414.33 85% $323.04 $3,876.51 $3,876.51 $684.09 B s Children $390.01 $4,680.12 2 C 48 $58,000 $500.22 $414.33 85% $425.19 $5,102.24 $4,226.17 $900.40 C s Spouse $4.12 $49.44 3 D 45 $35,000 $362.66 $414.33 75% $272.00 $3,263.94 $3,263.94 $1,087.98 4 E 45 $35,000 $413.75 $414.33 75% $310.31 $3,723.75 $3,723.75 $1,241.25 5 F 45 $35,000 $413.75 $414.33 75% $310.31 $3,723.75 $3,723.75 $1,241.25 6 G 35 $35,000 $292.43 $414.33 75% $219.32 $2,631.87 $2,631.87 $877.29 7 H 52 $35,000 $473.38 $414.33 75% $355.04 $4,260.42 $3,728.97 $1,420.14 8 I 25 $35,000 $256.77 $414.33 75% $192.58 $2,310.93 $2,310.93 $770.31 9 J 19 $35,000 $251.71 $414.33 75% $188.78 $2,265.39 $2,265.39 $755.13 10 K 30 $35,000 $292.43 $414.33 75% $219.32 $2,631.87 $2,631.87 $877.29 K s Family $743.09 $342.96 Total $393,000 $4,774.37 $2,815.89 $33,790.67 $32,383.15 $14,927.65 Average $39,300 HI Credit Average Wage HI Credit % HI Credit $ $39,000 15% $4,987.00 Owner A 46 $500.22 99% $495.22 $60.03 W/O Credit With Credit HI Deduction $33,790.67 $33,790.67 Less: HI Credit $0.00 $4,987.00 $33,790.67 $28,803.67 Tax Savings $8,447.67 $7,200.92 Hi Credit $0.00 $4,987.00 Total Tax Savings 25% $8,447.67 $12,187.92 36% After-tax Cost of HI 75% $25,343.01 $21,602.75 64% 11 NATP TAXPRO Journal Fall 2010 www.natptax.com