How To Sort Through The Complications Of The Small Business Health Care Tax Credit

As new guidance issued by the Internal Revenue Service makes clear, the path to receiving the small employer tax credit (under the Patient protection and Affordable Care Act) is complicated. Nevertheless, the Council of Economic Advisors estimates that as many as 4 million small businesses are eligible for the credit if they provide health care to their workers.

The maximum credit is 35% of premiums paid in 2010 by eligible small business employers and 25% of premiums paid by eligible employers that are tax-exempt organizations. In 2014, this maximum credit increases to 50% of premiums paid by eligible small business employers and 35% of premiums paid by eligible employers that are tax-exempt organizations.

The most recent guidance, issued just last week,  makes clear that sole proprietors, partners in a partnership, shareholders owning more than 2% of the stock in an S corporation, and any owners of more than 5% of other businesses are not taken into account as employees for purposes of the credit. Family members of these owners and partners are also not taken into account as employees.  This should make it easier for small businesses to claim the credit.

The definition of "family member" does not specifically refer to spouses, but Notice 2010-82 notes that the following individuals are not taken into account as employees for purposes the credit:

(1)        the employee-spouse of a shareholder owning more than two percent of the stock of an S corporation;

(2)        the employee-spouse of an owner of more than 5% of a business;

(3)        the employee-spouse of a partner owning more than a five percent interest in a partnership; and

(4)        the employee-spouse of a sole proprietor.

Part of the complication in claiming the credit involves the three methods that employers are permitted to use for calculating employees' hours of service for the taxable year: (1) counting actual hours worked; (2) using a days-worked equivalency; or (3) using a weeks-worked equivalency. Counting hours of service is important in determining how many full-time equivalent employees a company has, and thus is important in determining whether the company is eligible for the credit.

According to Notice 2010-82, 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 hours worked method for all hourly employees and the weeks-worked equivalency method for all salaried employees. In addition, employers may change the method for calculating employees' hours of service for each taxable year.

The new guidance also clarifies that because health reimbursement arrangements (HRAs) and health flexible spending arrangements (health FSAs) are self-insured plans, these arrangements are not health insurance coverage. Health savings accounts (HSAs) also are not health insurance coverage. Thus, employer contributions to HRAs, health FSAs, or HSAs are not taken into account for purposes of the credit.

Help Is Available

More detailed information on the most recent guidance and additional help in understanding the employer tax credit is available to Wolters Kluwer Law and Business subscribers here, here , and here.

The IRS also has provided a new Form 8941(Credit for Small Employer Health Insurance Premiums), and instructions to the form to assist businesses in claiming the credit. Additional information from the IRS is available here.

For a comprehensive analysis of the Patient Protection and Affordable Care Act, including the full text of the law and additional information on health reform and other recent developments in employee benefits, just click here.