LOTS OF TAX changes were included in the recently enacted health-care legislation. Most don’t take effect this year, but one that does is a new health insurance tax credit for eligible small businesses. This break can potentially cover up to 35% of the cost of providing health coverage for employees. Here’s what you need to know.
Eligible Small Businesses
To claim the credit, your business must have 24 or fewer full-time-equivalent (FTE) workers with an average FTE wage under $50,000, and you must pay at least 50% of the cost of health coverage for all enrolled employees.
In theory, you must pay same percentage for all enrolled employees, including those with more-expensive family coverage or self-plus-one coverage, to be eligible for the credit. For 2010, however, this uniform percentage rule is waived as long as the amount you pay for each enrolled employee equals at least 50% of the cost for single coverage.
The credit can be claimed by any type of business that meets the eligibility rules — including C and S corporations, partnerships, limited liability companies and sole proprietorships.
The maximum possible credit equals 35% of the lesser of: (1) the actual cost of coverage or (2) the imaginary cost of “benchmark” coverage in the small-group market as determined on a state-by-state basis by the Department of Health and Human Services.
If your company pays less than 100% of the actual cost of coverage (with employees picking up the balance), you can only claim the credit for the percentage you pay (whether the credit is based on actual cost or the imaginary benchmark cost).
Your company’s federal income tax deduction for employee health costs is reduced by the amount of the credit.
The maximum 35% credit is only allowed if your business has 10 or fewer FTE employees with an average FTE wage of $25,000 or less. Under a complicated phase-out rule, the credit percentage quickly approaches zero as the number of employees approaches 25 and as the average wage approaches $50,000.
For example, if your business has five FTE employees and an average FTE wage of $40,000, the credit percentage is reduced to only 14%. If the average wage is $50,000, the credit percentage is zero.
If your business has 18 FTE employees and an average FTE wage of $30,000, the credit percentage is reduced to only 9.3%. If you have 25 employees, the credit percentage is zero.
When all is said and done, the credit will only provide a meaningful benefit to truly small employers that pay truly modest wages. That said, it’s certainly helpful to those that qualify.
Calculating FTE Employees and FTE Wages
Because the phase-out rule quickly reduces the allowable credit if your business has over 10 FTE employees or an average FTE wage above $25,000, the FTE calculations are critically important. Here’s the drill.
Calculate the number of FTE employees by dividing total paid employee hours for the year by 2,080. However, if a worker is paid for more than 2,080 hours, exclude the excess hours from the calculation. Also exclude any hours worked by seasonal employees who work 120 days or less. If the calculation produces a number that is not a whole number (which it almost certainly will), round it down to the next whole number. The result is the number of FTE employees for the year. If your number exceeds 24, you’re a victim of the phase-out rule, and you get no credit. The good news: your company can have over 24 workers and still qualify for the credit as long as some of them are part-time employees or seasonal employees.