Calculating the tax credit

How much is the tax credit?

There is a sliding-scale tax credit of up to 35% of the employer’s eligible premium expenses for tax years 2010–2013. Employers with 10 or fewer full-time employees, paying annual average wages of $25,000 or less, qualify for the maximum credit.

Beginning in tax year 2014, the maximum tax credit increases to 50% of premium expenses and coverage must be purchased from a state health insurance exchange. Beginning in 2014, this tax credit is available for two years.

For tax-exempt employers, the same employee and wage requirements apply, but the maximum tax credit is 25% of eligible premium expenses for tax years 2010 – 2013, increasing to 35% in 2014.

The amount of the tax credit cannot exceed the total income and Medicare tax the employer is required to withhold from employees’ annual wages, plus the employer’s share of the Medicare tax.

What expenses are counted in calculating the credit?

  • Only the employer contribution to the premium amount counts as an eligible expense, subject to the limit described below. If an employer pays 80% of the premium, then 80% of the premium expense is counted. The premium contribution counted includes traditional health insurance, vision, dental and other limited-scope coverage.
  • An employer’s eligible premium contribution is capped at the average cost of health insurance for the small group market in the employer’s area. If an employer pays 80% of the premium, then the amount that counts is limited to the same portion—80% of the average cost of health insurance in their area. This provision is designed to avoid an incentive to choose a high-cost plan.
  • Any premium paid through a salary reduction arrangement under a section 125 cafeteria plan is not counted in determining the premium expense.

Note: Premium contributions for owners and family members are not eligible expenses for the tax credit.

How is the average premium for the small group market determined?

The Department of Health and Human Services (HHS) will determine the rate for a state (or within a state) and the information will be published on the IRS website (IRS.gov). The 2012 rates are available in an easy-to-read table. Current small group coverage rates for specific regions can be found at http://finder.healthcare.gov/ by answering several brief questions.

Example: Calculating the credit for an employer (non–tax-exempt)
For tax year 2010, an employer has 9 FTEs with average annual wages of $23,000 per employee. The employer pays $72,000 in premiums for those employees (which does not exceed the benchmark premium) and meets the requirements for the credit. This employer’s credit for 2010 equals $25,000 (35% X $72,000).

Example: Calculating the credit for a tax-exempt employer
For tax year 2010, a tax-exempt employer has 9 FTEs with average annual wages of $23,000 per FTE. The employer pays $72,000 in premiums for those employees (which does not exceed the benchmark premium) and meets the requirements for the credit. The total for the employer’s income tax and Medicare tax withholding, plus the employer’s share of the Medicare tax withholding, equals $30,000.

Here’s how the credit is calculated:
1) The initial amount of the credit is determined before any reduction: (25% X $72,000) = $18,000
2) The employer’s withholding and Medicare taxes are $30,000
3) Total tax credit for 2010 is $18,000

How soon can the tax credit be taken?

Eligible small businesses can claim the credit beginning in tax year 2010. The credit may be included in determining estimated tax payments for the year in which the credit applies, following regular estimated tax rules.

For tax-exempt organizations, see “How can non-profits take advantage of this resource?

Do premiums paid by an employer in 2010, before healthcare reform was enacted, count toward the tax credit?

Yes. All qualified premium expenses paid beginning January 1, 2010 may be counted for that tax year.

Does the state tax credit or subsidy I receive reduce my federal tax credit?

Generally, no. Small businesses can receive both a federal and state tax credit for providing health insurance to their employees. The new federal tax credit will not be reduced by state healthcare tax credits or subsidies (except in limited circumstances to prevent abuse of the credit) and it will be based on the entire employer contribution as long as the federal credit does not exceed the employer’s net contribution.

When state tax credits or state subsidies are paid directly to employers, their net premium payments are calculated by subtracting state credits or subsidies from the amount they pay their insurer, or their actual premium payment. For state direct payments (where states directly pay insurers part of the premium for coverage of a worker insured by their employer) employers’ net premium payments equal their actual premium payments.

More information on state tax credits is available in this premium tax credit FAQ from the IRS.

Will there be any transition relief for tax years beginning in 2010 to make it easier to meet the requirements for a qualifying arrangement?

Yes. The IRS and Treasury have issued formal guidance on this. To begin with, under transition rules:

  • As long as an employer pays at least 50% of the premium for each enrolled employee, s/he will still qualify for a tax credit even if s/he doesn’t pay a uniform percentage of the premium for each employee.
  • The 50% employer premium contribution requirement applies to an employee-only premium rate. For those with family or employee-plus-one coverage, the employer contribution is met if the contribution is equal to 50% of the employee-only rate, not 50% of broader coverage.

How can non-profits take advantage of this resource?

Tax-exempt organizations can claim the small business healthcare tax credit on a revised Form 990-T. The Form 990-T is currently used by tax-exempt organizations to report and pay the tax on unrelated business income. The 990-T has been revised for the 2011 filing season to enable eligible tax-exempt organizations—even those that owe no tax on unrelated business income—to also claim the small business healthcare tax credit.

Can non-profits take a health insurance credit that is larger than their payroll taxes?

No. The IRS has now clarified that non-profits are taking the credit against their payroll taxes, clearing up any confusion on whether non-profits qualified for this credit before. It’s important to note that non-profits cannot take a credit greater than their payroll taxes. Line 25 of the form informs tax-exempt organizations on how to determine the impact of this requirement.