IRS Issues Final Regulations on Small Business Health Credit

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Although many payroll and other employment provisions of the Affordable Care Act (ACA) are only just taking effect — or will go into effect soon — at least one significant element of the law has been kicking around for several years, but not without some difficulty.

Under the ACA, a qualified small business can claim a tax credit for providing health insurance to eligible employees. But numerous questions have dogged this credit since its inception in 2010. Now the IRS has issued final regulations on the credit that should make the law clearer. These regulations, which adopt and add regulations proposed in 2013, are effective as of June 30, but employers have the option of still applying the proposed regulations this year.

The Basics of How it Works

The small business health care credit is available to certain employers who purchase health insurance for their employees. To qualify, your business must employ fewer than 25 full-time employees who are paid an average annual wage of more than $50,000 (indexed to $50,800 for 2014). Your firm also must make non-elective contributions to a health insurance plan at a “uniform percentage” equal to at least 50 percent of the cost of premiums.

For 2014, the maximum credit is equal to 50 percent of the cost of your concern’s contributions. However, a full credit is available only if your organization has ten or fewer full-time employees and pays them average wages that don’t exceed $25,000 (indexed to $25,400 for 2014). Otherwise, the credit is subject to a reduction (see right-hand box).

Full-time employees do not include any of the following or their family members:

  • Owners of the business, such as sole proprietors;
  • Partners in a partnership;
  • Shareholders of more than 2 percent in an S corporation, and
  • Individuals owning more than 5 percent of another business.

If these individuals and their relatives are paid much higher salaries than other employees, the average annual wages will not increase.

Effective this year, you may claim the credit for no more than two consecutive tax years, beginning with the first year in which you offer health insurance through a Small Business Health Options Program (SHOP) Exchange (assuming one is available). The requirement to acquire health insurance through a SHOP Exchange is new for 2014.

New Guidance from the IRS

The extensive new regulations generally follow the 2013 proposals, but add these provisions:

1. Average premium limit: The employer’s premium payments are limited by the average premium in the small group market in the rating area in which the employee enrolls for coverage through a SHOP Exchange.

2. Payroll tax limit: For a tax-exempt entity, the amount of the credit can’t exceed the amount of payroll taxes during the calendar year in which the tax year begins.

3. Two-consecutive-tax-year rule: The first year of the two-consecutive-tax year credit period begins the year your organization claims the credit by filing Form 8941 (Credit for Small Employer Health Insurance Premiums) of Form 990-T (Exempt Organization Business Income Tax Return), with an attached Form 8941. This is the case even if you are eligible to claim only the credit for part of the first year.

4. Uniform percentage requirement: The final regulations incorporate the uniform percentage requirement provisions from the proposed regulations, but also provide detailed rules for how to apply the provisions if SHOP dependent coverage is offered.

5. Wellness programs: If your organization offers a wellness program with a premium discount for participation (or a surcharge for non-participation), the difference in employer contributions won’t violate the uniform percentage requirement as long as your concern contributes at least 50 percent of the premium (including any surcharge) for non-participants. Employer subsidies under the wellness program count in the credit calculation.

6. Seasonal workers: Employees who work on a seasonal basis for no more than 120 days aren’t considered employees for small employer status and average annual wages, although employer contributions for premiums count in determining an employer’s tax credit. The final regulations have added a “reasonable, good faith” standard for identifying seasonal workers.

7. Claiming the credit: Similar to the provisions in the proposed regulations, the final regulations prescribe rules for claiming the credit on Form 8941, reflecting the credit in estimated tax payments and offsetting the employer’s alternative minimum tax (AMT) liability. In addition, the final regulations clarify that no deduction is allowed as a business expense under Section 162 for the portion of the premiums attributable to the claim for the credit.

Finally, the new regulations include a slew of transitional rules. You can find more information here.

Employers should keep in mind that this isn’t likely the last word, as conflicts continue to arise. Varying interpretations of the law, as well as other challenges to the ACA can be expected.

Consult with your advisers to ensure that your business is in full compliance, while keeping an eye out for new developments.