The small business health care credit

We all know that the federal health care reform law of 2010 contains myriad confusing rules and regulations. One of the provisions that definitely warrants a clear understanding involves an income tax credit for small businesses that provide health insurance to their employees. The credit is also available to nonprofit organizations that are exempt from paying income taxes.

Only three general criteria are necessary for a business, including a nonprofit, to be eligible to receive this credit: It must have fewer than 25 full-time equivalent employees during its fiscal year, the average wage earned by its employees must be less than $50,000, and the business must pay at least 50% of the cost of the health care coverage. Please note that owners and relatives of owners do not count as employees for the purpose the Small Business Health Care Credit.

The criteria are straightforward, but the definitions of the terms listed above need further elaboration. (Note: The explanations below are not meant to be all-inclusive; for additional nuances of the provision, look to the IRS guidelines at www.irs.gov/uac/Small-Business-Health-Care-Tax-Credit-for-Small-Employers.)

A full-time equivalent employee (FTE) is based on 2,080 hours of work per year. The maximum amount of hours worked for the year can be 2,080 (40 hours times 52 weeks). Basically, the organization should add up all the hours for which its employees were paid during its fiscal year and divide by 2,080. Paid time off is included in this calculation, but work performed by seasonal workers (fewer than 120 days during the year) is not.

The average wage is calculated by taking the total wages paid during the fiscal year, excluding owners and relatives of owners, and dividing by the FTE amount calculated above. Once again, paid time off wages should be included, but wages to seasonal workers should not be.

The 50% cost provision is met if the organization pays at least half the health care premiums for its own employees; amounts paid on behalf of employee spouses or dependents are excluded from the calculation. Therefore, the calculation is based on the “single” premium rate. However, premiums for seasonal workers are included in this part of the analysis.

If the three criteria listed above are met, this is the payoff: A for-profit business is able to claim a credit of up to 35% of its health care premiums paid during the fiscal year, and a nonprofit may claim a credit of up to 25% of its premiums. Organizations with average wages of less than $25,000 and 10 or fewer FTEs are eligible for the full amount. The credit is phased out for employers with 11 to 25 FTEs and average wages from $25,000 to $50,000.

The credit in its present form lasts through 2013. Starting in 2014, the credit is scheduled to increase to 50% of premiums for for-profits and 35% for nonprofits.

The credit is claimed on the following year’s income tax returns, on Form 8941. For-profit businesses attach this form to their standard 1120 income tax returns to receive the credit. Nonprofits attach this form to a 990-T return prepared in conjunction with the normal 990 (or 990-EZ).

Mike Scholz is a partner at Wegner CPAs.