Health care benefits

guest commentary by David Potts

The dust seems to be settling and the strong emotions subsiding caused by the passage of Patient Protection and Affordable Care Act passed in March of this year.

Most “benefits” included in the tax act were deferred into the near future. However one benefit is currently available to small employers: the Tax Credit for Employee Health Insurance Expenses of Small Employers.

To be eligible for the tax credit, the employer must have fewer than 25 full-time equivalent employees (FTEs) for the taxable year, the average annual wage of its employees must be less than $50,000 per FTE, and the employer must maintain a qualifying arrangement.

As with most things related to the Internal Revenue Code, calculating the tax credit isn’t simple. For example, you can still qualify for the tax credit if you have more than 25 employees. You just can’t have more than 25 FTEs. So how do you determine your FTEs?

First you have to determine which employees are taken into account. All employees except for business owners and their family members and seasonal employees are taken into account. So if you own the business or part of the business, don’t count yourself. Also exclude family members: children, parents, brothers and sisters, in-laws. Also don’t count any of the family member’s dependents. If you hire seasonal workers and they work for less than 120 days, they are excluded from the count too.

Next you have to determine the number of hours of service worked by these “counted” employees in the taxable year. This is basically every hour for which the employee was paid including vacation, holidays, sick leave, jury duty and any leave of absence.

Let’s look at an illustration of how a employer with more than 25 employees could qualify for this tax credit. The IRS has provided employers with three different methods to calculate their employees’ hours of service; actual service hours, a days-worked equivalency, and a weeks-worked equivalency. I’m not going to discuss the details of each of these methods today. In my illustration I will use the actual service hours method in calculating the FTEs.

Let’s assume a business paid 35 workers in 2010. There are 15 full time employees and 20 part time employees. The full time employees worked 2,080 hours each for a total of 31,200 hours. The part time workers each worked 800 hours for a total of 16,000 hours. In order to determine the full-time equivalent employees (FTEs) you would divide the total services hours by 2,080, or 47,200 divided by 2,080 for a total full-time equivalent employee total of 22.7. The IRS instructs you to round down to the next lowest whole number so the business’ FTEs would be 22.

After determining that your FTEs, next you have to determine the average wages for the taxable year. This is determined simply by dividing the annual wages paid by the employer during the taxable year by the employer’s FTEs. The wages paid do not include the wages of the owners or the owners’ family. In the above illustration, if the annual wages paid in 2010 totaled $700,000, the average annual average wage per FTE would equal $31,000 ($700,000/22=$31,818; rounded down to the nearest $1,000 equals $31,000).

Finally, the employer must maintain a “qualifying arrangement.” A qualifying arrangement is an arrangement where the employer pays premiums for each employee enrolled in health insurance coverage offered by the employer in an amount equal to a uniform percentage, but not less than 50% of premium cost.

The maximum amount of the credit for 2010 through 2013 is 35% of the lesser of the employer’s health insurance premium cost or the premium cost that would have been paid if the employer paid the average premium for the small group market in the state in which the employer offers coverage. In other words, the employer’s premium cost for the purpose of calculating the tax credit is limited to the average premium for the small group market in the state. These amounts are published annually by the IRS.

For Arkansas the average small group market premiums for 2010 are $4,329 for single coverage and $9,677 for family coverage. For Oklahoma the average small group market premiums are $4,838 for single coverage and $11,002 for family coverage.

The credit is phased out beginning when the small employer’s FTEs exceed 10 and when the average annual wages exceed $25,000 per FTE. If the number of FTEs exceeds 10, the credit is reduced by a fraction where the numerator is equal to the number of FTEs in excess of 10 and the denominator is 15. If the employer’s FTEs totaled 22, the credit would be reduced by 80% [(22-10)/15)]. If the average annual wage totaled $31,000, then the credit would be reduced by 24% [($31,000-$25,000)/$25,000)]. The total reduction is the sum of the total from each fraction.

In our illustration the employer is out of luck because where both the FTEs exceed 10 and the average annual wage exceed $25,000, it is possible to reduce the credit to zero (but not below zero). In our illustration the sum of both fractions required the tax credit to be reduced 100% (80% + 24% = 104%, but not below zero).

The credit is taken by reducing your income tax when you file your income tax return. If the tax credit is more than your income tax, the unused credit is carried back one year and carried forward 20 years (except for 2010 where the unused amount of the credit can only be carried forward).

There are a number of places you can stump you toe in calculating this credit. This article doesn’t discuss every rule and every exception. For example, nonprofit organizations are eligible for this credit but the credit is equal to 25% of health insurance premiums, not 35%. Since nonprofit organizations generally don’t pay income tax, they won’t claim the credit by offsetting income taxes. As of today the IRS hasn’t determined how nonprofits will get credit for paying health insurance premiums. To determine whether you will qualify for this tax credit and how much the credit could offset your income taxes, talk with your tax advisor. The amount of the tax credit has the potential to be substantial for a small employer.

About Potts
David Potts is a certified public accountant also accredited in business valuation. Owner of Potts & Company, Certified Public Accountants for more than 25 years, his practice focuses on small and medium size businesses and their owners in the areas of taxation, accounting and bookkeeping, business valuation and business advisory services. He is a Fort Smith native and a graduate of the University of Arkansas. You can follow more of his thoughts at ThePottsReport.com. Although every effort is made to provide you accurate and timely tax information, it is general in nature and not specific to your facts and circumstances. Consult a qualified tax professional to discuss your particular case.

Also, feel free to e-mail topic suggestions or questions to [email protected]