Small Employer Tax Credit for Employee Health Insurance

Businesses have always been able to deduct expenses paid for employee health insurance.  Starting in 2010 there is a tax credit of up to 35% of the cost of providing nonelective contributions to employee health care insurance of an eligible small employer.  The credit percentage rises to 50% for tax years 2014 and 2015.

There are a couple of terms that have special meaning for the purpose of this credit.  The first is “nonelective contributions.”  Nonelective contributions must be at least 50% of the premium cost of the health insurance plan.  Simply contributing a flat dollar amount toward the health insurance premiums of employees may not be adequate.  The law requires that a uniform percentage of not less than 50% of the premium cost of the health insurance plan.

The second term with a special definition is “eligible small employer.”  There are three requirements to be an “eligible small employer.”  First, the employer must make the nonelective contributions described above.  Second, the employer must have no more than 25 full-time equivalent employees for the taxable year.  Third, the employees must have average annual wages that do not exceed $50,000.

The last two requirements to be an eligible small employer above are the top end of the phase-outs for the credit.  The credit begins to phase-out when the number of full-time equivalent employees exceeds 10.  For each full-time equivalent employee over 10 the credit is reduced by 6.67%.  The second phase-out for average annual wages begins at $25,000.  For each $1,000 in average annual wages over $25,000 the credit is reduced by 4%.

One additional limitation is that the amount of the health insurance premiums that qualify cannot exceed the average premium for the small group market in the state where the employee works.

Not everyone is counted in calculating the credit.  Excluded from credit (and the calculation of the phase-outs) are seasonal workers, sole proprietors, partners in partnerships, 2% shareholders in S corporations, 5% owners in eligible small businesses, and related parties & dependents.

Most health care plans will qualify, but some do not.  Examples of qualifying health care plans include any plan providing coverage for medical care (provided directly or through insurance reimbursement), hospital or medical service policies, and HMO’s.  The following plans are not qualified health care plans: Coverage only for accident or disability income; coverage issued as a supplement to liability insurance; automobile medical payment insurance; credit-only insurance; or similar insurance coverage for medical care that is secondary or incidental to other insurance benefits.

The credit is calculated and claimed on Form 8941 and is allowed for sole proprietors, corporations, partnerships, trusts and tax exempt organizations.  Tax exempt organizations have a lower credit percentage (25% for 2010 – 2013 and 35% for subsequent years).  Because tax exempt organizations do not pay income taxes, the credit is used to offset the organization’s employment taxes.

The deduction for health insurance paid on behalf of employees must be reduced by the amount of the credit.  For state tax purposes there is no corresponding credit so the reduction in the expense does not apply on state tax returns.

If you would like more information on how to claim the Small Employer Health Insurance Credit, contact one of the tax professionals at Seid & Company, CPAs.