Retroactive to January 1, 2010, and available through 2013, the credit is available to both taxable small businesses and non-profit employers. Small businesses will claim the credit on their annual income tax return and may carry the credit back one year (starting in 2011) or forward 20 years. Non-profits will be provided with additional guidance from the IRS on how to claim the credit. The credit is refundable only for eligible non-profits.
Requirements for Eligibility
To qualify for the credit, an employer must meet these three requirements:
- Have fewer than 25 full-time-equivalent employees (FTEs);
- Pay an average annual wage of less than $50,000 per year, per FTE employee; and
- Maintain a "qualifying arrangement."
1. Full-Time-Equivalent Employees (FTEs)
To calculate the number of FTEs under the first requirement, the employer would first exclude partners; certain owners (shareholders owning more than 2 percent of an S-corp and owners owning more than 5 percent of other businesses); family members and dependents of the owners and partners; and seasonal workers, provided that the workers do not work for the employer more than 120 days during the taxable year. (Though seasonal workers are excluded from the FTEs calculation, the premiums paid on their behalf are still be counted in determining the credit amount.)
Note, Section 45R follows the single employer, controlled group, and affiliated service group treatment of Section 414(b), (c), (m), and (o) of the Code. This means all employees meeting the definition of FTEs and all wages paid to the employees of a controlled group or affiliated service group are taken into account in determining whether any member of the controlled group or affiliated service group is eligible for Section 45R.
Continuing the FTE determination, the employer would next calculate the hours of service performed by the remaining employees, from one of three methods:
- Determine actual hours worked and hours for which employee is entitled to payment, including days for illness, vacation, holiday, and other leave;
- Utilize a days-worked equivalency of eight hours of service for each day for which the employee would be required to be credited with at least one hour of service; or
- Use a weeks-worked equivalency for which the employee is credited with 40 hours of service for each week for which he or she would be required to be credited with at least one hour of service.
Then, the employer need only take the total number of hours of service performed by the employees (not to exceed 2,080 hours for any employee) and divide by 2,080. Round down to the next lowest whole number. Note, if some of the employees are part-time, the calculation may allow employers with more than 25 employees to qualify for the credit. The calculated number of FTEs must be less than (not equal to) 25.
2. Annual Wages
To calculate the average annual wages paid per FTE take the total wages actually paid by the employer during the taxable year to employees taken into account for the credit and divide by the calculated number of FTEs for the year. Round down to the nearest $1,000. The average annual wage must be less than $50,000 per FTE.
3. Qualifying Arrangement
A qualifying arrangement is an arrangement under which the employer pays premiums for each employee enrolled in health insurance coverage offered by the employer in an amount equal to a uniform percentage of at least half (50 percent plus) of the premium cost of the coverage. For 2010 there is a special allowance. Since the credit is retroactive to before its effective date, an employer may satisfy the uniformity requirement if the employer pays an amount equal to or greater than 50 percent of the premium for single (employee-only) coverage for each employee enrolled, even if the employer does not pay the same percentage for each employee. Or, if the employer offers greater coverage (e.g., family or self-plus-one coverage), the employer will be deemed to have met the uniformity requirement if it pays an amount for each employee receiving coverage that is no less than 50 percent of the premium for single care coverage of the employee. Future guidance on the uniformity requirement will follow, and the IRS and Treasury are accepting comments now.
Health insurance coverage may also include dental, vision, nursing home care, and other specified plans. However, the different types of health insurance coverage are not aggregated for the purposes of this requirement; each must have a separate determination of whether it is a qualifying arrangement.
Maximum Credit Amount and Reduction Through Phase Out
For 2010 through 2013, Section 45R allows a maximum credit of a percentage (35 percent for small businesses employers and 25 percent for non-profit eligible small employers) of the lesser of:
- The amount paid by the employer under the arrangement that tax year; and
- The average premium amount for the small group market in the state in which the employer is offering health insurance coverage.
Only the premiums that the employer actually paid for health insurance coverage under a qualifying arrangement are counted in calculating the credit. If only portions of the premiums are paid by the employer, then only those paid portions may be taken into account for the credit.
For tax-exempt eligible small employers, the credit may not exceed the total income tax paid under §3402 and Medicare tax under §3101(b).
For eligible small employers, the credit is then phased out if:
- Number of FTEs in excess of 10; and
- Average annual wages are in excess of $25,000.
Employers Receiving State Tax Credits Still Eligible for Full Federal Credit
The federal Section 45R credit will not be reduced if the employer receives a state health care tax credit or subsidy.1 An eligible employer receiving a state health care tax credit or subsidy will still be entitled to the full federal credit. The only hindrance is that the credit cannot exceed the amount of the employer's net premium payments.
1 Though not discussed here, the notice describes limited exceptions where the federal credit will be reduced, to prevent abuse of the credit.