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What Every Small Business Owner Should Know About the Health Care Tax Credit
Small businesses that pay at least half of health insurance premiums for their employees may be eligible for a tax credit.
The Small Business Health Care Tax Credit provides a federal tax credit of up to 50% of employer-paid health insurance premiums. As with all tax credits, there are rules and limitations.
Qualifying for the Small Business Health Care Tax Credit
There's a three-part test for see if a small business qualifies for the health care tax credit:
- The business must have less than 25 full-time equivalent employees;
- The average wage of employees must be less than $51,600 (for tax year 2015) per full-time equivalent employee;
- Health insurance premiums must be paid through a "qualifying arrangement."
If all the eligibility criteria are met, the small business can take a tax credit for 50% of eligible health insurance premiums paid during the years 2014, 2015 and future years. (For the years 2010 through 2013, the tax credit was 35% of eligible health insurance premiums.)
No Tax Credit for Owners of the Business
Small businesses cannot take a tax credit for insurance premiums paid for owners of the business. This means that owners of corporations, partners in a partnership, and sole proprietors. For small businesses structured as a C-corporation, no tax credit is available for employees who own 5% or more of the corporation. For S-corporations, no tax credit is available for employees who own 2% or more of the S-corporation.
(Source: Internal Revenue Code, section 45R, paragraph (e)(1).)
Partners, members of LLC treated as a partnership, owners of a single-member LLC, S-corporation shareholders owning 2% or more of an S-corporation, and sole proprietors are all treated as self-employed persons for health insurance purposes, and are eligible for the self-employed health insurance deduction instead of the tax credit.
Qualifying Arrangement Means Employer Must Pay at Least Half of the Insurance Premiums
"A qualifying arrangement is generally an arrangement that requires you to pay a uniform percentage (not less than 50%) of the premium cost for each enrolled employee's health insurance coverage," the IRS advises.
In a set of frequently asked questions, the IRS clarified that this 50% test applies only to employee-only health coverage. So a scenario is which the employers pays half of the employee-only
coverage, and the employee pays all the premiums for covering spouse and children would still qualify for the tax credit.
For further details, see the Instructions for Form 8941 (pdf), and Small Business Health Care Tax Credit Questions and Answers: Calculating the Credit, both available on IRS.gov.
3 Limitations That Reduce the Health Care Tax Credit
Small employers may not qualify for the full amount of the credit. The 50% credit amount represents a maximum amount for the tax credit. The credit is be reduced (or phased out) in the following circumstances:
- The number of full-time equivalent employees exceeds ten,
- Average annual wages exceeds $25,800 per full-time equivalent for the year 2015,
- (Average annual wages exceeds $25,900 per full-time equivalent for the year 2016), or
- Actual health insurance premiums exceed average premiums paid for health coverage in the employer's area.
Claiming the Health Care Tax Credit
The Health Care Tax Credit will be claimed using Form 8941 and attached to the business's tax return.
The health care credit will reduce any income tax for the business. The credit is non-refundable (in other words, it can reduce income tax to at most zero). The credit cannot offset payroll tax or self-employment tax liabilities for small business owners.
The IRS has also published some frequently asked questions about the health care credit. The Taxpayer Advocate Service has produced a Small Business Health Care Tax Credit Estimator.
Can Businesses Take a Deduction for Health Insurance Premiums?
Small businesses can take both a deduction for health insurance premiums as the health care tax credit.
However, the amount of the deduction must be reduced by the amount of the tax credit.
Planning Tips for the Health Care Tax Credit
Small businesses should review their accounting systems to make sure they are keeping track of employer-paid and employee-paid health insurance premiums. This will become vitally important as employers may need to report the value of health insurance benefits on employees' W-2 forms.
Additionally, business owners will want to review how they structure their health benefits. For example, owners may want to revise what percentage of health insurance premiums they want to pay so as to be eligible for the tax credit.
First published: May 10, 2010. Last revised: October 27, 2015.
Category: Small business