Accountants CPA Hartford, LLC
William Brighenti, Certified Public Accountant
Certified QuickBooks ProAdvisor
Office Address:  46 Mildrum Road, Berlin, Connecticut 06037-2423      Phone:  (860) 828-3269      Email:  [email protected]
New Britain
Health Care Tax Credit
How to Calculate the Health Care Tax Credit
by William Brighenti, Certified Public Accountant, Certified QuickBooks ProAdvisor

Affordable Care Act Tax CreditSigned into law on March 23, 2010 by President Obama , the Patient Protection and Affordable Care Act (“Affordable Care Act”), as reflected  in Section 45R of the Internal Revenue Code, offers an attractive tax credit in order to encourage small businesses and tax-exempt organizations to offer and continue to offer health insurance to its employees.  The Act specifically targets businesses and organizations employing low-income and moderate-income employees.

The tax credit can be significant.  The maximum tax credit for the years 2010 through 2013 is 35% and 25% of health insurance premiums paid for by employers of small businesses and tax-exempt organizations, respectively.  In 2014 it increases to 50% and 35% of premiums paid by employers of small businesses and tax-exempt organizations, respectively.

To be eligible for the tax credit under the Affordable Care Act, there are several requirements that need to be met by the employer.  First, the company or organization must have less than the equivalent of 25 full-time employees.  In order to receive the maximum tax credit, the company or organization needs to exceed no more than the equivalent of 10 full-time employees.

Second, the average salary of these employees must be less than $50,000.  To be eligible for the maximum tax credit, their average salary must not exceed $25,000.

Third, in order to quality for any tax credit under the Act, the employer must pay an amount equal to a “uniform” percentage of not less than 50% of the premium cost of the health insurance coverage. 

Each of the above eligibility requirements warrant further clarification.  For instance, regarding the term “employee”, a sole proprietor, a partner in a partnership, a shareholder owning more than two percent of an S corporation, and any owner of more than five percent of other businesses are not considered employees for purposes of the credit.  Moreover, family members of any of the business owners or partners mentioned above, or a member of a business owner’s or partner’s household, is not considered an employee for purposes of the credit. Thus, the wages or hours of business owners, partners, and their family and household members are not counted in determining the number of full-time employees or the amount of average annual wages, while the insurance premiums paid on their behalf are not included in determining the amount of the health insurance cost eligible for the tax credit.   Similarly, businesses with the same owners or related businesses are treated as a single employer for purposes of the credit:  that is, the number of employees, average wages, and amount of insurance premiums paid are determined by including all employees, wages, and insurance premiums of all related entities—and not separately for each separate business— in order to determine its eligibility and amount of the tax credit.

Furthermore, the term “equivalent full-time employee” requires additional clarification as well.  It does not simply refer to a head count of the physical number of employees who report to work everyday.  Seasonal employees are excluded if they work no more than 120 days out of the year.  To determine the number of equivalent full-time employees at a company or organization, for all paid employees other than owners, related parties of owners, and seasonal employees as mentioned above, sum the lesser of the actual hours worked or 2,080 for each paid employee, divide that total by 2,080 hours, and round that result down to the next lowest whole number.  Consequently, an employer with literally more than 25 employees could qualify for the health care act tax credit depending upon the total annual hours worked by them.

If the calculated number of employees of the company or organization is less than the equivalent of 25 full-time employees, then the next step would be to calculate the average annual wages of the business’ or organization’s employees.  To determine the average annual wages, sum all of the FICA wages of all of the employees included in the equivalent full-time employee calculation previously determined, divide that total by 2,080 hours, and round down to the nearest $1,000 dollars, if the calculated result is not a multiple of $1,000.

In addition to the number of equivalent full-time employees and average annual wages, the third variable of the algorithm in the calculation of the health care tax credit is the amount of insurance premiums paid by the employer on the part of its employees.  The Act requires that it must be a uniform percentage of at least 50% of the premium cost of the coverage; however, to assist in the easement of the Act’s transition for the year 2010—since it was only signed into law on March 23rd— if the percentage of health insurance premiums absorbed by the employer is not the same for all equivalent full-time employees, the employer will not be denied the tax credit, as long as the employer pays at least 50% of each employee’s health insurance premiums for single (employee-only) coverage and otherwise satisfies the requirements for the credit described above.

The Internal Revenue Service has capped the amount of employee and family insurance premiums eligible for the tax credit by state since premiums may vary widely by location, as shown in the following table:

State Employee Family
State Employee Family
Alaska 6,204 13,723
Montana 4,772 10,212
Alabama 4,441 11,275
North Carolina 4,920 11,583
Arkansas 4,329 9,677
North Dakota 4,469 10,506
Arizona 4,495 10,239
Nebraska 4,715 11,169
California 4,628 10,957
New Hampshire 5,519 13,624
Colorado 4,972 11,437
New Jersey 5,607 13,521
Connecticut 5,419 13,484
New Mexico 4,754 11,404
District of Columbia 5,355 12,823
Nevada 4,553 10,297
Delaware 5,602 12,513
New York 5,442 12,867
Florida 5,161 12,453
Ohio 4,667 11,293
Georgia 4,612 10,598
Oklahoma 4,838 11,002
Hawaii 4,228 10,508
Oregon 4,681 10,890
Iowa 4,652 10,503
Pennsylvania 5,039 12,471
Idaho 4,215 9,365
Rhode Island 5,887 13,786
Illinois 5,198 12,309
South Carolina 4,899 11,780
Indiana 4,775 11,222
South Dakota 4,497 11,483
Kansas 4,603 11,462
Tennessee 4,611 10,369
Kentucky 4,287 10,434
Texas 5,140 11,972
Louisiana 4,829 11,074
Utah 4,238 10,935
Massachusetts 5,700 14,138
Virginia 4,890 11,338
Maryland 4,837 11,939
Vermont 5,244 11,748
Maine 5,215 11,887
Washington 4,543 10,725
Michigan 5,098 12,364
Wisconsin 5,222 12,819
Minnesota 4,704 11,938
West Virginia 4,986 11,611
Missouri 4,663 10,681
Wyoming 5,266 12,163
Mississippi 4,533 10,501

If the employer’s cost for coverage exceeds those premiums found in the above table for its location, it would use the table’s value to derive its tax credit and not its actual premium rate.  The Secretary of Health and Human Services is expected to be providing additional average premium rates for distinct market areas within some states in the near future.  Stay tuned.

It is important to note that for the purposes of this specific tax credit, any premiums paid pursuant to a salary reduction arrangement under a section 125 cafeteria plan is not treated as paid by the employer.  However, any premiums paid by employees under a cafeteria plan on behalf children who will not have reached age 27 by the end of the year—even if the cafeteria plan has not yet been amended to cover these individuals— are generally tax-free to the employee, effective March 30, 2010.

Once the number of equivalent full-time employees, average annual wages, and total eligible insurance premiums paid for these employees have been derived, the Affordable Care Act tax credit can then be determined.  If the number of equivalent full-time employees is no more than 10, and if average annual wages is no more than $25,000, simply multiply the total eligible insurance premiums paid by 35% for businesses.  That amount is the tax credit available to the business, subject to the employer’s actual income tax liability (or alternative minimum tax liability) for the year excluding its inclusion.  Any unused credit amount can generally be carried back one year and carried forward 20 years, except for 2010, since it cannot be carried back to a year before the effective date of the credit.

If the number of equivalent full-time employees exceed 10, and/or if the average annual wages exceed $25,000, then the amount of the credit calculated above is proportionately reduced over the respective “phase-out range” for each limit, i.e., 15 and $25,000, respectively.  The numerator of the “reduction factor” of the tax credit is the amount in excess over the above-mentioned thresholds of 10 and $25,000, respectively; its denominator is always the respective phase-out range, 15 and $25,000.  For example, to calculate the reduction factor for an employer with equivalent full-time employees in excess of 10, simply divide the excess number of employees by 15, its phase-out range.  If an employer determined that it had 15 equivalent full-time employees, then the reduction factor would have a numerator of 5; again, its denominator would always be 15:  therefore, the reduction factor would be 5/15, or 1/3rd.  Assuming a maximum total tax credit of $90,000 for this employer, $30,000 would be subtracted from that amount in the calculation of the tax credit.

To calculate the reduction factor for an employer with average annual wages in excess of $25,000, simply divide that excess by $25,000, its phase-out interval for wages.  If an employer determined its average annual wages were $30,000, then the reduction factor here would have a numerator of $5,000 and its denominator would always be $25,000.  Assuming again a maximum total tax credit of $90,000, $18,000 would be subtracted from that amount in the calculation of the tax credit.

If both exceedances, as determined above, existed for the employer for the year, then the entire reduction of the tax credit simply would be the sum of both reductions calculated individually:  in the above example, $48,000, leaving $42,000 of the maximum tax credit available to the employer.

The determination and application of the tax credit for a tax-exempt organization varies slightly.  In addition to the lower tax credit percentage available to the tax-exempt organization—25%—as compared to that for the small business—35%, the amount of the credit is also limited to the sum of income tax and Medicare tax withheld from the eligible employees’ wages and the Medicare tax paid by the organization.  Thus, if $22,000 in income and Medicare taxes were withheld, and $2,000 in Medicare taxes paid by the employer, the tax credit would be limited $24,000 for the year.

In addition, unlike the treatment for the small business, the tax credit for the tax-exempt organization is a refundable credit, so that even if the organization has no taxable income, it may receive a refund, so long as it does not exceed the income tax withholding and Medicare tax liability of the organization.

Although small businesses can claim the Affordable Care Act tax credit as part of the general business credit on their income tax returns, since tax-exempt organizations do not file income tax returns per se, the Internal Revenue Service will be providing information on how they will claim this tax credit sometime in the near future.  Needless to say, for businesses claiming the tax credit, the amount of health insurance premiums normally deducted on its tax returns under Section 162 would have to be reduced by the amount of the credit.  Of course, the credit can be included in determining a company's estimated tax payments for the year.

The Affordable Care Act tax credit for small businesses and tax-exempt organizations offers a significant opportunity to employers to offer health insurance benefits to their employees at a material reduction in cost by availing themselves of a generous subsidy on the part of the federal government in the form of a tax credit.  And in 2014, this tax credit will increase substantially.  It is important on the part of the taxpayer to know the requirements of the Act and to calculate the credit correctly.  It has been the purpose of this article to provide an overview of the health insurance tax credit to provide such assistance to the taxpayer.

This article is provided for informational purposes and is not intended to be construed as legal, accounting, or other professional advice.  For further information, please consult appropriate professional advice from your attorney and certified public accountant. 

Have a tax or an accounting question?  Please feel free to submit it to William Brighenti, Certified Public Accountant, Hartford CPA Accountants.  For information and assistance on any tax and accounting issue, please visit our website:  Accountants CPA Hartford.

If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.  The above tax advice was written to support the promotion or marketing of the accounting practice of the publisher and any transaction described herein.  The taxpayer recipients of this offering memorandum should seek tax advice based on their particular circumstances from an independent tax advisor.
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