When you add health care costs to running a business, it can get very expensive. One of the good things about these costs is that they can actually result in a lower overall tax bill for your business.
Small-business owners can take advantage of an incentive offered by the government to manage their employee health insurance costs: the small-business health care tax credit.
There are some restrictions and complicated calculations associated with the tax credit for small businesses, but this guide will explain everything you need to know.
Small business health care tax credit: What are they?
An organization may be entitled to a tax credit for health insurance premiums that it pays for employees as part of the small-business health care tax credit. The Small-Business Health Options Program Marketplace (SHOP) requires that small businesses offer its employees a qualified health plan, pay at least 50% of the costs, and have fewer than 25 full-time equivalent employees earning less than $55,000 on average. Your business tax return must include Form 8941 in order to claim this credit.
NOTE: This isn't a tax credit you can claim over and over again - it's a credit you can take up to twice in a row.
Qualifications for the small business health care tax credit
There are a few requirements you need to meet in order to qualify for the small-business health care tax credit:
A total of fewer than 25 full-time equivalent employees
Small businesses are those with fewer than 25 full-time equivalent employees (FTE) for purposes of this tax credit. FTEs are considered to work at least 2,080 hours per year, according to the IRS.
When you have only full-time employees, you can easily calculate the number of full-time equivalents. With part-time employees, things become more complicated. If multiple part-time employees are consolidated, they can be credited as full-time employees. Two half-time employees are the same as one full-time employee, for example.
If you have part-time employees in your workforce, the IRS clearly explains how to calculate your FTEs. We will provide more details in the next section about how to calculate a full-time equivalent employee.
Less than $55,000 in average salary
The average annual wages you pay per full-time employee must be less than $55,000 to qualify for the small-business health care tax credit.
Divide the number of employees by the total wages paid to full-time equivalent employees to find the average wage. Imagine you made $320,000 in total wages and had eight full-time workers, meaning you paid an average wage of $40,000.
Health insurance premiums that qualify
Obtaining this credit also requires you to pay a portion of your employees' health care costs. In order to qualify for a Small-Business Health Options Program Marketplace (SHOP), your company must offer employees a qualified health care plan and pay a uniform percentage of the cost of a minimum of 50%.
For employees with family health care plans, only 50% of the employee-only premium costs need to be covered - not 50% of the family plan.
What is the definition of a full-time equivalent employee?
The calculation of how many full-time equivalent employees you have can be tricky when you have a workforce of part-time employees.
It is imperative that you determine the number of hours each part-time employee works if you have part-time workers. To do this, you can use the following methods:
The number of hours an employee works: You can track the actual number of hours an employee works, including sick days, holidays, and vacations.
Number of days worked: An employee's service hours are calculated based on eight hours of work a day. As an example, a person working 150 days a year would work 1,200 hours (150 days x 8 hours).
Based on the weeks worked: The results from this method are nearly identical to the ones from the days-worked equivalency method if a 40-hour work week is assumed. It would count as 1,800 hours worked for an employee who works 45 weeks per year but takes seven weeks off without pay.
Then, you will be able to determine how many full-time employees you have based on the hours each employee works. As an example, you have four employees who work 30 hours a week, 52 weeks a year. The number of full-time equivalent employees is calculated as follows:
4 employees x 30 hours per week x 52 weeks per year = 6,240 hours
6,240 / 2080 = 3 full-time equivalent employees
When it comes to this tax credit, your four part-time employees are equal to three full-time employees.
Note: Owners and their families are not eligible
Full-time equivalent employees are counted except for this notable exception. This does not include the owners and their families, with:
One who owns a sole proprietorship.
In a partnership, one of the partners.
A shareholder with more than 2% of an S-corporation.
An owner with a stake of more than 5% in the company.
The spouse, children, grandchildren, siblings and step-siblings, parents, step-parents, nieces and nephews, aunts, uncles, son or daughters-in-law, and mothers and fathers-in-law of the owner do not qualify as full-time equivalents. In addition, any spouses of these family members would also not be included in the calculation of full-time equivalent employees. People who might be related to an owner are not allowed to be included.
The tax credit cannot be used to offset premiums paid for the health insurance of the owner or family member. However, the premiums paid can still be deducted from your taxes.
What is the amount of the small-business health care tax credit?
Calculating the small-business tax credit for health care is complicated. What is its value? Some small firms may be able to save a great deal of money by using this credit.
The credit is most valuable to small businesses that have fewer than ten full-time equivalent employees earning less than $27,000 annually. Small businesses with fewer than 10 full-time equivalent employees will be eligible for a maximum tax credit of 50% on premiums paid. A percentage of that will be phased out depending on the number of full-time employees and the average salary.
A tax-exempt employer can claim up to 35% of their premiums as a credit.
You can receive the maximum credit if you have fewer than 10 full-time equivalents paid no more than $27,000 per year. A credit will be phased out once 25 employees are on the payroll or the salary average is over $55,000. The credit won't be available after that point.
The Department of Health and Human Services publishes the average price of small-group coverage in your employer's market, as well as your tax credit. The deduction will be capped by the average premium, even if you pay more in premiums.
An employee-only health care plan, for instance, might have a premium of $6,000 per year, and you would contribute 50%, or $3,000. In your market, the average premium is $5,000. There will be an upper limit of $2500 on your credit, or 50% of the average premium in your small group market.
You can still benefit from this tax credit if you do not owe any taxes. You can claim this tax credit regardless of how much tax you owe. You can carry forward or backward the credit if you do not have any taxable income for the year.
Credits and deductions
Health insurance premiums can be written off both as a deduction and as a credit if you wish to take a health care tax deduction. Credits will reduce the deduction, though.
What are the steps for claiming the small-business health care tax credit?
Use Form 8941 to claim the small-business health care tax credit. When you attach the form to your business tax return, any taxes that are owed will be reduced. Please note that you can only claim the credit twice in consecutive tax years.
Have any questions about obtaining a tax credit? Please contact us at email@example.com or (212) 365-4553.