Health Care Tax Credit for Minnesota Small Businesses

Minnesota Health Care

The health care reform law – the Patient Protection and Affordable Care Act (P.L. 111‐148) provides that small businesses may be eligible for a federal tax credit based on health insurance premiums paid for employees. As part of the health care reform effort, the federal government is providing an incentive for certain small businesses (those meeting certain criteria) to provide health insurance coverage for their employees.

What are the Health Care Tax Credit Amounts?

For tax years beginning in 2010 through 2013, an eligible small employer may claim a tax credit of up to 35% of the annual premiums it paid toward health insurance for employees. The limit is 25% for tax‐ exempt employers.

Beginning in 2014, the tax credit ceiling jumps to 50% (35% for tax‐ exempts). The full amount of the credit is available only to the smallest employers with the lowest paid workers – 10 or fewer FTE employees, and with average wages of $25,000 or less. The credit phases out gradually for companies with average wages between $25,000 and $50,000 and the equivalent of 10 – 25 full time workers, and in order to discourage high‐cost plans, the credit does not apply to premium amounts that exceed the average cost of health insurance in the state.

After 2013, the tax credit can be claimed for only two additional tax years, and the employer must offer health coverage to its workers through one of the new Exchanges (purchasing pools) to be created by each state by 2014.

How does a business know if it qualifies for the health care tax credit?

There is a three‐part test to see if a small business qualifies for the health care tax credit:

  • The business must have less than 25 full‐time employees.
  • The average wage of employees must be less than $50,000 per full‐time equivalent employee.
  • Health insurance premiums must be paid through a “qualifying arrangement”.

The IRS has prepared guidelines a small business can use to determine eligibility for and application for the small business health care tax credit. ( )

  1. Determine the total number of employees (not counting owners or family members), up to 24. Count each full‐time employee. A full‐time employee is considered to work 2080 hours a year (52 weeks times 40 hours per week). Count each part‐time employee as a portion of a full‐time employee by multiplying the total annual hours of each part‐time employee by 2080. Add these two numbers together, and if you have fewer than 25 employees, proceed to Step Two.Seasonal workers are disregarded in determining FTEs and average annual wages unless the seasonal worker works more than 120 days.
  2. Calculate the average annual wages of employees (not counting owners or family members). Take the total annual wages paid to employees. Divide it by the number of employees from Step One. Total wages divided by the number of employees equal average wages.If the average wages are $50,000 or less and you pay at least half of the insurance premiums for your employees at the single (employee‐only) coverage rate, then you may be able to apply for the Small Business Health Care Tax Credit.

What is a Qualifying Arrangement?

So far the IRS is applying the term “qualifying arrangement” to any scenario in which the small business pays at least half of the insurance premiums for its employees. In a set of frequently asked questions, the IRS clarified that this 50% test applies only to employee‐only covered health coverage. So a scenario in which the employer pays half of the employee‐only coverage, and the employee pays all the premiums for covering the spouse and children would still qualify for the tax credit.

Can Owners of the Business Take a Tax Credit?

Small businesses cannot take a tax credit for insurance premiums paid for owners of the business. This means 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. Partners, members of the LLC treated as a partnership, owners of a single‐member LLC, S‐Corporation shareholders owning 2% or more of an S‐Corporation 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.

Limitations that Reduce the Health Care Tax Credit.

Small employers may not qualify for the full amount of the credit. The 35% credit amount represents a maximum amount for the tax credit. The credit must be reduced (or phased out) in the following circumstances:

  • The number of full‐time equivalent employees exceeds ten (see Table 1 below), or
  • Average annual wages exceeds $25,000 per full‐time equivalent (see Table 2 below), or
  • Actual health insurance premiums exceed average premiums paid for health coverage in the employer’s area. In Revenue Ruling 2010‐13, the IRS has set forth average health insurance premiums by state that can be used for 2010. For Minnesota that amount is $4,704 (employee‐ only coverage) as of June 2010.

Table 1 – Credit Amount Reduction for Employers With More Than 10 Full‐Time Equivalent Employees

Number of Full‐Time Equivalent Employees Credit Amount Reduction Percentage
1 – 10 0%
11 6.667%
12 13.334%
13 20%
14 26.668%
15 33.335%
16 40.002%
17 46.669%
18 53.336%
19 60.003%
20 66.67%
21 73.337%
22 80.004%
23 86.671%
24 93.338%
25 or more 100%

Table 2 – Credit Amount Reduction for Employers With Average Annual Full‐Time Employee Compensation in Excess of $25,000

Average Annual Compensation Credit Amount Reduction Percentage
$25000 0%
$26000 4%
27000 8%
28000 12%
29000 16%
30000 20%
31000 24%
32000 28%
33000 32%
34000 36%
35000 40%
36000 44%
37000 48%
38000 52%
39000 56%
40000 60%
41000 64%
42000 68%
43000 72%
44000 76%
45000 80%
46000 84%
47000 88%
48000 92%
49000 96%
50000 or more 100%

Claiming the Health Care Tax Credit

The IRS has not yet released any forms or instructions for claiming the credit. It’s clear, however, that the tax credit will be reported on the business’s income tax return. The health care credit will reduce any income tax. The credit is non‐refundable (meaning it can reduce income tax to at most zero). The credit cannot offset payroll tax or self‐employment tax liabilities for small business owners.

Can Businesses Take a Deduction for Health Insurance Premiums?

Small businesses can take both a deduction for health insurance premiums and 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 will need to report the value of health insurance benefits on employee W‐2 Forms starting in 2011.

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.

Originally published by the Minnesota Department of Employment and Economic Development