Tax credit can help ODs provide employee health insurance

June 21, 2012

By James R. Armstrong, CPA, and Jodi Permenter, CPA

According to a report issued by the White House Council of Economic Advisors, employers with fewer than 25 employees generally pay as much as 18 percent more for health insurance coverage than their larger counterparts. In order to level the playing field, the Internal Revenue Service (IRS) has created the Small Employers Health Insurance Credit (SEHIC) to reward small employers who provide health insurance for their employees. Businesses and non-profit organizations that pay at least 50 percent of their employee’s health insurance premiums could qualify for a credit of up to 35 percent of the premium paid.

In order to qualify for the tax credit, a business must have fewer than 25 full-time equivalent employees, pay an annual salary of less than $50,000 per employee, and pay at least 50 percent of their employee’s portion of health insurance premiums. The Small Employer Health Insurance Credit can be up to 35 percent of all health insurance premiums paid through 2013. In tax years 2014 and 2015, the credit will increase to 50 percent of premiums paid, but it will only be available to employers who purchase health insurance through state-sponsored insurance exchanges. All states must set up a state-sponsored insurance exchange by 2014, which is expected to reduce the price of health insurance for small employers by improving bargaining power and reducing broker fees and other administrative costs.

The credit does have limitations, however. Health insurance premiums paid for business owners with at least a 5 percent interest in the business (2 percent for S-Corporations) or their spouses and dependents are not eligible for the credit and are excluded from all calculations. The credit is also subject to a phase-out for employers with more than 10 employees or employers with more than $25,000 in average annual wages. Therefore, in order to qualify for the full 35 percent credit, a business must have fewer than 10 employees and less than $25,000 in annual wages. In addition, the credit is non-refundable, so it cannot be claimed unless the business, or the business owner in the case of a partnership or S-Corporation has tax liability. If a business qualifies for the credit but does not have enough tax liability in the current year, the credit can be carried back one year or carried forward 20 years to offset future tax liability.

The number of full-time equivalent employees is calculated using the total hours worked by all employees per year divided by 2,080 hours (full-time). However, employees who work in excess of 2,080 hours per year are considered, for purposes of calculating the number of full-time employees, to have only worked 2,080 hours. Because premiums paid for owners and their dependents are ineligible for the credit, they are also excluded from the calculation of full-time equivalent employees. In addition, seasonal employees who are employed for less than 120 days are excluded from the calculation. For example, ABC Optometry has two owners who each work full-time in the business. They have each hired their spouse as full-time employees, in addition to six other full-time employees, two of whom worked 100 hours of overtime each during the year. The business has two part-time workers who work 1,040 hours per year and three temporary workers who work for two months during the year. The business is expanding, so they hired an additional full-time employee on April 1. Because the number is rounded down to the highest whole number, ABC Optometry has seven full-time equivalent employees.

The next step in calculating the Small Employer Health Insurance Credit is calculating the average gross annual wage per employee. For example, ABC Optometry has a total annual payroll of $594,000. Each of the owners makes $100,000, and each of their spouses make $45,000 per year. The seasonal employees each made $5,000. The payroll for the owners, their spouses, and the seasonal employees is deducted from the total payroll, and the remaining $294,000 is divided by the number of full-time equivalent employees (in this case, seven), and rounded down to the highest $1,000 increment. The average annual payroll per full-time equivalent employee is $42,000.

ABC Optometry adopts a health insurance plan that pays for 100 percent of its employees’ health insurance premiums, but none of the premiums for the employees’ spouse or dependents. The insurance plan qualifies for the tax credit because the business is paying for more than 50 percent of the employees’ premiums, even though they do not contribute toward the premiums for the employees’ family.

Because ABC Optometry pays for 100 percent of its employees’ health insurance premiums, has fewer than 25 full-time equivalent employees, and the average annual wages are less than $50,000, it qualifies for the Small Employer Health Insurance Credit. In order to prevent abuse, the credit is calculated on the lower of either the health insurance premiums paid or the state average for health insurance premiums. This prevents employers from selecting expensive “Cadillac plans” in order to qualify for a larger credit. ABC Optometry pays $14,000 for health care coverage each year.

Of that, $1,500 of the premiums paid are paid on the health insurance policies of the owners and their spouses, which is not tax deductible nor is it eligible for the Small Employer Health Insurance Credit. The remaining $12,500 in premiums is eligible for the credit, provided that the cost is below the state average.

If ABC Optometry qualified for the full credit, it would be entitled to 35 percent of the total health insurance premiums paid, or $4,375. However, ABC Optometry does not qualify for the entire credit because its annual salary is in the phase-out range. In order to calculate the amount of the credit that has been phased-out, ABC Optometry will find the difference between its average annual wages and $25,000. In this case, the difference is $17,000 (the $42,000 average payroll – $25,000 starting phase-out). The phased-out percentage is equal to $17,000 divided by $25,000, which is 68 percent. The $2,975 ($4,375 x .68) is excluded due to phase-out, leaving a $1,400 ($4,375-$2,975) tax credit available.

The IRS does not allow anyone to receive two tax benefits from the same expense, however, so ABC Optometry will not be able to claim the full $12,500 health insurance expense deduction in addition to the credit. ABC Optometry must reduce the health insurance expense deduction by the amount of the credit. The allowed health insurance deduction is $11,100 ($12,500 gross expense less the $1,400 allowed credit). Assuming that the business or business owners are in a 25 percent tax bracket, the business will receive a net tax benefit of $1,050 ($1,400 x .25).

Although the value of employer-sponsored health coverage is nontaxable to employees, it may soon be required that the amount be reported on the Form W-2 issued to employees. Current guidance requires employers issuing in excess of 250 Form W-2s to report the cost of major medical insurance beginning with 2012 W-2s (which are issued in January 2013). The amount shown should include the portion of premiums paid by both the employer and the employee, and it should be shown on Form W-2, Box 12, Code DD. Employers that issue fewer than 250 W-2s have been granted temporary relief, but may be required to comply by as early as 2013.

The Small Employer Health Insurance Credit is an excellent opportunity for small businesses to offset the cost of health insurance for their employees, especially considering the increased pressure for employers to provide health insurance to their employees. In fact, recent health care reform measures will require businesses with more than 50 employees to offer health insurance to their employees by 2014 or pay a penalty of $750 per full-time employee. However, the number of employees may include all part-time employees as well, which could increase the number of small employers that would be subject to the penalty.

Armstrong is a partner in the firm of May & Company, LLP. Permenter is a member of the professional staff of May & Company, LLP. The firm consults with optometrists in 30 states, assisting with their tax planning and preparation, QuickBooks support, and business planning. May & Company was established in 1922 and has offices in Louisiana, Mississippi, and Alabama. Armstrong can be reached at 601-636-4762 or by e-mail at jarmstrong@maycpa.com.

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