Tax Credits for Employee Health Insurance

By Attorney Stephen Fishman

The massive health insurance reform enacted by Congress in 2010 created a brand new tax credit for small employers who pay for health insurance for their employees. From 2010 through 2013, employers who qualify can claim a tax credit of up to 35% of their contributions to their employees’ health insurance premiums, subject to certain limits. The percentage increases to 50% for 2014 and 2015. The credit ends in 2016. Obviously, if you qualify for the credit, you can save substantial taxes.

Currently, less than half of all employers with three to nine employees provide their workers with health insurance. One big reason is the cost. Small employers face higher premiums, broker fees, and administrative costs than large firms. As a result, small businesses pay up to 18% more per worker than large firms for the same health insurance policy. The small employer tax credit is intended to level the playing field and enable more small businesses to provide health insurance for their employees.

To qualify for the health insurance credit, you must satisfy three requirements.

Requirement #1: You Must Have Employees

You can qualify for the health insurance credit only if your business has non-owner employees who are not your relatives. You can forget about getting the credit if you’re running a one-person operation.

The credit is designed for smaller businesses. The full credit is available only to businesses with ten or fewer full-time employees. It is gradually phased out if you have more than ten full-time employees: It is reduced to 6.67% for each full-time employee over ten. Thus, it is phased out completely for a business with 25 full-time employees (15 × 6.67% = 100%).

As is the case with the business tax deduction for health expenses, business owners don’t count as employees for these purposes and don’t qualify for the tax credit. This includes sole proprietors, partners in partnerships, shareholders owning more than 2% of an S corporation, and any owner of more than 5% of the business. In addition, family members don’t count as employees. This includes a spouse; child (or descendant of a child); a sibling or step-sibling; a parent (or ancestor of a parent); a step-parent; a niece or nephew; an aunt or uncle; or a son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law. Thus, you can’t hire any of these people to work as employees in your business and qualify for the credit.

Requirement #2: Employee Compensation Must Average Less Than $50,000

The tax credit is intended to help employers pay for health insurance for employees with relatively low salaries. To qualify for the credit, the average annual wages of your employees for the year must be less than $50,000 per full-time employee. The credit is reduced by 4% for each $1,000 that the person’s average annual compensation exceeds $25,000. Thus, the credit is completely phased out if your employees are paid $50,000 or more in annual wages.

Requirement #3: You Must Pay at Least 50% of Employee Health Insurance Premiums

Finally, you must pay at least 50% of the annual premiums for your employees’ health insurance. Health insurance for purposes of the credit can take a variety of forms. It’s up to the employer to decide what type of coverage to provide. You can pay for the insurance directly or reimburse your employees for their payments. The coverage can be under any hospital or medical service policy, or a health maintenance organization (HMO) contract offered by a health insurance company. Employers also have the option of providing dental or vision coverage, long-term care, nursing home care, home health care, community-based care, or any combination of these. Medicare supplemental health insurance also qualifies for the credit.

Only the health insurance premiums paid by the employer are counted in calculating the credit. If an employer pays only a portion of the premiums (with employees paying the rest), only that portion is counted. For example, if an employer pays 80% of the premiums for employees’ coverage, only that 80% is counted in calculating the credit.

Amount of the Credit

For 2010 through 2013, the credit is equal to 35% of the employer’s health insurance payments for its employees. This amount is increased to 50% for 2014 and 2015.

However, there is a cap on the amount of premiums that can be used to calculate the credit. This prevents employers from providing their employees with “Cadillac” health care plans and reaping huge tax credits. The cap is equal to the average premium charged in the state’s small group health insurance market. This amount is determined by the Department of Health and Human Services (HHS).

The health credit is a general business credit you claim on your tax return. If the credit exceeds your tax liability for the year, the unused credit amount can be carried back one year and carried forward 20 years. 

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