Prescription for the New Health Care Credit

The new health care legislation signed on March 23, 2010—the Patient Protection and Affordable Care Act—will dramatically alter the landscape for small-business owners in the coming years. One critical change: Beginning in 2010, a business may qualify for a special tax credit that can partially offset rising health insurance costs.

The new health care credit is limited to small businesses that meet certain strict requirements. Nevertheless, your business may still be eligible for this tax break, due to certain exceptions. The IRS recently provided some valuable clarification in this area.

Background: To qualify for a partial health care credit as a “small business,” your business cannot employ 25 or more full-time employees with average annual wages of $50,000 or more. Your contributions to the health plan must be made on a nonelective basis on behalf of enrolled employees.

The maximum annual credit is 35% of qualified health insurance contributions made by your business for 2010 through 2013 (25% for a tax-exempt organization). However, for 2014 and 2015, the credit increases to 50% (35% for a tax-exempt organization) for a two-year period if your small business participates in a state-run insurance exchange and meets certain other requirements.

Beginning in 2010, the full credit is available to a small business, if it employs ten or fewer full-time employees with average annual wages of $25,000 or less. Now the IRS has explained the reduction of the credit. 

Under the new IRS guidance, the maximum health insurance credit is reduced by 6.667% for each full-time employee over ten employees. The credit is also reduced by 4% for each $1,000 of average annual wages paid to employees exceeding $25,000.

Many small businesses will not qualify because of the limits on the number of workers or their average annual wages or both. But note the following exceptions:

  • These limits only apply to full-time workers. If your business employs a large number of part-timers or seasonal workers, it still may qualify for a credit.
  • Frequently, the wages paid to the business owner will skew the amount of the average annual wages. However, the IRS has clarified that the calculation does not include wages of a sole proprietor, a partner, a 2%-or-more S corporation shareholder or any other employee owning more than 5% of another business.
  • Other relatives of the business owners are also generally excluded. Therefore, the average annual wages will not be tainted if the child you are grooming to replace you is paid a high salary.

The calculations for certain small businesses are complex. Be sure to obtain professional assistance.