The Affordable Care Act (ACA) contains a tax incentive for certain small employers to offer their employees a health insurance plan, and pay for at least half the cost. Employers eligible to take advantage of this provision are under the 50-worker "employer mandate" threshold, and thus not compelled by the ACA to "pay or play."

Tax Credit Basics

For tax years 2010 to 2013, there is a maximum tax credit of 35 percent of premiums paid by qualified small business employers (25 percent of premiums for small tax-exempt organizations).

There are changes to the tax credit for 2014. The IRS recently proposed regulations updating and fine-tuning the original Section 45R rules governing the credit, beginning next year. In addition, the tax break will be more valuable to eligible employers starting in 2014.

In order to qualify for the full tax credit, employers cannot have more than 10 full-time employees or the equivalent with part-timers factored in. The tax credit decreases if an employer has between 10 and 24 full-time equivalent employees or pays average wages of between $25,000 and $50,000. It is unavailable for employers with 25 or more employees and average wages above $50,000.

SHOP Tips 

These are the basic steps which need to be taken for health benefits to be secured in a SHOP plan, thereby possibly making you eligible for the federal tax credit: 

1. You review the plan options on your SHOP exchange and pick one.

2. You, or the exchange, will send notices to employees explaining how they can sign up.

Employees must then:

3. Verify the accuracy of basic information that you have provided about them -- name, date of birth and Social Security number

4. Add additional information about themselves, including their addresses, contact preferences, tobacco use, and whether they have dependents needing coverage. This data is used by the chosen plan to determine individual premiums.

5. Review the plan offer and price which comes back from the health plan provider. Then, they accept or reject it.

When the enrollment period is over, it's your turn to look at the big picture -- how many employees have signed up, and what the total cost will be. You can veto the plan, start over and review other SHOP plan offerings, and go through the process again, if you choose.

If employees reject the coverage you are offering, they can still buy their own via a public exchange. However, if the plan you are offering meets the ACA's basic affordability and minimum value standards, employees won't be eligible for any subsidies on the public exchange, and therefore won't get a better deal by shopping there.

Employees can also opt out of coverage entirely, and pay the token penalty -- which is $95 beginning next year -- through the tax system.

Here's what the new proposed regulations add to the mix:

Must Purchase SHOP coverage. In addition to the well-known public health exchanges, which are scheduled to be open for business October 1, the ACA provided for a small employer version -- the Small business Health Option Plan (SHOP). These state-based online marketplaces are scheduled to be up and running October 1 for coverage to begin January 1, just like the regular public plans for individuals.

Up until now, in order to claim a tax credit, small employers could find a suitable health plan any way they chose. The new proposed IRS regulations state that small employers can only be eligible for tax credits if they choose coverage via the SHOP system. 

Must Comply with Other Restrictions. Beyond the number-of-employees limit under which employers can claim a federal tax credit, there is a limit on the amount the employees can earn. Specifically, the aggregate employees' salaries cannot exceed an average of $50,000 per employee. This cap will be inflation-adjusted beginning next year.

Also, the percentage of the health plan's value paid by the employer must be the same for all employees. (Different tax credit formulas apply to tax-exempt organizations.)

Sole proprietors, partners in a partnership and shareholders who own more than 2 percent of a S corporation's stock are not counted as "employees" for purposes of the size or average salary calculations. The same applies to family members working in the business. 

Bigger Tax Credit Coming in 2014

How big a tax credit is available? The maximum credit, determined as a percentage of the business employer's contribution to the employee's health benefit (based on single employee coverage), will increase from 35 percent this year to 50 percent in 2014.

The maximum credit for eligible tax-exempt organizations increases from 25 percent to 35 percent, beginning in 2014.

Two Year Limit Ahead

The credit can only be taken for two years, beginning in 2014. But you can still claim the credit for two years beginning in 2014 (for 2014 and 2015) even if you claimed it for tax years before 2014. In other words, you could claim it for this year, with the lower maximum credit amount, without affecting what you do for next year. To claim the credit, you must complete an IRS form.

The credit, or a portion of it, can be carried back or forward if your tax liability is lower than the credit amount.

Transition rules allow you to be eligible for the tax credit for 2014 even if your plan year begins later than January 1.

Note: The new regulations make it clear you cannot create a new but identical business entity simply for the sake of allowing you to get around the two-year limit. 

Determining the Credit Amount

The actual amount of the credit your company can claim is based on a pretty complex formula. The first element is that the credit must be based on the lesser of:

a. The amount you paid on employees' behalf, or
b. What you would have paid if you used an average small group plan for your rating area.

In other words, if you offer a very generous health plan, you would only get the same tax benefit you'd receive for an "average" plan.

If you receive state tax credits for providing health benefits, they will not affect whether you satisfy the 50 percent minimum cost-sharing test, but they will impact the amount of the federal tax credit. 

Other components of the formula are the number of "full-time equivalents," average wages and possibly the phase-out calculations if you have more than 10 employees. As explained above, companies eligible for the maximum 50 percent credit must have no more than 10 employees with average wages not exceeding $25,000.

Here is an example from the IRS: An auto repair shop has 10 employees so it qualifies for the maximum tax credit. The total annual wages of the business was $250,000 in 2010, which averages to $25,000 per worker. The repair shop paid $70,000 in employee healthcare costs. For 2010, the business received a tax credit of $24,500 (35 percent of $70,000).

Assume the same annual wages and healthcare costs for 2014. The auto repair shop will be able to claim a $35,000 tax credit (50 percent of $70,000).

This is a simplified example. Consult with your tax adviser to see if you can benefit from this tax credit. Your tax pro can also assist you if you did not claim a credit on an earlier open tax return and want to file an amended return to claim it now. 

© Bizactions LLC.