The health insurance credit for small employers.

• Author: Schell, Wayne M.

Beginning in 2010, the Patient Protection and Affordable Care Act, P.L. 111-148, provides a credit to small employers who contribute to the purchase of health insurance for their employees. The amount of the small business health insurance tax credit (Sec. 45R) is typically a percentage of the employer's premium contribution subject to phaseouts related to number of employees and average employee compensation. This item explains and illustrates the computations.

To be eligible for the credit, employers must contribute a uniform percentage of at least 50% of the premium cost of qualified employee health plans (Sec. 45R(d)(4)), and that contribution cannot be the result of a salary reduction agreement (Sec. 45R(e)(3)). For the years 2010-2013, the amount of the credit is generally 35% (25% for tax-exempt entities) (Sec. 45R(g)(2)(A)) of the lesser of the nonelective contributions made by the employer on behalf of employees or a benchmark premium amount (Sec. 45R(b)). The benchmark premium is the average premium for the small group market in the rating area in which the employee enrolls for coverage (either the state or an area within the state).

The credit for taxable entities is part of the general business credit (Sec. 45R(a)) and thus is nonrefundable, but it may be carried back one year and carried forward 20 years to offset income tax liability. Because the health insurance credit is new for 2010, however, any unused amount will not be eligible for carryback to 2009 (Sec. 39(d)). The credit for tax-exempt entities is refundable to the extent of payroll taxes paid. The payroll taxes that may be offset by the health insurance credit include the employees' income tax withheld and both the employees' and employer's share of Medicare taxes (Sec.45R(f)).

The Phaseouts

The credit amount is subject to two phaseouts. One is for employers with more than 10 full-time equivalent (FTE) employees, and the other is for employers who pay employees an average annual wage that exceeds $25,000.

The credit is phased out as the number of FTE employees rises from 10 to 25 (Sec. 45R(c)(l)). As a result, no credit is given to employers who have 25 or more full-time equivalent employees. The phaseout computation is similar to many other phase-out computations in the Code. The initial credit is reduced by:

Initial credit x [(number of FTE employees - 10) / 15]

The number of FTE employees is found by totaling the number of employee hours of service for which the...