CRS Summarizes Small Business Health Insurance Credit

Eligible Small Employers

Under ACA, certain small employers will be eligible for a small business tax credit, provided they contribute a uniform percentage of at least 50% toward their employees' health insurance. For nonprofit (tax-exempt) organizations, the credit will be in the form of a reduction in income and Medicare tax the employer is required to withhold from employees' wages and the employer share of Medicare tax on employees' wages (with the credit thus limited by these amounts). For all other qualifying employers, it will be in the form of a general business credit. This type of credit is not refundable, but is limited by the for-profit employer's actual tax liability. In other words, if a for-profit company had a year in which it ended up paying no taxes (i.e., it had no taxable income, after accounting for all its other deductions and credits), then the small business tax credit could not be used for that year; there would be no income tax for this credit to reduce. However, as a general business credit, an unused credit amount can generally be carried back for one year¹ and carried forward up to 20 years. For for-profit employers, "the credit can be reflected in determining estimated tax payments for the year to which the credit applies in accordance with regular estimated tax rules."² The credit is available from 2010 to 2013, prior to the full implementation of the key insurance provisions of the health care reform law. Once the newly established health insurance exchanges are implemented in 2014, the credit will be available to small employers only if they offer their employees insurance through the Small Business Health Options Program (SHOP) exchange.³

Type of Credit

Full Credit

In each of the four years 2010 through 2013, the full (or maximum) credit covers up to 35% of a qualified for-profit employer's contributions to health insurance. The "employer contribution" for the year is calculated as the lesser of (1) the employer's actual premium contribution, or (2) the contribution the employer would have made if each of those same employees had enrolled in a plan with a premium equal to the average premium (determined by the Secretary of Health and Human Services [HHS]) for the small group market in the state, or area in the state, in which the employer offers health insurance.⁴ For example, if an employer paid for 60% of premiums, the maximum small business tax credit through 2013 will be equivalent to 35% of the employer contribution (or 21% of the total premium in this example -- i.e., 35% of 60%). In this case, assume the average total premium for this employer was $7,500, and the employer's contribution was $4,500 (60%) per full-time equivalent employee (FTE), the maximum tax credit would be $1,575 per FTE (35% of $4,500).⁵ For nonprofit employers, the maximum credit through 2013 is 25% (rather than 35%) of the employer's contribution -- $1,125 per FTE.

The recent budget sequester has led to a reduction in the amount of the refundable portion of the credit for non-profits as of March 1, 2013, and effective through September 31, 2013. Thus, the amount of the credit for nonprofit employers will be decreased by 8.7% over this time period.⁶ Using the above example for a nonprofit employer, the maximum tax credit was $1,125 per FTE (25% of $4,500) prior to March 1, 2013. After March 1, 2013, however, the maximum credit is reduced by about $98 (8.7% of $1,125), reducing the maximum credit to $1,027 per FTE over those months. When the differing credit amounts are weighted by the number of months over which they are applicable, the annual maximum credit amounts to about $1,068 per FTE, or 23.7% of the employer's contribution (see footnote 8).

Beginning in 2014, the maximum credit is 50% of the employer's contribution toward premiums for for-profit employers, and 35% of employer contributions for nonprofit organizations. The small business tax credit that is available beginning in 2014 is only available to an employer for two consecutive tax years, beginning with the first year that the employer offers coverage through a SHOP exchange. The employer contribution for purposes of determining the credit will be calculated as the lesser of (1) the employer premium contribution toward qualified health plans (QHPs) offered by the employer through an exchange, or (2) the contribution the employer would have made if each of those same employees had enrolled in a QHP with a premium equal to the average (determined by the HHS Secretary) for the small group market in the rating area in which the employee enrolls for coverage.

Small employers can claim the full credit amount if they meet the following two criteria:

• The employer has 10 or fewer FTEs. FTEs are calculated by dividing the total hours worked by all "employees" (see description below) during the tax year by 2,080 (with a maximum of 2,080 hours for any one employee).

• The employer's average taxable wages are $25,000 or less.This is calculated by dividing the aggregate amount of wages paid to the "employees" during the year by the number of FTEs (and then rounding to the nearest $1,000).

Partial Credit: Phase-Out

The credit is phased out as the number of FTEs increases from 10 to 25 and as average employee compensation increases from $25,000 to $50,000.⁷

Table 1 shows the amount of the tax credit as a percentage (maximum of 23.7%)⁸ of the employer contribution toward workers' health insurance for nonprofit organizations in 2013, accounting for the impact of the sequester from March-September.

Table 2 shows the amount of the tax credit as a percentage (maximum of 35%) of the employer contribution toward workers' health insurance for for-profit businesses in 2013. This table also applies as the maximum possible credit available to nonprofit organizations beginning in 2014.

Table 3 shows the amount of the tax credit as a percentage (maximum of 50%) of the employer contribution toward workers' health insurance for for-profit businesses beginning in 2014.

       Table 1. Small Business Tax Credit as a Percent (Maximum of 23.7%)

According to GAO data, 170,300 small businesses claimed the credit in tax year 2010, despite initial estimates of 1.4 to 4 million potentially eligible employers over the same period. Of the claimants, 83% were ineligible to receive the full credit, usually because they did not meet the average wage requirement. Additionally, 30% of employer credit claims were reduced because the credit cannot exceed state average premiums for small group plans.⁹

Most small business employers do not offer insurance. However, even among those who do offer insurance, the take-up rate for the credit has been less than expected. GAO cites the complexity of determining eligibility and calculating the credit amount, the need to collect employee data that may not be readily available, and the fact that the credit is available for a maximum of six years,¹⁰ as likely contributors to the lower than expected levels of participation.¹¹

Options for Expanding the Use of the Tax Credit

Given the low take-up rate of the tax credit, there have been a number of suggestions to expand the use of the tax credit. For example, GAO's recent study suggests amending eligibility requirements or increasing the amount of the credit.

Specifically, the GAO study recommends:

• Increasing the amount of the full or partial credit, or both.

• Increasing the amount of the credit for certain employers by eliminating consideration of rating area average premiums in the calculation of employer contributions.

• Increasing the number of FTEs and the wage limit allowable for claiming the full or partial credit, or both.

• Simplifying the calculation of the credit by:¹²

• • Using the employee and wage information already reported on the employer's tax return.

  • Offering a flat credit amount per FTE or number of employees.

• Doubling the credit availability threshold to employers with up to 50 FTEs and double the maximum credit eligibility threshold to 20 FTEs.

• Increasing the generosity of the credit's phase-out schedule.

• Eliminating the requirement that employers must pay a uniform percentage of the cost of each employee's health insurance in order to be eligible for the credit.

• Eliminating the consideration of rating area average premiums in the calculation of employer contributions.

The authors wish to thank Chris L. Peterson, former CRS Specialist in Health Care Financing, and Hinda Chaikind, Section Research Manager, who co-authored the original report.

² Internal Revenue Service, "Small Business Health Care Tax Credit: Frequently Asked Questions," 19, available at http://www.irs.gov/newsroom/article/0,,id=220839,00.html.

³ For more information on the SHOP exchange see CRS Report R42663, Health Insurance Exchanges Under the Patient Protection and Affordable Care Act (ACA), by Bernadette Fernandez and Annie L. Mach.

⁴ Any premium paid pursuant to a salary reduction arrangement under a section 125 cafeteria plan is not treated as paid by the employer.

⁵ An employer could claim a regular business deduction for the amount of the employer contribution not covered by the credit (i.e., the amount of the contribution minus the dollar amount of the credit).

⁶ Internal Revenue Service, "Affordable Care Act Tax Provisions," available at http://www.irs.gov/uac/Affordable-Care-Act-Tax-Provisions.

⁷ Beginning in 2014, these dollar amounts would be increased by the Consumer Price Index -- Urban (CPI-U). However, for purposes of this report, $25,000 and $50,000 will simply be cited, even for 2014 and beyond.

⁸ This amount is calculated by averaging the maximum credit available for those months when the sequester is in effect and for those months when it is not. The sequester began on March 1, 2013, and ends on September 31, 2013. From October 1, 2013, through the end of the calendar year, the calculation of the credit for nonprofit firms for 2013 assumes, in the absence of other information, that there will be no sequester. Should the sequester be extended, the credit would be lower. Thus, the calculation assumes that the sequester will not be in effect for five of the 12 months in calendar year 2013.

 

 

¹⁰ The credit is available for the initial four years (2010-2013) as well as any two consecutive years after 2013, provided that the employer purchases insurance through a SHOP exchange.

¹¹ GAO-12-549, "Small Employer Health Tax Credit," available at http://www.gao.gov/assets/600/590832.pdf.

¹² GAO notes that either of these options will reduce the precision with which the credit can be targeted towards specific subgroups of small employers. Counting employees instead of FTEs would necessitate an increase in the number of eligible employees in order to reach the same population of small employers. For example, 40 hours per week counts as one FTE, but could be performed by two employees working 20 hours per week. (See GAO-12-549, "Small Employer Health Tax Credit," page 17, available at http://www.gao.gov/assets/600/590832.pdf).

¹³ The White House, "Fact Sheet: President Obama's Budget Expands, Simplifies Small Business Health Care Tax Credits," February 16, 2012, available at http://www.whitehouse.gov/the-press-office/2012/02/16/fact-sheet-presidentobama-s-budget-expands-simplifies-small-business-he. The President's 2014 budget submission does not address the small business tax credit.