April 2010

Employers, Beware of Hidden Limits in New Tax Credits
 

Under the new health care legislation recently signed into law, certain small businesses and tax-exempt organizations that provide health insurance coverage to their employees will qualify for a new tax credit.  The credit is designed to encourage small employers to begin to offer health insurance coverage to employees or maintain their current coverage.

In order to qualify, a business must have fewer than 25 full-time equivalent (FTE) employees with average wages of less than $50,000 per employee per year.  They must also cover at least 50 percent of the cost of health care coverage.  As the calculation is based on FTEs, businesses that have more than 25 individual employees may still qualify.

The credit begins for the 2010 tax year.  According to the IRS, the maximum credit is 35 percent of premiums paid in 2010 by eligible small business employers and 25 percent of premiums paid by eligible tax-exempt employers.  The credit increases to a maximum of 50 percent for business and 35 percent for tax-exempt organizations by 2014.

Businesses with fewer than 10 FTEs and average wages of less than $25,000 will receive 100 percent of the credit.  The amount of the credit will be reduced for FTEs over 10 and/or average annual wages over $25,000.  For example:

For tax year 2010, assume that a tax-exempt organization has 16 FTEs and average annual wages of $35,000.  It pays $128,000 in health care premiums and otherwise meets all the requirements for the credit.

·    The initial amount of credit before any reduction would be $32,000

     (25% x $128,000).

 

·    The reduction for FTEs in excess of 10 would be $12,800 ($32,000 x 6/15).

 

·    The reduction for wages in excess of $25,000 would be $12,800

     ($32,000 x $10,000/$25,000).

·    The total reduction will be $25,600 ($12,800 + $12,800).  Thus, the total tax credit will be $6,400 ($32,000 - $25,600).

It is possible for the amount to be reduced to zero, even if the employer has met all of the qualifying conditions.

For tax-exempt organizations, the credit is applied as a refund on certain payroll taxes.  However, the amount of the credit cannot exceed the total of the employer’s income tax and Medicare tax withholding plus the employer’s share of the Medicare tax. 

With respect to for-profit businesses, the credit is part of Internal Revenue Code Section 38, the General Business Credit, which is designed to limit the amount of credit a business can receive under certain circumstances.  Thus, it is possible that even though a business may qualify for the new credit, it will not realize the benefit in the current year.

In light of the limitations, employers should seek the guidance of a qualified consultant or CPA before making any commitment to offer or expand their health insurance benefits to their employees.

Contact Vincent Ruocco, LLC, CPA at 203.932.2931 if you have any questions.

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