The IRS has issued guidance to help small business owners make sense out of tax changes included in the monumental health care legislation. (IRS News Release IR-2010-38)
Strategy: Protect against rising costs with a special tax credit. The credit can potentially offset up to 35% of the health insurance premiums your business pays.
Although many provisions in the new health care law are prospective, the small business credit is available in 2010. The new IRS guidance explains how the rules work in the form of frequently asked questions (FAQs).
Here’s the whole story: Under the new health care law, a small business is potentially eligible for credit for contributions used to purchase health insurance for its employees. To qualify, the business can’t have more than 25 full-time employees, and the average annual wage cannot exceed $50,000. The contributions must be made under an arrangement requiring the employer to make nonelective contributions to health insurance offered to enrolled employees equal to at least 50% of the premium cost.
Beginning in 2010, your small business can claim a credit of up to 35% of the cost of its qualified employer contributions. In 2014, the credit can increase to up to 50% of the contributions if you participate in a state-run insurance exchange.
If your small business employs 10 or fewer full-time employees with an average annual wage of no more than $25,000, it can potentially claim the maximum 35% credit. The credit percentage phases out if you exceed either of these two limits (see box below).
The new FAQs clarify that this calculation doesn’t include business owners such as sole proprietors, partners in a partnership, more-than-2% shareholders in an S corporation and individuals owning more than 5% of the business. Family members of these individuals are also excluded. So you may not have to worry about skewing the average annual salary if you and any relatives working in your business are paid hefty salaries.
According to the FAQs, the number of full-time employees is determined by dividing the total hours for which you compensate employees (but not more than 2,080 hours per employee) divided by 2,080. When appropriate, round up to the next lowest whole number. (See example below.)
Example: Your small business has a total of 10 employees on the payroll in 2010. Five are paid wages based on 2,080 hours for the year, one is paid based on 2,400 hours and the remaining four are paid for 1,040 hours. The calculation is as follows:
- Employees working 2,080 hours: 2,080 hours x 5 employees = 10,400 hours
- Employees working 2,400 hours: 2,080 hours x 1 employee = 2,080 hours
- Employees working 1,040 hours: 1,040 hours x 4 employees = 4,160 hours
- 16,640 total hours divided by 2,080 hours = 8 full-time employees
So, an employer with more than 25 employees may still qualify for the credit if it employs part-time workers. Caveat: Seasonal workers are excluded from the calculation.
Tip: The penalty for failing to provide employee health insurance coverage doesn’t apply to a business with fewer than 50 employees. This is a separate provision and isn’t tied to the small business credit.
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