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Tax Tip: Small Business Healthcare Tax Credit

October 20, 2010

The new health reform law gives a tax credit to certain small employers that provide healthcare coverage to their employees, effective with tax years beginning in 2010.  The new law, the Patient Protection and Affordable Care Act, was passed by Congress and was signed by President Obama on March 23, 2010.

Small employers that provide healthcare coverage to their employees and meet certain requirements ("qualified employers") generally are eligible for a federal income tax credit for health insurance premiums they pay for certain employees.  In order to be a qualified employer, (1) the employer must have fewer than 25 full-time equivalent employees ("FTEs") for the tax year, (2) the average annual wages of its employees for the year must be less than $50,000 per FTE and (3) the employer must pay the premiums under a "qualifying arrangement."

An organization exempt under Code Section 501(c) may qualify for the credit.  However, special rules apply in calculating the credit for a tax-exempt qualified employer.

Only premiums paid by the employer under an arrangement meeting certain requirements (a "qualifying arrangement") are counted in calculating the credit.  Under a qualifying arrangement, the employer pays premiums for each employee enrolled in healthcare coverage offered by the employer in an amount equal to a uniform percentage (not less than 50 percent) of the premium cost of the coverage.

If an employer pays only a portion of the premiums for the coverage provided to employees under the arrangement (with employees paying the rest), the amount of premiums counted in calculating the credit is only the portion paid by the employer.  For purposes of the credit (including the 50% requirement), any premium paid pursuant to a salary reduction arrangement under a section 125 cafeteria plan is not treated as paid by the employer.

For tax years beginning in 2010 through 2013, the maximum credit is 35% of the employer's premium expenses that count towards the credit.  The credit increases to 50% in the year 2014.

The credit phases out gradually where eligible employees exceed 10 or if the average annual wages exceed $25,000.

The credit offsets an employer's actual liability for the year, and any unused credit amount can be carried back one year and forward 20 years.  However, an unused credit amount cannot be carried back to a year before the effective date of the credit.  Thus, any unused credit amount for the year beginning in 2010 can only be carried forward.


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