May 6th, 2010
For owners of small businesses and their employees, the recently enacted health reform legislation has some key provisions to pay attention to. Whether a business will be affected by the new law depends on a variety of factors, such as the number of employees the business has.
One of the most talked-about provisions, the so-called “pay” or “play” penalties the new law imposes for not providing coverage to employees take effect January 1, 2014. However, small businesses with fewer than 50 employees aren’t subject to the penalty. For businesses with at least 50 employees, the possible penalties vary depending on whether or not the employer offers health insurance to its employees.
The new law provides small businesses with a tax credit for nonelective contributions to purchase health insurance for their employees. To qualify, a business must offer health insurance to its employees as part of their compensation and contribute at least half the total premium cost. The business must have no more than 25 full-time equivalent employees (“FTEs”), and the employees must have annual full-time equivalent wages that average no more than $50,000. However, the full amount of the credit is available only to an employer with 10 or fewer FTEs and whose employees have average annual full-time equivalent wages from the employer of less than $25,000.
The credit is initially available for any tax year beginning in 2010, 2011, 2012, or 2013. Qualifying health insurance for claiming the credit for this first phase of the credit is health insurance coverage purchased from an insurance company licensed under state law. For tax years beginning after 2013, the credit is only available to an eligible small employer that purchases health insurance coverage for its employees through a state exchange and is only available for two years. The maximum two-year coverage period does not take into account any tax years beginning in years before 2014. Thus, an eligible small employer could potentially qualify for this credit for six tax years, four years under the first phase and two years under the second phase.
For tax years 2010 through 2013, the credit is generally 35% of the employer’s nonelective contributions toward the employees’ health insurance premiums. This amount jumps to 50% for tax years beginning after 2013. The credit phases out as company-size and average wages increase.
The employer is entitled to an ordinary and necessary business expense deduction equal to the amount of the employer contribution minus the dollar amount of the credit. For example, if an eligible small business pays 100% of the cost of its employees’ health insurance coverage and the amount of the tax credit is 50% of that cost (i.e., for tax years beginning after 2013), the employer can claim a deduction for the other 50% of the premium cost.
Self-employed individuals, including partners and sole proprietors, 2% shareholders of an S corporation, and 5% owners of the employer are not treated as employees for purposes of this credit. There is also a special rule to prevent sole proprietorships from receiving the credit for the owner and their family members. Thus, no credit is available for any contribution to the purchase of health insurance for these individuals and the individual is not taken into account in determining the number of FTEs or average full-time equivalent wages.