Section 45R of the Internal Revenue Code (“Code”) offers a tax credit to certain small employers including tax-exempt organizations that provide health insurance coverage to their employees. The credit is effective for taxable years beginning in 2010.
Section 45R was added to the Code by section 1421 of the Patient Protection and Affordable Care Act (“Affordable Care Act”), enacted March 23, 2010. In Notice 2010-44 recently issued by the IRS, the IRS provides guidance on section 45R and what requirements must be met to qualify for the credit. This article discusses these requirements as described in the Notice.
Employers Eligible for the Credit
An employer is eligible for the credit if (1) the employer has fewer than 25 full-time equivalent employees (“FTEs”) for the taxable year, (2) the average annual wage of its employees for the year is less than $50,000 per FTE, and (3) the employer pays at least 50 percent of the premiums of the health insurance coverage for their employees. However, a federal or state employer is not an eligible small employer for purposes of the credit unless it is a section 501(c) non-profit organization.
Specifically, we can determine whether an employer is eligible for the credit by following the array of steps set forth in Notice 2010-44:
Determine the employees who are taken into account for purposes of the credit.
Determine the number of hours of service performed by those employees.
Calculate the number of the employer’s FTEs.
Determine the average annual wages paid per FTE.
Determine the premiums paid by the employer that are taken into account for purposes of the credit.
Determining the Employees Taken into Account for Purposes of the Credit
Generally, employees who perform services for the employer during the taxable year are taken into account in determining the employer’s FTEs, average wages, and premiums paid. However, certain individuals are not taken into account as employees for purposes of the credit.
Accordingly, their wages and hours are disregarded in determining the FTEs and average annual wages, and the premiums paid on their behalf are not counted in determining the amount of the credit. These excluded individuals include sole proprietors, partners in a partnership, shareholders owning more than two percent of an S corporation, and any owners of more than five percent of other businesses. Family members of these owners and partners are also not taken into account as employees. A family member is defined as a child, sibling, step-sibling, parent, step-parent, a niece or nephew, an aunt or uncle, or a son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law. Any other member of the household of these owners and partners who qualifies as a dependent for tax purposes is not taken into account as an employee.
Seasonal workers are disregarded in determining FTEs and average annual wages unless the seasonal worker works for the employer more than 120 days during the taxable year.
Determining the Number of Hours of Service Worked by Employees for the Taxable Year
An employee’s hours of service for a year include the following: (1) each hour for which an employee is paid, or entitled to payment, for the performance of duties for the employer during the employer’s taxable year and (2) each hour for which an employee is paid, or entitled to payment, by the employer on account of a period of time during which no duties are performed due to vacation, holiday, illness, incapacity including disability, layoff, jury duty, military duty, or leave of absence. Only a maximum of 160 continuous hours may be counted as hours of service worked by employees for periods of vacation, holiday, illness, or incapacity.
In calculating the total number of hours of service which must be taken into account for an employee for the year, the employer may use any of the following methods: (1) determine actual hours of service from records of hours worked and hours for which payment is made or due, (2) use a days-worked equivalency whereby the employee is credited with 8 hours of service each day, or (3) use a weeks-worked equivalency whereby the employee is credited with 40 hours of service for each week. The number of hours per employee cannot exceed 2,080 hours.
Calculating the Number of an Employer’s FTEs
We demonstrate by example. Consider an employer during the 2010 taxable year who pays 5 employees wages for 2,080 hours each. The employer’s FTEs would be calculated by multiplying 5 by 2,080 and dividing by 2,080, which equals 5 FTEs.
In some circumstances, an employer with 25 or more employees may qualify for the credit if some of its employees work part-time. For example, an employer with 46 half-time employees (meaning they are paid wages for 1,040 hours) has 23 FTEs and, therefore, may qualify for the credit.
Determine the Average Annual Wages Paid per FTE
We demonstrate by example. For example, during the 2010 taxable year, an employer pays $224,000 in wages and has 10 FTEs. The employer’s annual wage paid per FTE is $22,000 ($224,000 divided by 10 = $22,400, rounded down to the nearest $1,000).
Determining the Premiums Paid by the Employer for the Taxable Year
Only premiums paid by the employer for health insurance coverage are counted in calculating the credit. For example, if an employer pays 80 percent of the premiums for employees’ coverage (with employees paying the other 20 percent), the 80 percent paid by the employer is taken into account in calculating the credit. In calculating the credit for a taxable year beginning in 2010, an employer may count all premiums paid by the employer during 2010, including premiums paid during 2010 before the Affordable Care Act was enacted.
Small businesses may receive the credit not only for regular health insurance but also for add-on dental and vision coverage.
The amount of an employer’s premium payments that are taken into account in calculating the credit is limited to the premium payments the employer would have made under the same arrangement if the average premium for the small group market in the State in which the employer offers coverage were substituted for the actual premium. For example, if an eligible small employer pays 80 percent of the premium for coverage provided to employees (and employees pay the other 20 percent), the premiums taken into account for purposes of the credit are the lesser of 80 percent of the total actual premiums paid or 80 percent of the premiums that would have been paid for the coverage if the average premium for the small group market in the State were substituted for the actual premium.
Maximum Credit Amount and Credit Phaseout
For taxable years beginning in 2010 through 2013, the maximum credit is 35 percent of premiums paid by eligible small business employers and 25 percent of premiums paid by eligible small employers that are tax-exempt organizations.
The maximum credit goes to smaller employers – those with 10 or fewer FTEs – paying annual average wages of $25,000 or less. The credit is completely phased out for employers that have 25 FTEs or more or that pay average wages of $50,000 per year or more.