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Church, Nonprofit and Small Business Health Care Tax Credit: What It Is and How to Claim It

Don’t leave money on the table this tax season!  The small business health insurance tax credit is granted to small employers, including tax-exempt employers such as churches and nonprofits, who pay at least 50% of their employees’ health insurance premiums for a qualified health plan. The tax credit is calculated as a percentage of the amount an employer spent on its employees’ health insurance premiums during the taxable year.

For 2014, eligible tax-exempt employers can receive a refundable credit (meaning they receive cash from the IRS) for up to 35% of the amount they spent on employees’ premiums, while other eligible small business employers may receive a tax credit of up to 50%.  Are you eligible to receive a tax credit?

Who is eligible for the tax credit? Eligible employers (including tax-exempt employers) are those that meet the following requirements:

  1. The employer has fewer than 25 full time equivalent (FTE) employees. That means an employer can have more than 25 employees, if some are part-time. Calculating the number of FTEs is discussed below.
  2. The employees’ average annual wage is less than $50,800 (adjusted for inflation for 2014) per FTE. How to calculate the average annual wage is discussed below.
  3. The employer pays a uniform rate of at least 50% for employee-only premiums.
  4. The premiums are for qualified health plans (QHP) purchased on the Small Business Health Options Program (SHOP) Marketplace.

The credit is available for two consecutive tax years only. Note that for tax-exempt employers, refund payments issued between October 1, 2014 and September 30, 2015 are subject to reduction by the 2015 sequestration rate of 7.3%.

Who is an employee for purposes of determining the number of FTEs and the average annual wage?  When calculating the number of FTEs and the average annual wage, exclude seasonal workers, family members of the small employer, and the owners of the small business (sole proprietors, partners, shareholders owning more than 2% of an S corporation or more than 5% of a C corporation) from the calculations.

In the case of churches, ministers are included in the number of FTEs only if they are considered an employee of the church under the common law employee test utilized by the IRS. If they are self-employed, they do not factor into the FTE calculation. A minister’s compensation is not included in the average annual wage calculation.

Calculating the number of full time equivalent employees (FTEs). To calculate the number of full time equivalent (FTE) employees, add up the total hours of service per year for which the employer pays wages, and divide it by 2,080 (the number of hours a full-time employee works per year).   Round down to the next lowest whole number. That number is the number of FTEs for purposes of calculating the tax credit. However, if the quotient falls below one, round up to one.

Example:

Church or “Company ABC” paid wages to two full time employees for 2,080 hours in 2014, and paid five part-time employees’ wages for 1,040 hours each in 2014. The employer paid wages for a total 9,360 hours last year. Dividing 9,360 by 2,080 yields 4.5, this is then rounded down to four. Company ABC has four FTEs.

Calculating the average annual wage. The tax credit is available for employers that pay an average annual wage of less than $50,800 (adjusted for inflation in 2014). To determine the average annual wage, add up all the wages paid to employees and divide by the number of FTEs. Round down the answer to the nearest $1,000 to determine the average annual wage for each FTE.

Example:

Church or “Company ABC” pays its two full time employees a yearly wage of $40,000 each, and each of the five part-time employees $20,000 each, for a total $180,000 paid in wages paid to four FTEs (see previous example). The average annual wage is $45,000, which is still within the realm of eligibility, but subject to a credit reduction.

Reductions in the tax credit.  Just because an employer has fewer than 25 FTEs and an average annual wage of less than $50,800 does not mean that the employer will receive the full tax credit. The tax credit is on a sliding scale – meaning that the credit begins to phase out when an employer has more than 10 FTEs – and drops to zero at 25 FTEs.  It begins to shrink when the average annual wage is over $25,400, reducing the tax credit to zero at $50,800.

The FTE and wage reductions operate separately, and the combined effect of the reductions may reduce the tax credit to zero, even if the employer has fewer than 25 FTEs and an average annual wage of less than $50,800 per FTE.

The FTE credit reduction is calculated using the following formula:

(Otherwise applicable tax credit) x [(Number of FTEs – 10) / (15)] = Tax Credit Reduction

Example:

A tax-exempt church has 15 FTEs. The employer pays a uniform rate of 50% for the employees’ health insurance premiums for a QHP, for a total $20,000 paid in premiums in 2014. The otherwise applicable tax credit would be $7,000, which is 35% of $20,000. However, because the church employs more than 10 FTEs, the credit would be reduced according to the following formula:

(35% credit rate x $20,000) x [(15-10)/(15)]

= $7,000                          x         .333           = $2,333.33 reduction.

$7,000 – $2,333 = $4,666. The employer would receive a reduced credit of $4,666.

The average annual wage credit reduction is calculated using the following formula:

(Otherwise applicable tax credit) x [(Avg. Annual Wage – $25,400)/($25,400)] = Tax Credit Reduction

Example:

A small business has nine FTEs, with an average annual wage of $40,000. The employer pays $25,000 in premiums, which is a uniform 60% of the premium cost. The otherwise applicable credit would be $12,500: 50% of the premium cost. The credit reduction would be calculated in the following manner:

(50% credit rate x $25,000) x [(40,000 – $25,400)/($25,400)]

= ($12, 500)                            x                            (.57)                  = $7,125 reduction.

$12,500 – $7,125 = $5,375. The employer would receive a reduced credit of $5,375.

An employer may be subject to credit reductions on account of both an elevated average annual wage and number of FTEs.

Example:

A small employer paid an average annual wage of $30,000 to 15 FTEs, and paid $35,000 in premiums for the FTEs, a uniform 50% rate. The employer is subject to both credit reductions because it has more than 10 FTEs and pays an average annual wage of more than $25,400. The credit reductions would be calculated separately and then combined.

FTE reduction:

(Otherwise applicable tax credit)        x [(Number of FTEs – 10) / (15)] = Credit reduction

(50% credit rate x $35,000)   x [(15 FTEs – 10) / (15)]

= ($17,500)                                         x         (.33)                              = $5,775 reduction

(Otherwise applicable tax credit) x [(Avg. Annual Wage – $25,400)/($25,400)] = Credit reduction

(50% x $35,000) x [($30,000 – $25,400) / ($25,400)]

= ($17,500)         x   (.18)                                                           = $3,150 reduction

Together, the two reductions equal $8,925, and reduce the credit from $17,500 to $8,575.

Calculating the premiums Only the portion of the premium paid by the employer is included in calculation of the credit. This includes any payments made to cover the cost of coverage for an employee’s dependents. Employers may also include any state subsidies or state tax credits for health insurance coverage in the amount paid for employees’ premiums, as they are considered paid on behalf of the employer.

When calculating the premium amounts paid by the employer, it is important to note that premiums paid under a section 125 cafeteria plan via a salary reduction arrangement are not treated as employer-provided. Additionally, premiums are limited by the average premium for the small group market in the area where the employee enrolls for coverage, as defined by the Department of Health and Human Services. The average premiums for each rating area are listed in the Form 8941 instructions.

How to claim the credit    Small employers that are partnerships, S corporations, cooperatives, estates, trusts, and tax-exempt organizations must file Form 8941 with their tax return. Tax-exempt small employers such as churches and nonprofits must also claim the credit as a refundable credit on Form 990-T, Exempt Organization Business Income Tax Return.

For all other small employers, if their only source for the small business health insurance credit is a partnership, S corporation, cooperative, estate, or trust, then they do not need to fill out Form 8941, but must report the credit on line 4h of Part III of Form 3800 General Business Credit.

If you are unsure if you are eligible for the tax credit, contact an experienced attorney at Simms Showers to help you understand and navigate the health care tax credit.


Disclaimer: This memorandum is provided for general information purposes only and is not a substitute for legal advice particular to your situation. No recipients of this memo should act or refrain from acting solely on the basis of this memorandum without seeking professional legal counsel. Simms Showers LLP expressly disclaims all liability relating to actions taken or not taken based solely on the content of this memorandum.  Please contact Robert Showers at hrs@simmsshowerslaw.com or Elyse Smith at ems@simmsshowerslaw.com for legal advice that will meet your specific needs.

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