Running a business is expensive, especially when you add in employee health care costs. The good news is that some of these expenses can reduce your overall income tax.
The government is offering an incentive to help small business owners deal with the cost of employee health insurance: the Small Business Health Care Tax Credit.
The small business health care tax deduction has some limitations and confusing calculations, but this guide will tell you everything you need to know.
What is the small business health care tax credit?
The Small Business Health Care Tax Credit is a credit available to small businesses to offset the cost of health insurance premiums they pay for their employees. To qualify for the credit, small businesses must offer their employees a qualified health insurance plan through the Small Business Health Options Marketplace (SHOP), pay at least 50% of its cost, and have fewer than 25 full-time employees with an average salary of less than $55,000. To claim this credit, you must file Form 8941 with your tax return.
But it's not a tax deduction that you can claim year after year - you can claim it two years in a row, and that's it.
Requirements for small business health care tax credits
Before you can claim the small business health care tax credit, you must meet a few strict requirements :
Less than 25 full-time employees
For purposes of the tax credit, a small business is defined as a business with fewer than 25 full-time employees (FTEs). The IRS considers one FTE to be a person who works at least 2,080 hours per year.
Calculating the number of full-time employees is easy if you have only full-time employees. It gets more complicated if you have part-time employees. Several part-time employees can be combined and counted as one full-time employee. For example, two part-time employees would count for one full-time employee.
The IRS provides examples of exactly how to calculate FTEs if you have part-time employees. We will provide more information on how to calculate full-time equivalents in the next section.
The average salary is less than $55,000
To qualify for the small business health care tax credit, the average annual wages you pay during the year must be less than $55,000 per full-time employee.
To calculate the average salary, take the total salary paid to full-time employees and divide by the number of employees. For example, if you paid a total salary of $320,000 and you have eight full-time employees, the average salary paid to employees would be $40,000.
Qualified health care premiums
To get this credit, you must also pay a portion of your employees' health plans. You must offer employees a qualified health plan on the Small Business Health Options Marketplace (SHOP) and pay a single cost share of at least 50%.
If you offer family health plans, you don't have to pay 50% of the family plan to qualify - just pay at least 50% of the cost of employee-only premiums.
How much do you need?
We'll start with a brief questionnaire to better understand the unique needs of your business.
Once we determine your individual parameters, our team will advise you on the process going forward.
Who is considered a full-time employee?
When there are part-time employees on staff, finding out how many full-time employees there are makes things a bit more complicated.
If you have part-time employees, the first thing to do is to calculate how many hours each part-time employee works. You can do this in three ways:
-
Actual Hours Worked: Track the actual number of hours worked by the employee, including vacation, vacations and sick time.
-
Days worked: Count each day the employee works as eight hours. For example, if an employee works 150 days per year, that is 1,200 hours (150 days x 8 hours per day).
-
Weeks worked: This method assumes that the working week is 40 hours per week and is calculated in the same way as the days worked equivalent method. If an employee works 45 weeks per year and takes seven weeks of unpaid leave, this will be counted as 1800 hours worked per year.
Once you know how many hours each part-time employee works, you can calculate the number of FTEs. For example, using actual hours worked, you have four employees who work 30 hours per week, 52 weeks per year. To calculate how many full-time equivalent employees you have, you need to calculate:
4 employees x 30 hours per week x 52 weeks per year = 6,240 hours
6,240 / 2,080 = 3 full-time equivalent employees
Four of your part-time employees count as three full-time employees for purposes of the tax credit.
Owners and their family members are ineligible to participate
There is a notable exception to counting full-time employees. Owners and their family members do not count as FTEs. These include:
Sole proprietor of a sole proprietorship.
Partner in Partnership.
An S-corporation shareholder who owns more than 2% of the stock.
An owner who owns more than 5% of a business.
Members of the owner's family who are not counted as full-time employees include spouses, children, grandchildren, siblings, parents, step-parents, nephews and nieces, aunts and uncles, sisters-in-law, mothers and fathers-in-law. In addition, the spouses of these family members will also not be counted when counting full-time employees. Virtually anyone who may be related to the owner cannot be included in the calculation.
You also can't include in the credit premiums paid for health insurance for the owner or a family member. But don't worry, the premiums paid can still be deductible.
How much is the health care tax deduction for small businesses?
There has been a lot of work involved in calculating the small business tax credit for health care. So how much is it really worth? For some small businesses, it can mean significant savings.
The credit will be most valuable for small businesses with fewer than 10 full-time employees and an average salary of less than $27,000, in which case the maximum tax credit will be 50% of the premiums paid. This percentage will gradually decrease depending on the number of full-time employees and the average salary.
For small employers who do not pay taxes, the maximum credit is 35% of the premiums paid.
Credit constraints
To qualify for the maximum credit, you must have fewer than 10 full-time employees earning an average salary of $27,000 or less. The deduction gradually decreases until you have 25 employees or an average salary of more than $55,000. After that threshold, you will not be eligible for the tax deduction.
Your tax deduction is also limited by the average premiums in the small employer group market published by the Department of Health and Human Services. For example, even if you pay more in premiums, your deduction will be limited to the average premiums.
For example, the premium for an employee-only health care plan is $6,000 per year and you pay 50%, or $3,000. The average premium in the small group market is $5,000. You would qualify for a credit equal to 50% of the average premium in the small group market, or $2,500.
When to apply
If you owe nothing in taxes, you can still take advantage of this tax credit. The credit is not limited to the amount of your tax liability for the year. If you had no taxable income for the year, the credit can be carried over to the next year or refunded.
Application for credit and deduction
If you want a tax deduction related to health care, know that you can receive both a deduction and a credit for health insurance premiums paid. However, the deduction will be reduced by the amount of the credit received.
How do I get a health care tax deduction for small business?
The small business health care tax credit can be claimed on Form 8941. This form is attached to your tax return and reduces the amount of tax. Remember, the credit can only be claimed for two consecutive tax years. If you don't know if you are eligible for this deduction or how to claim it, contact your CPA or other tax professional to help you through the process.