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Health Care Reform – a closer look at tax credits for small business

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Despite the controversy surrounding the passage of the new Health Care Reform Legislation, it is now the law of the land. There is a provision for a Small Business Health Care Tax Credit which is available to small businesses that provide health insurance to their employees. It is in effect for 2010 tax returns. To keep things as simple as possible, I will include an IRS example (from Question #5 of the Q & A provided) of how this will work below.

The facts: (rules effective for years 2010-2013)

• 9 full time equivalent employees (FTE’s) in a for profit company
• Average wage per employee is less than $25,000
• Employer paid premiums = $72,000 (an 80%-20% split is assumed with no Sec 125 deduction)
• 35% = maximum amount of employer expenses that count towards the credit
• Calculation of credit: (35% X $72,000) = $25,200

That may sound like a good deal but to qualify for the credit there are some strings attached:

1. The credit is phased out as total employees exceed 10 and is not available for firms with 25 or more employees.

2. In addition, if average wages per employee exceed $25,000 a phase out begins and if average employee wages are greater than $50,000 the company is not eligible.

3. The phase out for employee total and average wages work together so a company with 12 employees and average wages of $30,000 would have a reduced credit as calculated below:

Phase out range for employee total is between 10 and 25 employees (range = 15) and the company is over by 2 employees. Calculation is 2/15 X $25,200 = $3,360 reduction for employee total > 10

Phase out range for average wage is between $25,000 and $50,000 (range = 25,000) and the average wage is $30,000 – greater by $5,000. Calculation is 5,000/25,000 X $25,200 = $3,150

Recap:
• Total maximum original credit    25,200
• Reduction for 12 employees          (3,360)
• Reduction for average wages         (3,150)

• Allowable credit                                  18,690

Another problem:

Section 125 cafeteria plans count against the employer portion of the expenses paid. I assume Congress did not want to allow a “double dip” benefit of the reduction for the Section 125 cafeteria plan AND allowing that as part of the qualifying employer expenses.

The biggest problem with qualifying for the credit is:

 An employer must pay at least 50% of the medical premiums – which sounds reasonable.   However, the portion that the employee deducts using a Section 125 cafeteria plan counts against the employer’s portion of medical premiums paid.  This means if a company has a Section 125 cafeteria plan for the employee portion of  medical premiums this will greatly reduce the ability for firms to take advantage of the credit due to the “50% employer paid rule”.

Suppose an employer pays 74.5% of the premium and the employees pay 25.5% of the premium the employer will not qualify for the tax credit – if the 25.5% employee portion is deducted using a “premium only” Section 125 cafeteria plan. The company will not qualify because they do not meet the 50% employer paid rule.

See below for a numerical example that may better illustrate the problem:

• Employee pays                                25.5%
• Cafeteria plan deduction             25.5%
• Total                                                     51.0% – Employer pays only 49% and is NOT eligible for credit

In summary, it will be very difficult for many firms, especially ones that are already taking advantage of cafeteria plans, to take advantage of this new tax credit. Perhaps, based on the massive deficit we are operating under that is a good thing. We do not need to add to national our debt.

To read more about this I have included several useful links to the IRS web site below.

Click below to read an IRS news release on the tax credit:
http://www.irs.gov/newsroom/article/0,,id=220848,00.html?portlet=7

Click below for a 22 point Q & A on the tax credit:
http://www.irs.gov/newsroom/article/0,,id=220839,00.html

Click below for a simple way (according to the IRS) to determine if your firm qualifies for the credit:
http://www.irs.gov/pub/irs-utl/3_simple_steps.pdf

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