Today, one of the most pressing issues concerning nearly all small business owners as well as their employees is the impact of the federal health care legislation signed into law by President Obama in March 2010, the Patient Protection and Affordable Care Act (“ACA”). Much uncertainty has surrounded the ACA since it became law. In fact, for a period of time, some questioned whether the teeth of the legislation would even go into effect, as the ACA’s constitutional validity remained in question. However, on June 28, 2012, any doubt as to the ACA’s constitutional validity was extinguished as the U.S. Supreme Court upheld what is now President Obama’s signature piece of legislation.
The Patient Protection and Affordable Care Act (Pub. L. No. 111-148) was enacted on March 23, 2010, and was amended on March 30, 2010, by the Health Care and Reconciliation Act of 2010 (Pub. L. No. 111-152). Collectively, they are commonly referred to as the Patient Protection and Affordable Care Act, the federal health care act, the Affordable Care Act and, by many, affectionately referred to as Obamacare.
The ACA includes many components, including health insurance reforms such as creation of protections for high-risk insureds with pre-existing conditions and the requirement that dependents up to age 26 have the ability to be covered under a parent’s health plan. In addition, the ACA creates health insurance exchanges with their purpose being to provide more individuals access to health insurance.
Besides the health insurance reforms, the ACA makes numerous changes to the Internal Revenue Code (the “Tax Code”) by modifying or creating numerous provisions that affect both individuals and businesses. A few of the tax provisions that affect individuals include an increase from 7.5 percent to 10 percent for the Adjusted Gross Income threshold to claim an itemized deduction for unreimbursed medical expenses; a Medicare investment tax of 3.8 percent for certain high-income earners; a Medicare payroll tax of 0.9 percent on wages and self-employment income in excess of $200,000 ($250,000 for those married filing jointly); as well as an individual requirement or mandate to purchase health insurance by way of a shared responsibility penalty or tax for failure to purchase health insurance. Several new Tax Code provisions also impact businesses. These provisions include new penalties for certain employers who do not provide health insurance for full-time employees, the employer shared responsibility provisions, as well as the creation of tax credits for certain small businesses.
For many small business owners and employees alike, the uncertainty continues with respect to what the future holds as a result of the ACA. That is, what will be the direct impact on the employers and their employees. The following presents a general explanation of several changes made to the Tax Code by the ACA with respect to the employer shared responsibility provisions, also known as the “employer mandate” and the Small Business Health Insurance Tax Credit. Regarding the employer mandate, the following addresses the types of employers that are affected, to what extent they will be affected and the penalties for the failure to provide health insurance. With regard to the Small Business Health Insurance Tax Credit, the following addresses which businesses qualify for the credit and, for those that qualify, the amount of credit available.
The Employer Shared Responsibility Provisions – The Employer Mandate
Generally, beginning after December 31, 2013, employers with 50 or more full-time employees or full-time equivalents (“FTEs”) will face a shared responsibility payment or “assessable payment,” in other words a tax, if they do not provide health insurance coverage to their full-time employees, or if health insurance is provided, such insurance is unaffordable or doesn’t provide minimum value. In order to determine whether or not a particular employer will be subject to the assessable payment, it is important that the employer first understand the ACA related Tax Code provision changes and the special definitions contained therein.
First, the ACA employer mandate applies only to “applicable large employers.” An applicable large employer is any business with 50 or more full-time employees or FTEs. A “full-time employee” is an employee who works on average at least 30 hours per week. To calculate the total number of employees for purposes of determining whether or not a business is an applicable large employer, not only are full-time employees counted but also FTEs are counted. That is, the labor hours contributed by part-time employees are also counted. Under the rules, every 120 hours per month of part-time labor makes up one FTE. Therefore, even if an employer has fewer than 50 full-time employees, labor hours provided by part-time employees may result in an employer being considered as having 50 or more full-time employees and FTEs and would therefore be an applicable large employer and subject to the mandate.
Next, once it is determined that an employer is considered an applicable large employer subject to the mandate, an employer may be subject to the assessable payment if any full-time employee is certified to receive federal insurance subsidies in the form of an applicable premium tax credit or cost-sharing reduction payment in an exchange and either (1) the employer does not offer to all its full-time employees (and their dependents) the opportunity to enroll in minimum essential coverage under an eligible employer-sponsored plan, or (2) the employer does offer full-time employees (and their dependents) the opportunity to enroll in minimum essential coverage under an eligible employer-sponsored plan, but the plan is either unaffordable relative to the employee’s household income or does not provide minimum value.
Under the rules, if an applicable large employer does not provide any insurance to its full-time employees (and their dependents) and if at least one full-time employee receives federal insurance subsidies in an exchange, the employer will have to pay an assessable payment or “tax” in the amount of 1/12 of $2,000 per full-time employee, per month. However, this penalty will not apply for the first 30 full-time employees. In addition, part-time employees are not counted in determining the amount of the tax.
To illustrate, in 2014 an employer with 50 full-time employees does not offer health insurance to its full-time employees (and their dependents). Two of the employees receive a tax credit for the year for enrolling in a state health insurance exchange-offered plan. The employer will be required to pay $40,000 ($2,000 x (50 – 30) = $40,000), assessed on a monthly basis ($3,333.33 per month).
The results differ, however, if an applicable large employer does provide health insurance to its full-time employees (and their dependents). If an employer provides insurance and if at least one full-time employee receives a federal insurance subsidy, either because the employer-sponsored plan is unaffordable or does not provide minimum value, the employer will pay a tax in the amount of 1/12 of $3,000 per subsidized full-time employee per month, or 1/12 of $2,000 per full-time employee (minus the first 30), per month, whichever is less.
To illustrate, in 2014 an applicable large employer with 50 full-time employees provides health insurance to 48 full-time employees (and their dependents), while two full-time employees receive a tax credit for the year for enrolling in a state health insurance exchange-offered plan. The employer will pay $6,000 ($3,000 x 2 = $6,000), assessed on a monthly basis ($500.00 per month). However, in this example, if the employer had 14 or more full-time employees that received subsidies, the employer would pay $40,000 (20 X $2,000 = $40,000), assessed monthly ($3,333.33 per month). This is because 14 subsidized full-time employees would result in $42,000, assessed monthly at $3,500, which is higher than the $40,000, or $3,333.33 per month.
To qualify for federal insurance subsidies, a full-time employee must meet several criteria. First, his or her household income must be less than 400 percent of the federal poverty level for a family of the size involved. For example, in 2011 the amount of household income to qualify would be $89,400 for a family of four. Second, if the employee’s employer provides coverage under an employer-sponsored plan, the plan must be determined to be unaffordable or to not provide minimum value. An employer-sponsored plan is unaffordable if an employee’s portion of the insurance premium exceeds 9.5 percent of the employee’s household income. Since employers typically do not know their employees’ household incomes, the IRS has issued a safe harbor that permits an employer to measure the affordability of coverage based upon an employee’s W-2 wages from the employer. That is, for a plan to be affordable, the employee contribution cannot exceed 9.5 percent of the employee’s W-2 wages.
To illustrate, an employer with 50 full-time employees allows all its employees to enroll in an employer-sponsored plan. One employee receives a tax credit for the year for enrolling in a state health insurance exchange-offered plan. The employer has designed its plan so that the employee portion of the self-only premium for the employer’s coverage is no more than 9.5 percent of the employee’s W-2 wages. Therefore, under the safe harbor, the employer is not subject to an assessable payment with respect to that employee even though the employee receives a premium tax credit.
In addition to being affordable, an employer-sponsored plan must provide minimum value. An employer-sponsored plan does not provide minimum value when the plan pays less than 60 percent of the total allowed cost of benefits for its full-time employees. The IRS intends to issue regulations that will describe approaches to determining whether a plan provides minimum value.
The IRS has recognized the complications for employers in determining which employees qualify for full-time status on a monthly basis for the purpose of calculating an employer’s assessable payment liability. As a result, the IRS has issued voluntary look-back/stability period safe harbor methods as an alternative to the month-to-month determination of full-time status. Further, in the case of a new employee who is reasonably expected to be full-time, the employer’s plan may offer coverage to the employee at or before the conclusion of three months of employment without being subject to the assessable payment liability. Other safe harbors have been provided by the IRS for determining full-time status of seasonal employees as well as variable hour employees where it cannot be reasonably determined whether such employees will work full-time.
Another potential issue is that for certain corporations that are part of a controlled group of corporations under the applicable provisions of the Tax Code, those corporations may be treated as a single employer. If the corporations are treated as a single employer, the full-time employees and FTEs in the multiple corporations will be added together in determining whether the full-time employee and FTE count is 50 or more, causing a single corporation, which may not have otherwise had 50 full-time employees or FTEs, to be an applicable large employer subject to the mandate.
While assessment of the payment or tax is on a monthly basis, the IRS may provide that the payment be made annually, monthly or on some other basis. Furthermore, the payment of the tax will be nondeductible to the employer. In addition, employers who must make the assessable payments will be required to file a return that provides the health insurance information and will be required to provide informational statements to the employees.
The Small Business Health Insurance Tax Credit
Starting in 2010, the ACA provided an incentive for small businesses and small tax-exempt organizations to help obtain and afford the cost of covering their employees by creating a credit for health insurance premiums paid for their employees, the Small Business Health Insurance Tax Credit (the “Credit”). The purpose of the Credit was to target small businesses with low- to moderate-income employees and to assist those businesses in paying for employee health insurance coverage when the business may not have otherwise provided coverage due to the cost.
The determination of whether a business qualifies for the Credit or the amount of the Credit, involves a complex set of rules under the Tax Code. Because of this, many employers aren’t aware that they may actually be eligible. The following is a 30,000-foot overview of the types of businesses that are eligible, how much of a Credit may be available, as well as other rules regarding the use of the Credit.
Generally, to qualify for the Credit, the business must be considered an “Eligible Small Employer.” An Eligible Small Employer is an employer that (1) has less than 25 full-time equivalent employees (“FTEs”) for the taxable year; (2) the average annual wages for the employees do not exceed $50,000 for each full-time equivalent employee (the amount is inflation-adjusted starting in 2014); and (3) has a qualifying arrangement to provide for the cost of at least 50 percent of the employee health insurance premiums.
To determine the amount of FTEs, the total hours for all employees during the year is divided by 2,080. Certain employees’ hours, however, are not included, such as seasonal employees who worked fewer than 120 days during the year. In addition, no more than 2,080 hours can be attributed to any one employee. Several different methods may be used to determine the hours of service for an employee, including the actual hours worked, days-worked equivalency or weeks-worked equivalency methods. Furthermore, certain employees are completely excluded as employees for determining the FTE count, including owners, partners, shareholders owning more than 5 percent of a corporation as well as their family members.
With respect to the number of FTEs and that number’s impact to the amount of the Credit, the Credit begins to be reduced as the employer exceeds 10 FTEs for the year. Furthermore, no Credit is available if the employer has 25 or more FTEs for the year.
As long as the employer has fewer than 25 FTEs, the next step is to determine the average annual wages. To do this, the wages paid to all the individuals considered employees are totaled and then the total is divided by the amount of FTEs. The Credit is reduced if the employer paid average annual wages of more than $25,000. If the employer paid average annual wages of $50,000 or more for the year, the Credit is reduced to zero.
Finally, only premiums paid for health insurance coverage under a qualifying arrangement for individuals considered employees are counted when figuring the Credit. A qualifying arrangement is one in which an eligible small employer is required to make a non-elective contribution on behalf of each employee who enrolls in a qualified health plan offered to employees by the employer. The amount paid by the employer must not be less than 50 percent of the premium cost of the qualified health plan. Only the portion of health insurance premiums paid by the employer is counted in determining the Credit, even if the employee pays the balance.
When calculating the Credit, the amount of the Credit is based upon the total health insurance premiums paid by the employer for the year. For tax years 2010 through 2013, the maximum Credit is 35 percent for small businesses; for 2014 and beyond, the maximum Credit is 50 percent for small businesses. While these amounts represent the maximum percentage Credit available, as mentioned above, there is a phase-out for the percentage amounts based on the amount of FTEs, if more than 10, and for the annual wages, if more than $25,000. Therefore, the smaller the business, the bigger the Credit the business will receive.
The Credit may be used to reduce the tax owed by the employer. Even if the employer does not owe tax during the year premiums are paid, the employer can carry the Credit back or forward to other tax years. Also, since the amount of the health insurance premium payments are more than the total Credit, eligible small businesses can still claim a business expense deduction for the premiums in excess of the Credit resulting in both a credit and a deduction for employee insurance premium payments.
Conclusion
Obviously, application of the various rules regarding increased or new taxes, the requirements to provide, the exceptions for providing health insurance to employees, and the computation of the Small Business Health Insurance Tax Credit, as well as the nuances in determining and calculating the amounts of each, are both new and, at least at this point, complicated. As IRS regulations and additional guidance are issued, hopefully consideration of the foregoing will become easier.