IRS Issues Proposed Rule on the Small Business Health Care Tax Credit for SHOP

On Aug. 26, 2013, the IRS issued proposed regulations addressing the small business health care tax credit in 2014 and beyond, which incorporate previously issued guidance from previous years. The IRS webpage dedicated to the tax credit has been updated, including revised Q&As.

 As background, the small business health care tax credit applies to certain small employers that offer health insurance coverage to their employees. The tax credit has been available since 2010, but some important changes occur starting in 2014:

  • · The maximum credit amount increases from 35 percent to 50 percent of premiums paid (from 25 percent to 35 percent for eligible small tax-exempt employers);
  • · The coverage must be offered through a Small Business Health Options Program (SHOP) exchange (employers must contribute a uniform percentage of at least 50 percent of premiums);
  • · The credit can be claimed for only two consecutive years beginning on or after 2014, and cost-of living adjustments may be made to the average annual wage phase-out amounts.

 Here are some highlights of the proposed regulations:

 Eligible Small Employers

The tax credit is available only for eligible small employers, which are those with no more than 25 full-time equivalent (FTE) employees whose average annual wages are less than $50,000, as adjusted for inflation starting in 2014. Controlled group rules apply to aggregate employers under common control.

Two-Consecutive-Year Limit

Starting in 2014, an employer may claim the credit for only two consecutive taxable years, starting with the first year for which the employer files a Form 8941 claiming the credit, even if the employer is only eligible to claim the credit for part of the first year. There is a transition rule for an employer with a noncalendar-year plan that allows the 2014 credit to be calculated for the entire 2014 taxable year so long asthe employer switches to SHOP coverage as of the first day of the plan year beginning in 2014. Years prior to 2014 for which the employer claimed the credit do not count in determining the two-year limit. The proposed regulations incorporate employment tax rules to prevent avoidance of the two-year limit through the use of successor entities.

Determining Employees Taken Into Account

All employees are generally taken into account when determining FTE employees and average annual wages, including part-time employees, former employees who terminate midyear, and employees who are not offered, or do not enroll in, health coverage. Certain individuals are excluded for purposes of the credit, including independent contractors, sole proprietors, partners in a partnership, more-than-2 percent shareholders in an S corporation, and more-than-5 percent owners of other businesses (and certain amily members of some owners). Seasonal workers are not counted for determining FTE employees and wages, but premiums paid on behalf of a seasonal worker are counted in determining the amount of the credit. The rules for determining FTEs are generally the same as those in earlier IRS notices—employers choose among counting actual hours or using an equivalency and divide all aggregated hours by the number of employees. The proposed regulations and the IRS Q&As provide detailed examples.

 Uniform Percentage Requirement

Employers must pay a “uniform percentage” of at least 50 percent of the premium for each employee enrolled in SHOP coverage. The proposed regulations explain the rules (with examples) for a variety of situations, including both list billing and composite billing arrangements for QHP premiums, offering tiers of coverage in addition to self-only coverage (such as self-plus-one or family coverage) and offering more than one QHP. Premiums paid through salary reductions or employer-provided flex credits under a cafeteria plan are not treated as employer-paid premiums for purposes of the tax credit. Amounts made available by an employer under an HRA or health FSA, or contributed by an employer to an HSA, are also not counted as employer-paid premiums.

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