IRS Issues Proposed Regulations for Small Business Tax Credit

On August 26, 2013, the Internal Revenue Service published proposed regulations on the small-employer tax credit available under health care reform. The proposed regulations are effective for tax years beginning after December 31, 2013. While the proposed regulations provide much-needed guidance, they are complex.

The following summarizes the proposed regulations:

Tax Credit Eligibility: Small employers with no more than 25 full-time equivalent employees (FTEs) whose average annual wages must not exceed $50,000 in 2014 are eligible. (The average annual wage will be adjusted for inflation each year.) The small employer must have a qualifying arrangement that requires the payment of a uniform percentage of at least 50 percent of the premium cost of a qualified health plan offered to their employees on a Small Business Health Options Program (SHOP) exchange. Federal, state, local or Inter tribal governments are not eligible unless described in section 501(c) as being exempt from taxes under section 501(a).

Tax Credit Amount: The maximum tax credit is 50 percent of the employer’s premium payments made on behalf of its employees under a qualified arrangement; except for tax-exempt employers whose maximum is 35 percent. The maximum tax credit begins phasing out if the employer employs more than 10 employees or annual wages for FTEs exceed $25,000. The tax credit is limited to two consecutive tax years.

Counting Employees: IRS sections 414(b), (c), (m), or (o) must be used when determining if an entity is a small employer. Employers must count all employees under common control when determining small-employer status. Employers must use the common law definition of employee – that is, the employer has the right to control and direct the individual who performs the service, not only as to results but also as to the means. Not considered employees are: independent contractors, sole proprietors, partners, shareholders holding more than 2 percent ownership in an S-corporation, owners of more than 5 percent of other businesses, family of owners and partners listed, and individuals who are not family members but are listed as dependents on the individual income tax return of an excluded worker. Seasonal workers are not counted unless they provide service on more than 120 days during the taxable year.

Counting Work Hours: To determine the number of FTEs, the regulations require adding together the total number of hours of service of all employees during the taxable year and dividing by 2080 hours. Hours of service includes hours worked and hours employees did not work but received pay such as vacation pay or holiday pay. Employers can use one of three methods when determining hours of service: actual hours of service, a days-worked equivalency, or a weeks-worked equivalency.

The proposed regulations can be found by clicking here.