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Small Employer Health Insurance Tax Credit

February 10, 2023

Qualified small employers, including nonprofit employers, may reduce the cost of providing health insurance to their employees during the year through use of the small business health insurance tax credit. However, the credit is complex and there are important limitations, especially when calculating the number of employees and other provisions.

Small employers

The small business health insurance tax credit is targeted to employers that have no more than 25 full-time equivalent (FTE) employees paying wages averaging less than $50,000 (adjusted for inflation annually) for each employee per year. The credit is claimed on IRS Form 8941, Credit for Small Employer Health Insurance Premiums, which must be attached to your return.

The maximum credit is 50 percent of qualified premium costs paid by for-profit employers (35 percent for tax-exempt employers). However, an employer may claim the credit only if it offers one or more qualified health plans through a state insurance exchange.

Let's look at an example of how the credit works. A small manufacturer employs nine individuals with average annual wages of $23,000 for each employee. The manufacturer pays $72,000 in health care premiums for its employees. If the manufacturer meets all the other requirements, its credit is $36,000 (50 percent x $72,000).

Employees

To determine eligibility for the credit, employers must calculate their number of FTEs. The number of an employer's FTEs is determined by dividing the total hours for which the employer pays wages to employees during the year (but not more than 2,080 hours for any employee) by 2,080. The result, if not a whole number, is rounded to the next lowest whole number. Lawmakers selected 2,080 hours because 2,080 hours comprise the number of hours in a 52-week assuming a 40-hour work week. Any hours beyond 2,080, such as overtime hours, are not considered when calculating FTEs.

Average annual wages

Employers also need to calculate average annual wages. The amount of average annual wages is determined by first dividing the total wages paid by the employer to employees during the employer's tax year by the number of the employer's FTEs for the year. The result is then rounded down to the nearest $1,000 (if not otherwise a multiple of $1,000).

Additional requirements

Congress imposed some important limitations on the credit. Employers must exclude certain individuals from the calculation of FTEs and average annual wages. These individuals include a sole proprietor, a partner in a partnership, a shareholder owning more than two percent of an S corporation, and any owner of more than five percent of other businesses. Certain family members of these individuals are also excluded from the calculation of FTEs and average annual wages. These include a child, a parent, a sibling, and others.

Additionally, the credit applies only to premiums paid by the employer under a qualifying plan. An employer's contribution is also linked to the average cost of health insurance in its state or part of a state.

The credit also affects an employer's deduction for the cost of health insurance premiums paid on behalf of employees. The amount of premiums that an employer may deduct is reduced by the amount of the small employer health care tax credit.

Please contact our office if you have any questions about the small employer health insurance tax credit.

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