Regulations Provide Guidance for Small-Employer Premium Tax Credit

The IRS issued final regulations on the Sec. 45R credit for small employers that offer health insurance coverage for employees (T.D. 9672). The regulations provide guidance on how to determine full-time-equivalent employees (FTEs) and average annual wages, how to calculate the credit, and what is a “qualifying arrangement” for purposes of the credit. The rules finalize the proposed regulations issued in August 2013 (REG-113792-13), with a few minor changes and clarifications.

Sec. 45R was added to the Code by the Patient Protection and Affordable Care Act, P.L. 111-148. It provides a tax credit for small businesses that make nonelective contributions on behalf of their employees for insurance premiums. For these purposes, small businesses are defined as businesses with 25 or fewer FTEs and average annual wages of those FTEs of less than $50,000.

From 2010 to 2013, small businesses were eligible for credits of up to 35% of nonelective contributions the businesses made. Tax-exempt organizations were eligible for a 25% credit against payroll taxes. Beginning in 2014, the maximum credit increased to 50% (and 35% for tax-exempt organizations). Tax-exempt eligible small employers are employers described in Sec. 501(c) that are exempt from tax under Sec. 501(a).

The credit amount is based on a percentage of the lesser of: (1) the amount of nonelective contributions paid by the eligible small employer on behalf of employees under a qualifying arrangement during the tax year, and (2) the amount of nonelective contributions the employer would have paid under the arrangement if each employee were enrolled in a plan that had a premium equal to the average premium for the small group market in the rating area in which the employee enrolls for coverage.

The regulations define a “qualifying arrangement” as an arrangement under which an eligible small employer pays a uniform percentage (not less than 50%) of the premium cost of the health insurance coverage for each employee enrolled in the employer’s health insurance coverage plan.

Under the final regulations, to calculate the credit, all employees (determined under common law rules) are included in determining FTEs and average annual wages. The IRS rejected a commenter’s request that FTEs include only full-time employees who work 40 hours a week, because Sec. 45R(d)(2) requires the calculation be done using FTEs. Leased employees are included, and former employees may be included in calculating the credit as long as they are also included for purposes of the uniform percentage requirement.

Seasonal workers who work less than 120 days a year are excluded from the FTE calculation and the average annual FTE wage calculation, but they may be counted in calculating the amount of the credit if the employer pays a premium on their behalf. A commenter asked that the definition of seasonal worker be clarified by providing that any employee who terminates employment before 120 days be considered seasonal, but the IRS did not adopt that suggestion. However, the final regulations permit employers to apply a reasonable, good-faith interpretation of the term.

Sec. 45R is available only for two consecutive tax years. Employers claim the credit by filing Form 8941, Credit for Small Employer Health Insurance Premiums, the first year of the two-consecutive-year period. An employer that was eligible for the credit for only part of the tax year will be eligible for the credit for only those two calendar years because the statute limits the credit to two tax years. Although a commenter criticized the two-year limitation, the IRS pointed out that it could not issue regulations that conflict with the statutory language.

Another suggestion that the IRS rejected was that household employers be allowed to claim the credit through use of a health reimbursement arrangement (HRA). Beginning in 2014, the credit is available only for health insurance provided through a SHOP exchange. Because an HRA is a self-insured plan, it does not qualify for the credit.

The final regulations also address the impact of tobacco surcharges and wellness programs, which are allowed to affect the amount of the premium an employee pays for health insurance coverage.