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Small Business Healthcare Tax Credit

This information is current as of January 2015 and does not reflect any guidance issued on or after this date. As a summary, it is intended to be educational and informational and should not be considered legal advice. Church employers considering the Tax Credit should consult with their own legal counsel and appropriate tax advisors.

The Small Business Health Care Tax Credit (Tax Credit)

The legislation commonly referred to as Healthcare Reform (The Patient Protection and Affordable Care Act – PPACA) created a tax credit as an incentive for small employers to provide health insurance coverage to their employees. If eligible, the Tax Credit can be up to 35% of tax-exempt employer paid premiums and will take the form of a refundable credit against the amounts required to be withheld from your employees’ wages for federal income taxes and Medicare tax, plus the employer share of Medicare taxes (the credit is therefore also limited by these amounts). Small churches and church-related employers can qualify for the Tax Credit if coverage is obtained through the Small Business Health Options Program (SHOP) in the small business marketplaces established under PPACA.

Eligibility for the Tax Credit

Small employers with fewer than 25 full-time equivalent employees (FTEEs) and average employee wages of less than $50,000 per FTEE are eligible for the Tax Credit if “qualifying health insurance coverage” (i.e., coverage obtained through the Small Business Health Options Program (SHOP) in the small business marketplaces established under PPACA is offered) to their employees under a “qualifying contribution arrangement.”

FTEEs, average wages and “qualifying contribution arrangement” are defined below:

  • Full-Time Equivalent Employees: Generally, all of your employees employed during the year for which the Tax Credit is being claimed are counted in computing your FTEEs—including part-time employees, former employees terminated during the year and employees who do not enroll in your health insurance plan (whether or not they are covered under another plan). There are limited exceptions by which certain employees are not counted in the calculation of the number of your FTEEs. For example, seasonal workers are not taken into account in determining FTEEs unless they work more than 120 days during the tax year. (However, the premiums paid on behalf of seasonal employees may be taken into account in determining the amount of the credit.)

There are special rules as to whether a clergyperson may be counted in the FTEE calculation. Please see the discussion below on this subject. With respect to identifying the number of hours an employee works for purposes of making the FTEE calculation, different methods of calculating employees’ hours of service may be used for different classifications of employees (e.g., counting actual hours worked or a days or weeks worked equivalency), as long as the classifications are reasonable and consistently applied. For example, you may use an actual hours method for all hourly employees and a weeks-worked equivalency method for all salaried employees. The number of FTEEs employed is generally calculated by dividing the total hours worked by all employees during the year by 2,080 and rounding down to the nearest whole number (but not less than 1). However, the maximum number of hours that may be counted for any single employee in this calculation is 2,080.

  • Average Wages: In calculating an employer’s average annual “wages,” the wages taken into account are those wages subject to Social Security payroll taxes (FICA), but without the Social Security wage base limitation. However, wages paid to clergy are excluded from this calculation because their wages are not subject to FICA (see Special Rules for Clergy below). To calculate the average wages paid, divide the total annual wages paid to employees taken into account in the FTEE calculation (but excluding wages paid to clergy) by the number of FTEEs (including FTEEs who are clergy), and round down to the nearest $1,000. As a reminder, wages paid to a seasonal worker are not taken into account in determining average annual wages unless he or she worked more than 120 days during the tax year. (However, as described above, the employer premiums paid for seasonal workers are included in the total premium amount used for computing the credit.)
  • Qualifying Contribution Arrangement: A qualifying contribution arrangement is an arrangement where the employer must make a contribution (i.e., a direct employer contribution, not employee contributions made through a cafeteria plan or otherwise) on behalf of each employee who is enrolled in health care coverage. The employer’s contribution must also be a “uniform percentage” of the premium cost for all covered employees. In order to satisfy the uniformity requirement, the church must pay the same percentage of the premium cost for all covered employees (including the clergyperson). The rules vary depending on, for example, whether the employer offers a single health insurance plan or more than one plan, or whether the employer offers a more expensive tier of coverage than single coverage. IRS Notice 2010-82 and the related FAQs provide many examples to illustrate the application of these rules. If an employee is receiving coverage that is more expensive than single coverage (e.g., family coverage), the employer generally need only pay at least 50% of the premium for single coverage for that employee (even if it is less than 50% of the premium for the coverage the employee is actually receiving).

Qualifying health insurance is coverage obtained through the Small Business Health Options Program (SHOP) in the small business marketplaces established under PPACA. However, health reimbursement arrangements (HRAs), flexible spending accounts (FSAs), and health savings accounts (HSAs) are not Qualifying Arrangements and employer contributions for these plans are not eligible for the Tax Credit.

  • Special Rules for Clergy

Inclusion in FTEE and Average Annual Wage Calculations Depends on Employment Status: Clergy who are considered common-law employees of a church employer for income tax and benefits purposes (i.e., they generally receive a W-2 Form from you) are counted as employees for purposes of the Tax Credit, with respect to your FTEE calculation and the premiums paid for coverage. If, under the common-law test, the clergyperson is considered self-employed (and thus generally receives a 1099 Form from you), he or she is not taken into account for the Tax Credit. In addition, even if a clergyperson is counted as an employee for calculating the number of FTEEs, the clergyperson’s compensation is not included in the calculation of average annual wages because his/her wages are not subject to FICA. This exclusion may be beneficial by resulting in a lower overall average wage, because clergy wages are excluded from annual wages in the calculation, but clergy are included in the calculation of the number of FTEEs.

Impact of Lack of Tax Withholding With Respect to Clergy on Available Tax Credit: As described above, the amount of the Tax Credit is limited to the aggregate amount of federal income and Medicare taxes an employer withholds from employee compensation, plus the employer portion of Medicare taxes. Regardless of the clergyperson’s employment status, employers do not pay Medicare taxes on behalf of clergy or withhold Medicare taxes from their pay, and many churches do not withhold federal income taxes from clergy compensation. Therefore, if you do not withhold federal income tax from your clergy compensation, your potential tax credit will be limited by the amount of federal income tax and Medicare tax you withheld from your lay employees’ compensation plus the amount of Medicare taxes you contributed on your lay employees’ behalf. This is true even if you reimburse your clergy for any portion of SECA taxes. SECA tax payments are not available for the Tax Credit. In some cases, to maximize the potential Tax Credit, clergy may wish to have federal income taxes voluntarily withheld from their compensation.

Affiliated Entities

All employers who are part of the same “controlled group” are considered one employer for purposes of the Tax Credit. Therefore, for example, all employees of the controlled group must be counted in the FTEE calculation (except the employees not taken into account which are described above, such as seasonal employees). The controlled group rules rely on the controlled group rules in Internal Revenue Code §§ 414(b), (c) and (m).

It is not clear exactly how the controlled rules apply to churches and their affiliated organizations. If your organization shares day-to-day operational and financial control with another church or church-affiliated employer (such as a day care facility), the two employers might be treated as one employer under these rules; making it more difficult to qualify for the Tax Credit. If you have an affiliated organization, you should discuss with your legal and/or tax advisor how to calculate the number of employees for purposes of the Tax Credit.

The Amount of the Tax Credit

The Tax Credit is a percentage of the amount you pay for qualifying healthcare coverage. It is applied as a refundable credit, which is limited by certain payroll taxes as discussed below. The maximum credit for 2014 is 35% of the premiums you pay for qualifying health coverage but only applies to premiums paid by the employer for coverage purchased through the Small Business Health Options Program (SHOP) in the small business marketplaces established under PPACA.

However, the full tax credit may not be available in all circumstances. First, the full tax credit is available only if you have 10 or fewer FTEEs with average annual wages of $25,000 or less. The credit is phased out as your FTEE count or the average annual wages increases. Second, if the premiums you pay for qualifying health coverage exceed the average premium for policies in the small group markets in your state, your credit will also be limited. The state average premiums are listed in the Instructions to Form 8941.

The Tax Credit is taken as a refundable credit against any federal income taxes and Medicare taxes withheld from your employees’ pay, plus the amount of your share of Medicare tax obligations. The Tax Credit is therefore limited to the amount of these payroll tax obligations for all of your employees.

If a church has only clergy employees and is not paying any FICA taxes or withholding any federal income taxes, the Tax Credit may not be of any value.

How to Claim the Tax Credit

If you are eligible for the Tax Credit, use Form 8941 to calculate the amount of your Tax Credit. Then claim the Tax Credit on Line 44f of Form 990-T. You may have never filed this form as it is usually used only when church entities have unrelated business income (UBIT). However, you must file Form 990-T to claim the Tax Credit, even if you don’t have UBIT. Form 990-T must be filed by May 15, 2015 for employers with a fiscal year ending December 31, 2014.