The Internal Revenue Service (IRS) recently issued guidance on a tax credit made available through the Patient Protection and Affordable Care Act that benefits certain small employers who help defray the cost of their employees’ health insurance premiums.

In general, in order to qualify for the credit:

  • The employer must have fewer than 25 full-time-equivalent employees for the tax year,
  • The average annual wages of its employees must be less than $50,000, and
  • The employer must pay at least half of the cost of insurance premiums for their employees at the single coverage rate.

Calculating Full-Time-Equivalent Employees

To calculate the number of full-time-equivalent employees, an employer must add the number of full-time employees (employees working at least 40 hours per week) plus the number of full-time-equivalent part-time employees. With certain exceptions, full-time-equivalent part-time employees are calculated by dividing the total annual hours of part-time employees by 2080. To be eligible for the credit, the total number of full-time employees and full-time-equivalent part-time employees must be fewer than 25.

Calculating Full-Time-Equivalent Employees

To calculate the number of full-time-equivalent employees, an employer must add the number of full-time employees (employees working at least 40 hours per week) plus the number of full-time-equivalent part-time employees. With certain exceptions, full-time-equivalent part-time employees are calculated by dividing the total annual hours of part-time employees by 2080. To be eligible for the credit, the total number of full-time employees and full-time-equivalent part-time employees must be fewer than 25.

Calculating Average Annual Wages

To calculate the employees’ average annual wages, an employer must determine the total annual wages paid to employees and divide that number by the total number of full-time-equivalent employees (see above). To be eligible for the tax credit, employees’ average annual wages must be less than $50,000.

Assuming the above requirements are met, and the employer contributes at least 50 percent of the single coverage premium and at least that dollar amount toward more expensive coverage, the employer will be eligible for the tax credit in 2010. For periods after 2010, the amount of the employer contributions must comply with certain uniformity provisions as described in the notice from the IRS.

Maximum Tax Credit

From 2010 through 2013, the maximum credit will be 35 percent of the employer’s contribution toward premiums (25 percent for tax-exempt employers). Beginning in 2014, the maximum credit will be 50 percent of the employer’s contribution (35 percent for tax-exempt employers). Also, the tax credit will only be available for two consecutive years following 2013.

Although the criteria to be eligible for any tax credit is described above, to be eligible for the maximum tax credit, an employer must have fewer than 11 full-time-equivalent employees (see calculation above) and the average wage must be no more than $25,000. The available tax credit is reduced as the number of full-time employees increases from 10 to 25 and the average employee wage increases from $25,000 to $50,000. (IRS Notice 2010-44)