On March 23, 2010 President Obama signed into law one of the largest and most controversial pieces of legislation ever passed called the Patient Affordable Care Act (aka Health Care Reform Bill). This new legislation is so complex that it will take nearly eight years to fully implement. The first stage takes effect in 2010 with four distinct provisions. This article will address one of those provisions, The Small Business Tax Credit.

Beginning January 1, 2010, small businesses who contribute 50% or more toward their employees health insurance premiums for are eligible for a non-refundable small business income tax credit. This provision creates two classes of employers:
1.  Eligible small employers and
2.  Large employers.

Eligible small employers are defined as employers with 25 or fewer full-time employees with average annual wages of $50,000 or less. Everyone else exceeding these thresholds is, by default, a large employer and not eligible for the credit.

Full-Time Employees:
To determine the number of eligible full-time employees, an employer must divide total hours worked by all employees by 2,080. Total hours worked by employees cannot include hours worked by any employee that exceeds 2,080 hours for the year. Thus, overtime is excluded from the calculation of total hours. 5% owners and 2% S Corporation shareholders are not considered employees for purposes of the full-time employee calculation.

Average Annual Wages:
To determine the average annual wage base, an employer must divide total wages paid to employees during the year by the total number of full-time employees (from previous calculation). 5% owners and 2% S Corporation shareholders are not considered employees for purposes of the average annual wage base calculation.

Calculation of the Non-Refundable Income Tax Credit:
A maximum non-refundable income tax credit of 35% will be available only to employers with 10 or fewer full-time employees and average annual wages of $25,000 or less. This credit is applied to the employer's share of health insurance premiums and this dollar amount is the credit that is applied against business income tax (or passed through to partners or S Corporation shareholders).

These are the two baselines for the credit:

1. 10 full-time employees and
2. $25,000 in average annual wages. 

As the number of full-time employees rise above 10 and/or the average annual wage base rises above $25,000, the credit quickly disappears. This is known as a phase-out, and because of the complexity of the formula to determine an employer's eligible credit, a table was created to make it easier to compute the eligible credit. For example, if an employer has 11 full-time employees with an average annual wage base of $15,000, the credit is 33%. For each additional full-time employee above 10, the credit is reduced by 2%. If an employer has 10 full-time employees with an average annual base exceeding $25,000, but not exceeding $30,000, the credit is 28%. The credit is reduced by 7% as the average annual wage base exceeds the $25,000, $30,000, $35,000, $40,000 and $45,000 average annual wage base table amount. If you use the tables, the credit is 0% once the total number of full-time employees exceed 24.9 or once the average annual wage exceeds $45,999.

Other Rules:

• Aggregation rules apply, which means affiliated companies must be aggregated in determining eligibility, the number of full-time employees and average annual wage base.
• The credit may be applied against regular income tax and alternative minimum tax.
• If an eligible small business employer qualifies for the credit but cannot use the credit in the current year, they may carry the credit back one year to use against the prior year's income tax.

There is also a credit for non-profit organizations of 25%. This credit, unlike the 35% business credit, may be used to reduce the Medicare portion of payroll taxes (Form 941 will have a line item for this credit).

I wish to thank the 22 year old Congressional staff members who write the tax code and regulations, the IRS for their incomprehensible explanations thereof and the tax court rulings for making the U.S. income tax system as complex as it is, thus affording me and many other CPAs the opportunity to make a living in a completely unnecessary field.

For more information, please consult with a tax advisor or attorney.