Background

Workers employed by small firms are more likely than workers generally to be uninsured. Small firms are less likely to offer coverage at all and, if they do offer coverage, they are less likely than large firms to contribute half or more of the monthly premium costs.^[1] Small firms tend to experience higher premiums because of their size, which magnifies the impact of health status considerations among firm employees and their families. With 2009 health benefit premiums for group health plans averaging over $4,800 for individual coverage and more than $13,000 for family coverage,^[2] the cost burden on smaller employers is considerable.

Changes Made by the Health Reform Law
Pub. L. 111-148, §1421, amended by §10105

The Act provides a small-employer tax credit^[3] available in two phases: the 2010-2013 time period, and the time period that begins with the establishment of state health insurance exchanges in 2014 and beyond.^[4]

• The term “small employer” means one with ten or fewer employees and average annual wages of less than $25,000.^[5] The small-employer credit phases out completely for firms with more than 25 full-time-equivalent workers and average annual wages greater than $50,000.^[6]
  • The term “average annual wages” represents the total of the average annual wages paid divided by the number of full-time-equivalent employees.^[7] Part-time workers thus may be included in calculating full-time-equivalent wages,^[8] but seasonal workers (i.e., those who perform labor or services on a seasonal basis) cannot be included.^[9]
• In order to qualify for the credit, a small employer must make a “nonelective contribution” (i.e., one that is not contingent on a salary reduction election by the employee)^[10] equaling at least 50 percent of the employee’s health insurance premium for a “qualified health plan.”^[11]
  • A qualified health plan is a health plan is one that meets federal standards for qualified health plans offered through or recognized by state health insurance exchanges.^[12]
• In calculating the number of employees for whom a credit is available, a full-time-equivalency test is used, comparing the total number of hours worked to 2,080 hours for full-time work.^[13] (Excess hours cannot be counted.)^[14] The definition of eligible employee excludes seasonal workers as well individuals who are 2 percent shareholders or 5 percent owners.^[15] Leased employees are counted, and special rules apply to tax-exempt employers.^[16]
• During the 2010-2013 time period, the credit equals 25 percent of the employer contribution for nonprofit employers and 35 percent for the case of for-profit employers. Nonprofits can claim the credit during each pay period and may apply the credit against taxes withheld from payroll. For-profit employers must wait until the end of the year and can claim the credit only against profits.^[17] Beginning January 1, 2014 the credit rises to 35 percent for nonprofit and 50 percent in the case of for-profit employers.^[18]
• Only the amount actually contributed by an employer counts toward the tax credit.^[19] The amount of employer premium payments that qualify for the credit is capped at the average small-employer premium for the state in which the employer is located.^[20] The average small-group-market premium for each state will be calculated by the United States Department of Health and Human Services.^[21]

Implementation

Agency and Timetable

The Internal Revenue Services within the United States Department of the Treasury, in consultation with the Departments of Labor and Health and Human Services, oversees the tax credit implementation in conjunction with other tax laws applicable to business. Because the credit becomes available beginning in 2011, the Internal Revenue Service has already posted guides and questions and answers, as well as a calculator for determining whether a firm qualifies for the tax credit.

Process

The legislation directs the Secretary to prescribe regulations implementing the credit.^[22] Therefore the early implementation guidelines posted at the IRS website will be followed by formal rulemaking.

Key Implementation Issues

• Calculating the credit: Will guidance and regulations refine instructions on how the credit will be calculated, including which employee services can be counted and how the total amount of hourly wages paid will be determined?
• Qualified health plans: What is the meaning of a “qualified health plan” before state health insurance exchanges come into effect in 2014? In the Act, the significance of a qualified health plan is tied to its status as offered in or recognized by state health insurance exchanges. (The IRS guidance as of April 4 2010 indicates that small group coverage purchased through state-licensed insurers would be considered qualified health plans).
• Applying the credit following the establishment of the exchanges: How will the credit be operate once health insurance exchanges are established in 2014?

Recent Agency Action

The IRS has posted instructions at its website.

Authorized Funding Levels

Tax credits are a legal entitlement and thus the cost of the tax credit, as defined in the law, is not subject to an aggregate annual permissible level. The cost will depend on how many eligible employers take advantage of the credit and how many eligible employees receive coverage.

Implementation stakeholders

• Small employers that may qualify for the credit.
• Employees of small employers for whom the cost of coverage would be made more affordable.
• Health care providers treating patients who work for small employers and health insurers selling products to small employers.
• State insurance agencies that regulate small business health insurance products.