Tax Law: Health Care Tax Credits, Penalties and “Cadillac” Plans

Tax Law: Health Care Tax Credits, Penalties and “Cadillac” Plans

Sep 1, 2010

The newly enacted health reform legislation has some key provisions affecting small business owners and their workers. The major ones include tax credits, excise taxes and penalties. Whether a business is affected depends on a variety of factors, such as the number of workers the business employs. This is an overview of certain provisions in the new law with the biggest impact on small businesses.

Tax credits to certain small employers that provide insurance.

The new law provides small employers with a tax credit for nonelective contributions to purchase health insurance for their employees. The credit can offset an employer’s regular tax or its alternative minimum tax (AMT) liability.

Small business employers eligible for the credit. To qualify, a business must offer health insurance to its employees as part of their compensation and contribute at least half the total premium cost. The business must have no more than 25 full-time equivalent employees (“FTEs”) and the employees must have annual full-time equivalent wages that average no more than $50,000. However, the full amount of the credit is available only to an employer with 10 or fewer FTEs and whose employees have average annual full-time equivalent wages from the employer of less than $25,000.

Years the credit is available. The credit is initially available for any tax year beginning in 2010, 2011, 2012 or 2013. Qualifying health insurance for claiming the credit for this first phase of the credit is health insurance coverage purchased from an insurance company licensed under state law. For tax years beginning after 2013, the credit is only available to an eligible small employer that purchases health insurance coverage for its employees through a state exchange and is only available for two years.

The maximum two-year coverage period does not take into account any tax years beginning before 2014. Thus, an eligible small employer could potentially qualify for this credit for six tax years, four years under the first phase and two years under the second phase.

Calculating the amount of the credit. For tax years beginning in 2010, 2011, 2012 or 2013, the credit is generally 35 percent (50 percent for tax years beginning after 2013) of the employer’s non-elective contributions toward the employees’ health insurance premiums. The credit phases out as firm-size and average wages increase.

Special rules. The employer is entitled to a tax deduction equal to the amount of the employer contribution, less the dollar amount of the credit. For example, if an eligible small employer pays 100 percent of the cost of its employees’ health insurance coverage and the amount of the tax credit is 50 percent of that cost (i.e., in tax years beginning after 2013), the employer can claim a deduction for the other 50 percent of the premium cost.

Self-employed individuals, including partners and sole proprietors, two percent shareholders of an S corporation and five percent owners of the employer are not treated as employees for purposes of this credit. There is also a special rule to prevent sole proprietorships from receiving the credit for the owner and his or her family members. Thus, no credit is available for any contribution to the purchase of health insurance for these individuals and the individual is not taken into account in determining the number of full-time equivalent employees or average full-time equivalent wages.

Most small businesses exempted from penalties for not offering coverage to their employees.

Although the new law imposes penalties on certain businesses for not providing coverage to their employees (so-called “pay or play”), most small businesses will not have to worry about this provision because employers with fewer than 50 employees are not subject to the “pay or play” penalty. For businesses with at least 50 employees, the possible penalties vary depending on whether or not the employer offers health insurance to its employees. If it does not offer coverage and it has at least one full-time employee who receives a premium tax credit, the business will be assessed a fee of $2,000 per full time employee, excluding the first 30 employees from the assessment. For example, an employer with 51 employees that does not offer health insurance to its employees will be subject to a penalty of $42,000 ($2,000 multiplied by 21). Employers with at least 50 employees that offer coverage, but have at least one full-time employee receiving a premium tax credit will pay $3,000 for each employee receiving a premium credit (capped at the amount of the penalty that the employer would have been assessed for a failure to provide coverage, or $2,000 multiplied by the number of its full-time employees in excess of 30). These provisions take effect Jan. 1, 2014.

The “Cadillac tax” on high-cost health plans.

The new law levies an excise tax on high-cost employer-sponsored health coverage (often referred to as “Cadillac” health plans). This is a 40 percent excise tax on insurance companies, based on premiums that exceed certain amounts. The tax is not on employers themselves unless they are self-funded. However, it is expected that employers and workers will ultimately bear this tax in the form of higher premiums passed on by insurers.

The new tax, which applies for tax years beginning after December 31, 2017, places a 40 percent nondeductible excise tax on insurance companies and plan administrators for any health coverage plan to the extent that the annual premium exceeds $10,200 for single coverage and $27,500 for family coverage. An additional threshold amount of $1,650 for single coverage and $3,450 for family coverage will apply for retired individuals age 55 and older and for plans that cover employees engaged in high risk professions. The tax will apply to self-insured plans and plans sold in the group market but not plans sold in the individual market (except for coverage eligible for the deduction for self-employed individuals). Stand-alone dental and vision plans will be disregarded in applying the tax. The dollar amount thresholds will be automatically increased if the inflation rate for group medical premiums between 2010 and 2018 is higher than projected. Employers with age and gender demographics that result in higher premiums could value the coverage provided to employees using the rates that would apply using a national risk pool. The excise tax will be levied at the insurer level. Employers will be required to aggregate the coverage subject to the limit and issue information returns for insurers indicating the amount subject to the excise tax.

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