Small Employer Tax Credits

The credit is available to employers with fewer than 25 full-time equivalent employees (FTEs) and less than $50,000 in average annual wages. Seasonal workers are disregarded in determining FTEs and annual wages, unless they work more than 120 days during the tax year.

Eligible employers must also pay at least 50 percent of the premium cost under a "qualifying arrangement." A qualifying arrangement is an arrangement under which the employer pays premiums for each employee enrolled in health insurance coverage offered by the employer in an amount equal to a uniform percentage (not less than 50 percent). Special IRS transition rules apply for 2010.

The same definition of qualifying employer applies to an organization described in the Internal Revenue Code section 501(c) that is exempt from tax under section 501(a). However, special rules apply in calculating the credit for a tax-exempt, qualified employer.

An employer that is an agency or instrumentality of the federal government, or of a state, local or Indian tribal government, is not a qualified employer unless it is an organization described in Code section 501(c) that is exempt from tax under Code section 501(a).

Yes. The credit only places a limitation on the number of full-time equivalent employees (FTEs), so an employer with more than 25 employees may qualify if some those employees are part-time.

Determining eligibility involves four steps:

1. Determine the employees who are taken into account for purposes of the tax credit. Exclude seasonal workers—individuals who worked for the employer on fewer than 120 days during the year. Also exclude individuals with ownership interest in the employer, and relatives of such individuals.

2. Determine number of FTEs. Calculate the total hours worked by all eligible employees, but do not include more than 2,080 hours worked by any one employee. Divide the total by 2,080 and round down to the next whole number. If this number is 25 or less, go to Step 3; otherwise, the employer is not eligible for the tax credit.

3. Determine average annual wages. Take the total annual wages paid to eligible employees and divide by the number of FTEs calculated in Step 2. Round this number down to the next $1,000 (for example, $22,400 rounds to $22,000). If average annual wages are less than $50,000, then proceed to Step 4; otherwise, the employer is not eligible for the tax credit.

4. Determine premium contribution. In tax year 2010, during which the IRS transition rules apply, if the employer pays at least 50 percent of the premium rate for single (employee-only) coverage, then the employer is eligible to claim the small business tax credit.

For further information beyond what is listed here, the IRS has issued detailed guidelines (Notice 2010-44) as well as answers to common questions that can be found at www.IRS.gov.

Members of a controlled group (i.e., businesses with the same owners) or an affiliated service group (i.e., related businesses which perform services for one another) are treated as a single employer for purposes of the credit.¹

1. Consult the Internal Revenue Code for specific rules for determining whether an employer is a member of a controlled group or an affiliated service group (i.e., Internal Revenue Code section 414(b), (c), (m), and (o)).

The maximum credit available to qualified employers for tax years 2010 through 2013 is 35 percent (25 percent for tax-exempt organizations) of the employer's premium expenses.

Employers with 10 or fewer full-time equivalent (FTE) employees that pay $25,000 or less in average annual wages are eligible for the maximum credit.

The tax credit gradually phases out for companies with average wages between $25,000 and $50,000 and for companies with 10 to 25 full-time equivalent (FTE) workers.

• Phase-out Based on FTEs: If the number of FTEs exceeds 10, the reduction is determined by multiplying the otherwise applicable credit amount by a fraction, the numerator of which is the number of FTEs in excess of 10 and the denominator of which is 15.


• Phase-out Based on Average Annual Wages: If average annual wages exceed $25,000, the reduction is determined by multiplying the otherwise applicable credit amount by a fraction, the numerator of which is the amount by which average annual wages exceed $25,000 and the denominator of which is $25,000.


• Phase-out Based on Both FTEs and Wages: For an employer with both greater than 10 FTEs and average annual wages exceeding $25,000, the reduction is the sum of the amount of the two reductions. This sum may reduce the credit to zero for some employers with fewer than 25 FTEs and average annual wages of less than $50,000.

Consult the Internal Revenue Code for specific rules for determining whether an employer is a member of a controlled group or an affiliated service group (i.e., Internal Revenue Code section 414(b), (c), (m), and (o)).

The following employees are ineligible for the tax credit and should NOT be included in any full-time equivalent employees (FTEs) or wage calculations (premiums paid on behalf of these individuals are not counted in determining the tax credit):

• Self-employed individuals or sole proprietors
• Partners in a partnership
• Any two percent (or greater) shareholders of an S corporation
• Any five percent (or greater) owners of an eligible small business
• Employees with a relationship to above bullets (i.e., family members²)

Seasonal employees working for fewer than 120 days per year are also generally disregarded in determining FTEs and average annual wages, but premiums paid on their behalf may be counted in determining the amount of the small business tax credit.

2. For this purpose, a family member is defined as a child (or descendant of a child); a sibling or stepsibling; a parent (or ancestor of a parent); a stepparent; a niece or nephew; an aunt or uncle; or a son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law. Finally, any other member of the household of these owners and partners who qualifies as a dependent under section 152(d)(2)(H) of the Internal Revenue Code is not taken into account as an employee for purposes of the small business tax credit.

Yes. When calculating the credit for the 2010 tax year, employers may count all premium costs paid under the qualifying arrangement but not more than the average small group premium in the employer's state.

The IRS has created a Form 8941 with instructions that may be used by both small businesses and tax-exempt organizations to calculate the small business tax credit. For more information, please read the IRS news release.

Yes. The IRS and Department of the Treasury have issued guidance providing that, for tax years beginning in 2010, the following transition relief applies with respect to a qualifying arrangement:

• Qualifying employers must only pay at least 50 percent of the premium rate for single (employee-only) coverage. If the employee is receiving coverage that is more expensive than single coverage, such as family coverage, the employer satisfies the contribution requirements if the employer pays an amount of the premium that is no less than 50 percent of the premium for single coverage for that employee.


• Under this special transition rule, employers will be treated as satisfying the uniformity requirement (to be treated as a qualifying arrangement), even if the same percentage is not paid for each employee, as long as the employer pays an amount for each employee that is no less than 50 percent of the cost of single coverage (even if the coverage provided is family coverage, which is more expensive).