IRS Finalizes Regulations for Health Insurance Tax Credits for Small Employers

The Internal Revenue Service has issued final regulations on the tax credit available to certain small employers that offer health insurance coverage to their employees under the Affordable Care Act.

As under the original law, the final regulations in TD 9672 define an eligible small employer as an employer that has no more than 25 full-time equivalent employees, or FTEs, for the taxable year, whose employees have average annual wages of no more than $50,000 per FTE (as adjusted for inflation for years after 2013), and that has a qualifying arrangement in effect that requires the employer to pay a uniform percentage of not less than 50 percent of the premium cost of a qualified health plan offered by the employer to its employees through a Small Business Health Options Program, or SHOP, Exchange. Consistent with the proposed regulations, the final regulations further provide that employees (determined under the common law standard) who perform services for the employer during the taxable year generally are taken into account in determining FTEs and average annual wages.

In determining FTEs, the regulations provide that FTEs should be calculated by computing the total hours of service for the taxable year (using one of three allowable methods) and dividing by 2,080. If the result is not a whole number, the result is rounded down to the next lowest whole number, except if the result is less than one the employer rounds up to one FTE.

One commenter on the proposed regulations requested that the FTE calculation include only full-time employees who work 40 hours a week and not part-time employees. The final regulations do not adopt this suggestion, however, because the IRS said it would be inconsistent with the statutory definition of full-time equivalent employee set forth in Section 45R(d)(2) of the Tax Code. The final regulations provide that leased employees, as defined in Section 414(n)(2), are counted in computing a service recipient’s FTEs and average annual wages.

The final regulations also provide that premiums paid on behalf of a former employee may be treated as paid on behalf of an employee for purposes of calculating the credit provided that if so treated, the former employee is also treated as an employee for purposes of the uniform percentage requirement.

Consistent with the proposed regulations, the final regulations provide that an employee’s hours of service for a year include the hours for which the employee is paid, or entitled to payment, for the performance of duties for the employer during the employer’s taxable year and provide three methods for calculating the total number of hours of service for employees for the tax able year.

A commenter on the proposed regulations requested that employees of educational organizations be credited with hours of service during employment breaks because the use of a 12-month measurement period for employees who provide services only during the active portions of the academic year could inappropriately result in these employees not being treated as full-time employees. The IRS said the final regulations do not adopt this suggestion because it is inconsistent with the statutory framework of Section 45R, which bases calculations on FTEs, not full-time employees. Wages, for purposes of the credit, are defined in the final regulations (and the proposed regulations) as amounts treated as wages under Section 3121(a) for purposes of FICA, determined without considering the Social Security wage base limitation. To  calculate average annual FTE wages, an employer must determine the total wages paid during the taxable year to all employees, divide the total wages paid by the number of FTEs, and if the result is not a multiple of $1,000, round the result to the next lowest multiple of $1,000.

Another commenter requested that the final regulations clarify whether bonuses are included in the average annual wage calculation. The proposed and final regulations provide that the average annual wage limitation is determined using the definition of wages found in Section 3121(a), determined without regard to the Social Security wage base limitation under Section 3121(a)(1); therefore, bonuses would be included to the extent treated as wages under Section 3121( a) for purposes of FICA.