The IRS issued proposed regulations governing the Sec. 45R credit for small employers that offer health insurance coverage for employees (REG-113792-13). The proposed rules incorporate the provisions of Notices 2010-44 and 2010-82 (which were issued to provide guidance for employers claiming the credit between its original 2010 effective date and now) as modified to reflect the different statutory rules in effect before 2014 and for 2014 and later. The biggest differences involve the amount of the credit, the fact that employers must obtain the insurance coverage through an exchange, and a new two-year limit on taking the credit.
Mechanics of the Credit
Sec. 45R was added by the Patient Protection and Affordable Care Act, P.L. 111-148. From 2010 to 2013, small businesses—defined as businesses with 25 or fewer employees and average annual wages of less than $50,000—have been eligible for credits of up to 35% of nonelective contributions the businesses make on behalf of their employees for insurance premiums. Tax-exempt organizations have been eligible for a 25% credit against payroll taxes. Beginning in 2014, the maximum credit increases to 50% (and 35% for tax-exempt organizations).
The amount of the credit is based on a percentage of the lesser of: (1) the amount of nonelective contributions paid by the eligible small employer on behalf of employees under a qualifying arrangement during the tax year, and (2) the amount of nonelective contributions the employer would have paid under the arrangement if each employee were enrolled in a plan that had a premium equal to the average premium for the small group market in the rating area in which the employee enrolls for coverage.
Eligible Employers and Employees
The proposed rules provide that employers that are exempt from tax under Sec. 501(a), but not described in Sec. 501(c), are not eligible for the credit, but a Sec. 521 farmers’ cooperative that is subject to tax under Sec. 1381 is eligible for the credit as a taxable employer (as long as it meets the other eligibility requirements).
The regulations incorporate the rule that the credit does not require the employees to be performing services in a trade or business. An employer who otherwise meets the eligibility requirements can take the credit for employees who are not performing services in a trade or business, such as a household employee. Eligible small employers located outside the United States that have income effectively connected with the conduct of a trade or business in the United States may claim the credit only if the employer pays premiums for health insurance coverage issued in and regulated by one of the 50 states or Washington, D.C.
Under Sec. 45R, sole proprietors, partners in a partnership, shareholders owning more than 2% of the stock in an S corporation, and any owners of more than 5% of other businesses—and their family members—are not taken into account as employees for purposes of the credit. Although Sec. 45R does not specifically refer to spouses, the IRS says that spouses are nevertheless excluded from the definition of employee for those purposes.
A “qualifying arrangement” is an arrangement under which the employer pays premiums for each employee enrolled in health insurance coverage in an amount equal to a uniform percentage (not less than 50%) of the premium cost. If an employer is entitled to a state tax credit or a premium subsidy that is paid directly to the employer, this amount is not included in determining whether the employer has satisfied the “qualifying arrangement” requirement to pay an amount equal to a uniform percentage (not less than 50%) of the premium cost. It is taken into account in calculating the credit, however.
SHOP Exchange Requirement
One major difference reflected in the proposed regulations is that to qualify for the credit for 2014 and later, employers must obtain health insurance through a Small Business Health Options Program (SHOP) exchange, which is an insurance exchange specifically set up for small businesses to obtain coverage. Because these exchanges had not been set up when the health care act was enacted, Sec. 45R(g)(3), which contains the credit rules for 2010 through 2013, provides that a qualified arrangement can be insurance obtained outside an exchange.
Another difference is the two-year limit on taking the credit. Before 2014, there was no time limit on taking the credit, so employers that qualified could have taken it in 2010, 2011, 2012, and 2013. Beginning in 2014, there is a two-year limit, which begins with the first year the employer files Form 8941, Credit for Small Employer Health Insurance Premiums. However, employers that took the credit before 2014 can take the credit for two more years in 2014 and later. If an entity’s predecessor entity (as determined under employment tax rules) previously claimed the credit, that predecessor’s period will count toward the successor entity’s two-year credit period.
Transitional Rule for Non-Calendar-Year Plans
A transitional rule applies to employers with health plans that are not on calendar years because it may not be possible for such employers to offer health insurance through an exchange at the beginning of their first tax year beginning in 2014. Therefore, if an employer has a health plan year that begins after Jan. 1, 2014, but before Jan. 1, 2015, and that health plan year begins after the start of the employer’s first tax year beginning after Jan. 1, 2014, and the employer offers one or more qualified health plans to its employees through a SHOP exchange as of the first day of its 2014 health plan year, then the employer is treated as providing coverage through a SHOP exchange for its entire 2014 tax year for purposes of the Sec. 45R credit if the health care coverage provided from the first day of the 2014 tax year through the day immediately preceding the first day of the 2014 health plan year would have qualified for a credit under Sec. 45R using the rules applicable to tax years beginning before Jan. 1, 2014. The transitional rules also treat the 2014 year as the first year the employer with a non-calendar-year health plan qualifies for the credit for purposes of the two-year limit on the credit.
The regulations will be effective the date they are published as final in the Federal Register, but taxpayers may rely on them for tax years beginning after 2013 and before Dec. 31, 2014. If future guidance is more restrictive, it will not be retroactive.