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, modified to reflect the statutory changes starting in 2014, notably, a higher credit amount, the fact that employers must obtain the insurance coverage through an exchange, and a two-year limit on taking 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 credit amount 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.
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.
In a “qualifying arrangement,” the employer pays a uniform percentage (not less than 50%) of the premium cost for each employee enrolled in health insurance coverage. 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 premium payment requirement. It is taken into account in calculating the credit, however.
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. Before 2014, there was no time limit on taking the credit, so employers that qualified could have taken it in 2010 through 2013. Beginning in 2014, a two-year limit begins with the first year (after 2013) the employer files Form 8941, Credit for Small Employer Health Insurance Premiums. However, if an entity’s predecessor entity (as determined under employment tax rules) claimed the credit, that predecessor’s period will count toward the successor entity’s two-year credit period.
The proposed regulations also provide a transitional rule for employers with non-calendar-year insurance plans.
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.
By Sally P. Schreiber, J.D., a JofA senior editor.