Small businesses struggle to navigate provisions of the health care law

Owners wait for exchanges, fear getting hit by penalties.

Small businesses have enough to worry about without having to wade through the intricacies of hundreds of pages of the health care legislation enacted in 2010: the Patient Protection and Affordable Care Act, P.L. 111-148, as amended by the Health Care and Education Reconciliation Act P.L. 111-152, referred to here as the health care law. And even if they have spent time learning about the law, questions remain for small business owners and for advising CPAs: What exactly are exchanges? How is the number of full-time-equivalent (FTE) employees calculated, and why does it matter? Who qualifies for the small employer health insurance credit? What is the shared responsibility penalty, and does it apply?

These are among many questions that have small businesses flummoxed. Three provisions in particular—health care exchanges, the small employer’s health insurance tax credit, and the shared responsibility penalty—affect small businesses, whose CEOs often act as accountant, IT director, sales manager, and any number of other roles.

The Sec. 45R small employer’s health insurance tax credit is designed to help very small businesses whose employees do not earn a lot pay for their employees’ health insurance. The credit is unavailable to employers with more than 25 FTE employees and whose average annual wages exceed $50,000, and it begins to phase out at 10 employees and wages of $25,000.

Larger businesses that don’t provide health insurance for their employees or that provide insurance that is unaffordable, as defined in the law, may be subject to the “shared responsibility penalty” in Sec. 4980H. Although this is called a penalty for large employers, it applies to employers with as few as 50 full-time employees, hardly large by most definitions. For determining whether the penalty applies, any employee who works an average of 30 hours per week is considered an FTE. The number of FTE employees is counted in order to prevent employers from hiring all part-time employees to avoid the penalty.

The health care law requires each state to set up a health insurance exchange, which is intended to be a competitive marketplace for health insurance for individuals and small businesses. If a state does not set up an exchange, the health care law permits the federal government to step in and do so in its stead. Several states whose current governments are opposed to the health care law, e.g., Texas and Florida, have said they will not set up exchanges.

For purposes of participating in the exchange, the definition of a small business is a business with 100 or fewer employees. The exchanges are intended eventually to lower costs for both individuals and small businesses because they will be more transparent and will allow people to compare coverage costs and plans over the internet.

The track of health care reform in this country is still unknown, but change is coming.

“One thing we have to understand,” said Phil Kennedy, a small business owner from Oklahoma, “is that this is a train that’s moving.”

Here is how four businesses are trying to keep up with that locomotive. Each business has spoken out about the law on behalf of lobbying organizations or interest groups, and three of the owners—Kennedy, Rick Poore, and Larry Schuler—testified before the House Energy & Commerce Committee’s health subcommittee in March 2011.


The scenario. The Tulsa Rib Company opened more than 30 years ago, when Steve Parker decided to start his own venture after working in a variety of jobs in the food-service industry. He’d been a dishwasher at International House of Pancakes as a teenager, and he’d also worked at high-end restaurants. Most places he worked did not offer health care, and he’d seen a few co-workers get into major financial difficulty when beset with serious illness.

So he made providing health care coverage a priority when he began his business, serving ribs in Orange, Calif.

“Back then, it was just a blip in [the restaurant’s] expenses,” Liz Parker, Steve’s wife, said. “At that point, health care was a big deal to the employees. We have some employees who have been with us 32 years. If you take care of them, then they stay.”

Liz Parker now oversees the catering side of the business. She also handles the bookkeeping, with the help of CPA firm Krost, Baumgarten, Kniss & Guerrero (KBKG). Starting in about 2000, the business’s health care premiums began to rise dramatically. The company paid 100% of each full-time employee’s premiums and 50% of any dependent premiums. But as the costs rose, the quality of coverage the business could afford dropped.

Liz Parker said health care costs rose sometimes 30% a year as quality of coverage declined. Copays of $5 became $20 or $25, and deductibles went from $200 to as much as $2,000.

“Our dollar didn’t go as far, and we were buying worse coverage,” she said.

The company’s total bill for the health care premiums of 16 full-time employees rose to more than $90,000 a few years back before Tulsa Rib switched to a cheaper plan. In September, Liz Parker said the bill for renewal was $65,000.

Liz Parker sat down with the business’s accountant and did the math spelled out in the Sec. 45R formula for computing the credit for small employers, which starts to phase out for businesses with 10 or more employees (see Exhibit 1). The tax credit Tulsa Rib would receive under the terms of the law: $200.

“We’ve been through this in detail,” said Liz Parker, whose comments have been featured on the website for Small Business Majority, a group that supports the law. “We don’t know what happened. Our outlay was $60,000, and our credit was $200. Our CPA said, ‘You are exactly who this law is for.’ We should be right in the wheelhouse, but it’s not saving us much.”

The plan. Tulsa Rib Company will continue to offer health care coverage to employees, but Parker and her husband are hoping for more options and possibly savings when state-based health insurance exchanges become operational on Jan. 1, 2014. “We love that we can produce the best ribs in Orange County,” she said. “We don’t know much about health care other than that our employees need it. We cannot wait for that exchange.”

Rob Campbell, employment tax credit manager at KBKG, which specializes in restaurant-related accounting and consulting, worked with Tulsa Rib on analyzing the business’s small employer health insurance credit. He says the credit’s “aggressive” phaseouts make it difficult for most clients to realize substantial tax savings. “It’s really geared toward companies that don’t pay their employees very much,” Campbell said. “It’s almost a disincentive to compensate your employees. This credit has not helped most of our clients. Those that it has, the [credit has] been very, very minimal.”


The scenario. Larry Schuler’s restaurant, Schu’s Grill & Bar, overlooks Lake Michigan and is a popular destination for vacationers, particularly between Memorial Day and Labor Day. That’s also when Schu’s has increased staffing, with college students and other young people helping out.

“Those college students are a tremendous impact in productivity for the seasonal businesses,” said Schuler, a fourth-generation restaurant owner who, before the House subcommittee, spoke out against the law on behalf of the National Restaurant Association.

The restaurant must keep those employees’ days worked in the summer under 120, or the seasonal workers will be counted as employees for purposes of the Sec. 4980H shared responsibility penalty.

Schu’s full-time employees, the year-round ones, are offered health care for which the premium now is $186 a month, he said. The company pays half. He says many peak-season workers don’t want to pay for health care. Some might be on a parent’s plan; some want to spend their money elsewhere.

“They look at that hundred bucks a month” as an unnecessary expense, Schuler said. “Some of them work out every day, and they feel invincible. That hundred bucks? They think, ‘I could use that to pay [for] my BMW.’”

The plan. Although the traditional summer season, between those two Monday holidays, is about 100 days, many students want to work as long as possible from the time school ends until it begins. Even after school resumes, some come back to work Labor Day weekend, because Schuler offers a bonus to employees who work two shifts then. Because the peak-season workers’ presence puts Schu’s over the 50-employee mark, Schuler would be required to offer health care coverage to all of them or pay a fine.

Schuler plans to continue offering health care for his year-round full-timers. He’s not certain about how to deal with the peak-season younger workers. He might, like some of his business peers, cut off those seasonal workers when they reach the limit, to avoid having to provide health insurance or pay the Sec. 4980H penalty.

To illustrate the effect of seasonal employees on the number of employees for purposes of calculating the Sec. 4980H penalty, an employer is an “applicable large employer” if the employer’s workforce exceeds 50 full-time employees for more than 120 days a year. But if the employer’s workforce does exceed 50 employees and those employees in excess of 50 are seasonal employees, the employer will still not be an applicable large employer (Notice 2012-58). “Seasonal employee” is defined by the Labor Department (and includes retail workers employed exclusively during the holiday season). Through at least 2014, employers can use a reasonable, good-faith interpretation to calculate the number of employees for purposes of the penalty.

Michelle Neblett, the director of labor and workforce policy for the National Restaurant Association, said the association continues to seek clarification from the Treasury Department on the definition of seasonal employee versus new employee. Because the maximum waiting period for providing health care to new full-time, permanent employees is 90 days, Schuler wants his summer workforce to be classified as seasonal (working up to 120 days) instead of new.

“The timing is getting very short as far as complying by 2014,” Neblett said. “We think we’ll have a rule [soon] with some certainty behind it.”


The scenario. Rick Poore started DesignWear Inc. in 1994, printing and embroidering shirts for college fraternities and sororities. Today, the business has 33 employees and at least one college campus client in every state, extending its reach via

“We’ve grown quite a bit,” Poore said. “We’re up about 35% in sales this year.”

Poore and a benefits specialist met in 1999 or 2000 and laid out a plan for employee benefits, including health care and a 401(k). The health care bills steadily rose, including one year in the mid-2000s when the increase was 43%.

“That’s the basis for my angst over this whole thing,” Poore said. “I was just tired of getting ripped off. Just year after year, getting less and paying more. It was so frustrating.”

That’s why he’s willing to give the new law a chance. Poore, who spoke in favor of the law before the House subcommittee on behalf of Main Street Alliance, for which he serves on the 2012 steering committee, compares uncertainty over the law’s provisions to having to deal with other business challenges. His mantra: Come up with a solid plan; do what it takes to get there.

“I’m not going back on the system we had,” he said. “What we had was not a free market. There were no real choices. … Hopefully the competition that comes with 3 million new customers should drive down cost.”

The plan. Poore is hopeful that his business can take advantage of those planned lower costs that will come from the competition fostered by the health insurance exchanges.


The scenario. Norman and Christine Kennedy opened Comanche Lumber Co. in Lawton, Okla., in 1967, selling residential building materials. As Lawton grew, so did the business, expanding into floor covering and becoming an Ace Hardware location in a bigger building on C Avenue.

Today, the business is known as Comanche Home Center, and it’s owned by the Kennedys’ son, Phil. Several years ago, Phil Kennedy said, his father decided to offer health care to employees. Comanche pays part of the employees’ premiums, even though the costs have risen dramatically.

The approximately 42 employees at Comanche are “like family,” Kennedy said. But the good of the business might outweigh that sentiment. “We have a business that’s looking at shrinking margins, and we need to be making headway on improving our expense structure,” he said.

In 2011, Kennedy testified before the House subcommittee that premiums for his company’s health plan had increased 30%. Since then, his recent renewal bill for health care premiums has increased 10%. “That’s not sustainable for our company,” said Kennedy, a member of the board of directors for the U.S. Chamber of Commerce.

The plan. Based on cost comparisons, it might make more sense financially to hire fewer workers even in peak seasons to stay below 50 employees (see Exhibit 2). If Comanche goes above 50 employees and doesn’t offer health care, it would be subject to a yearly fine of at least $40,000 ($2,000 times each employee over 30).

When Kennedy testified before the health subcommittee, he said the fines made no sense.

“The mandate will basically punish businesses that have 50 or more employees by fining them if they don’t offer a certain level of coverage,” he testified. “Even if a business does offer a ‘qualified plan,’ it still might be fined just as much. Ironically, the fine for businesses that don’t offer coverage is $2,000 per employee … and the fine for a business that does offer coverage is $3,000 per employee, plus the cost they’re paying for coverage. In other words, it may be more cost-effective for Comanche to drop its coverage under the new mandate. Considering that Comanche’s profits are about 1%, I am not sure how we could afford to pay these fines.”

The second penalty of $3,000 applies only to each employee who qualifies for a cost-sharing reduction or a premium tax credit (see Exhibit 2), as opposed to the $2,000-per-employee penalty that applies to all employees over 30.

Nearly two years after Kennedy’s testimony, business owners still have many questions about the law. For instance, if Comanche Home Center is above 50 employees for only two months a year, does Kennedy have to offer coverage or pay a fine for the entire year? both penalties are calculated monthly, so the penalty applies only to months in which the employer is an “applicable large employer” and the employer offers coverage that is unaffordable or does not offer coverage. However, whether or not Comanche Home Center is an applicable large employer is determined based on the number of employees the business employed in the preceding year, not the current year. If an employer averaged at least 50 full-time employees during the preceding year, it is an applicable large employer for the whole (current) year, even for months when the actual number of employees falls below 50. On the other hand, if it did not average at least 50 full-time employees in the preceding year, it is not an applicable large employer, even if it went over 50 during some months in the preceding year. Furthermore, if an employer’s workforce exceeds 50 full-time employees for 120 days or fewer during a calendar year, and the employees in excess of 50 who were employed during that period of no more than 120 days were seasonal workers, the employer is not an applicable large employer.

“I don’t think there’s been much clarity brought to these issues,” Kennedy said. “What does it do to us, a company that wants to grow and expand? Does it impact whether we go above 50 or not? It certainly does, if we’re above 50 employees in the long haul. This is part of the decision to grow the business. It’s not just because of the Affordable Care Act. In an economy that has the challenges that we have today, you don’t want to have anything that hinders it.”


Know the law: The hundreds of pages in the health care reform legislation are plenty to digest. It’s difficult to advise clients if you don’t have a firm understanding of the law.

Identify and respond to penalty provisions: Management needs support in understanding the provisions and the penalties that can accompany those provisions. CPAs should work with the businesses to create strategies to avoid the penalties.

Evaluate the impact of coverage decisions: The ramifications go beyond how much money is devoted to health care coverage. Advise businesses on issues such as recruitment, retention of full- and part-time workers, employee satisfaction, and possible effects on brand and reputation.

Assist with process changes: HR and payroll systems will need to change as a result of the law because of expanded reporting requirements.

Keep leadership updated on legislative changes: The health care law should be viewed more as a process than a single event. There’s a good chance many parts of the law will be modified.

Exhibit 1
Calculation of the Phaseout for the Small Employer Health Care Credit

Sec. 45R provides a credit to small employers who contribute to the purchase of health insurance for their employees. For the years 2010–2013, the amount of the credit is generally 35% (25% for tax-exempt entities) of the lesser of the nonelective contributions made by the employer on behalf of employees or a benchmark premium amount. After 2013 the 35% credit for taxable entities becomes 50% (35% for tax-exempt entities), but will be available only to employers who purchase health insurance through a state exchange.

The phaseout begins as soon as the number of full-time employees exceeds 10 and the average annual wages exceed $25,000—and both amounts reduce the credit. The reduction for employee size is determined by multiplying the credit amount (for 2010 to 2013, 35% times the outlay for health insurance) by a fraction, the numerator of which is the number of full-time equivalent employees in excess of 10 and the denominator of which is 15.

A full-time employee is determined by dividing the total number of hours of service for which the employer paid wages during the year by 2,080, lowered to the next lowest whole number. Overtime hours in excess of 2,080 that an employee works are excluded from hours of service, as are hours of seasonal workers, unless they work more than 120 days during the year. Other people who are excluded are sole proprietors or partners in a partnership (people who are self-employed under Sec. 401(c)(1)), 2% S corporation shareholders, 5% owners of partnerships or other businesses, and their relatives. However, leased employees are included.

If average annual wages exceed $25,000, the reduction for wages is determined by multiplying the 35% times the amount spent on health insurance 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.

Both of these amounts are subtracted from the credit, which is why Tulsa Rib qualified for only a $200 credit after spending $60,000 on health care premiums. To illustrate how drastic the phaseout is, take a company that, like Tulsa Rib, has 16 full-time employees, whose average wages are about $40,000. The credit amount without the phaseout would be $21,000 (35% credit times $60,000). The first reduction for the number of employees greater than 10 is calculated as follows: $21,000 (credit amount) × (6/15) = $8,400. The second reduction for wages greater than $25,000 is calculated as follows: $21,000 × (15,000/25,000) = $12,600. The two phaseouts, $8,400 and $12,600, total $21,000, reducing the credit to zero.

In 2014, the credit increases to 50% of premium costs from 35% (and from 25% to 35% for tax-exempt employers). The increase in the credit will not change the phaseout, and the result will be the same for small employers who have more than 10 employees and compensate their employees well: little or no credit. Of course, the credit is generous for very small employers with modestly paid employees.

Exhibit 2
Shared Responsibility Penalty

Beginning in 2014, employers that employ an average of 50 full-time employees (i.e., an employee who is employed on average at least 30 hours per week) must pay a penalty if they do not provide health insurance or if the health insurance they provide isn’t affordable. Coverage for health insurance is generally considered not affordable if the employee’s contribution costs exceed 9.5% of his or her household income. (For simplicity, the IRS allows employers to use wages on Form W-2, Wage and Tax Statement, to determine household income for this purpose, and to determine the affordability of coverage using the cost of an employee’s premium for self-only coverage, which is apparently a loophole that could allow employers to easily avoid the penalty. The IRS’s interpretation has been criticized as contrary to the statute.)

The first penalty for not providing coverage is $2,000 per employee over 30, and it applies if one employee gets insurance through an exchange for which a premium tax credit or a cost-sharing reduction is allowed. The Sec. 36B premium tax credit is a refundable credit to help people with incomes of up to 400% of the federal poverty line get health insurance through an insurance exchange. A cost-sharing reduction is a limit on the amount of out-of-pocket expenses such as deductibles and copays that people at certain income levels are responsible for paying. Once these costs reach a certain level, the government makes cost-sharing payments to cap these costs.

The second penalty for not providing affordable coverage or offering a plan under which the plan’s share of the total allowed cost of benefits is less than 60% is $3,000 a year for each employee who obtains coverage through a health exchange and receives a premium tax credit or cost-sharing reduction. That penalty cannot exceed the amount the employer would have paid using the first calculation (i.e., $2,000 per employee over 30 employees, regardless of how many employees are receiving a premium tax credit or cost-sharing reduction).
Because employees will qualify for the premium tax credit and cost-sharing only if they make no more than 400% of the federal poverty line, it is possible that an employer with well-compensated employees may not be subject to either penalty. For 2012 (the income year that applies to determine eligibility for the credit in 2014), 400% of the federal poverty line level for a single person is $44,680, and for a family of four, it is $92,200.


The Patient Protection and Affordable Care Act has three provisions of particular significance to small businesses. Those provisions are the small business health care credit, the shared responsibility penalty for large employers, and the health care exchanges.

Because the small business health care credit has an aggressive phaseout, it is not much benefit to any but the smallest employers, and often those smallest employers only see a benefit if their employees are not highly compensated.

The shared responsibility penalty on large employers can apply to employers in two ways. It applies to those who do not provide health insurance and to those who provide insurance that is not classified as affordable or does not meet certain requirements for level of coverage.

Health care exchanges, which each state is supposed to have running by 2014, are intended to help small employers and individuals find affordable health insurance by creating an open marketplace where people can compare coverage and costs.

This article examines the effect of the law’s complexity and uncertainty on a number of small businesses and recommends ways CPAs can advise their small business clients.

To comment on this article or to suggest an idea for another article, contact Neil Amato, senior editor, at or 919-402-2187 or Sally P. Schreiber, senior editor, at or 919-402-4828.


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