The new health care reform law includes a golden opportunity for sellers working the 25-employee-and-under group market: the “small employer tax credit.” In many cases it can lower a client’s health care costs in a heartbeat.

Effective for tax years beginning this year, qualified employers that provide health care coverage to their employees and certain meet requirements are generally eligible for a federal income tax credit for the health insurance premiums they pay for certain employees. Here are the requirements:

• The employer must have fewer than 25 full-time equivalent employees for the tax year.
• The average annual employee wages for the year must be less than $50,000 per FTE.
• The employer must pay the premiums under a “qualifying arrangement.”

Calculating the credit

Premiums paid by an employer under a “qualifying arrangement” are the only expenses that can be used for calculating the tax credit. The term “qualifying arrangement” means that an employer pays premiums for each employee enrolled in the health insurance plan offered by the employer in amounts equal to a uniform percentage (not less than 50 percent of the premium) of the cost of the coverage.

For example, let’s say an employer pays 80 percent of employee health insurance premiums, with employees paying the remainder. The 80-percent premium amount paid by the employer is the amount that is counted in calculating the employer credit. Any premiums paid pursuant to a salary reduction arrangement under a Section 125 arrangement are elective contributions and not counted as paid by the employer.

Additionally, the amount of an employer’s premium payments that counts for purposes of the credit is capped. The cap is determined by the premium payment the employer would have made under the same arrangement if the average premium for the small group market in the state in which the employer offers coverage were substituted for the actual premium. If an employer pays only a portion of the premium for the coverage provided to employees (for example, under the terms of the plan the employer pays 80 percent of the premiums and the employees pay the remainder), then the premium amount that counts for purposes of the credit is the same portion (80 percent in this example) of the premiums that would have been paid for the coverage if the average premium for the small group market in the state were substituted for the actual premium.

The IRS issued a chart providing each state's average premiums on May 3. Click here for the rates and more information.

Maximum credit

Here’s the great part. The maximum credit for qualified employers for tax years beginning in 2010 and going through 2013 is 35 percent of the employer’s premium expenses. For example, say a qualified employer has nine FTEs during 2010 with average annual wages of $23,000 per FTE. The employer pays, say, $72,000 toward health insurance premiums for those employees and otherwise meets the requirements for the credit. That employer’s 2010 credit is $25,200 (35% of $72,000). That would be good news for you to deliver on a renewal to such an employer — a hard savings of $25,200.

Tax-exempt employers

Your tax-exempt prospects and customers can also save money on their health insurance premiums through a sister rule in the law. Here are the requirements for tax-exempt employers:

• The maximum tax credit for tax-exempt qualified employers is 25% of employer-paid health insurance premiums.
• The amount of the credit cannot exceed the total amount of income and the Medicare tax the employer is required to withhold from employees’ wages for the year, and the employer share of Medicare tax on employees’ wages.

For example, during the 2010 tax year, a qualified tax-exempt employer has 10 FTEs with average wages of $21,000 per FTE. The employer pays, say, $80,000 in health care premiums for those employees (which does not exceed the average premium for the small group market in the employer’s state) and in all other ways meets the requirements for the credit. The total amount of the employer’s income tax and Medicare tax withholding plus the employer’s share of the Medicare tax equals $30,000 in 2010.

Here’s what the tax credit would look like for this employer.

1. Initial amount of credit determined before any reduction is (25% of $80,000) = $20,000.
2. The employer’s withholding and Medicare taxes are $30,000.
3. This employer’s 2010 tax credit is $20,000 (the lesser of $20,000 and $30,000).

The credit for tax-exempt qualified employers will be reduced if the number of FTEs exceeds 10 or average wages exceed $25,000. Here’s how that works. If the number of FTEs for a tax-exempt qualified employer exceeds 10, the reduction is determined by multiplying the otherwise applicable credit amount by a fraction, of which the numerator is the number of FTEs in excess of 10 and the denominator is 15. If the average annual wages exceed $25,000, the reduction is determined by multiplying the otherwise applicable credit amount by a fraction whose numerator is the amount by which average annual wages exceed $25,000 and the denominator is $25,000.

In each case, the result of the calculation is subtracted from the otherwise applicable credit to determine the credit for which the employer is entitled. Say an employer has both more 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.

Here’s an example. For the 2010 tax year, a qualified employer has, say, 12 FTEs and average wages of $30,000. The employer pays $96,000 in health insurance premiums for those employees (which does not exceed the average premium for the small group market in the employer’s state) and otherwise meets the requirements for the credit.

The credit calculation goes like this:

1. Initial amount of credit determined before any reduction is $33,600 (25% of $96,000).
2. Credit reduction for FTEs in excess of 10 is $4,480 ($33,600 of 2/15).
3. Credit reduction for average annual wages in excess of $25,000 is $6,720 ($33,600 of $5,000/$25,000).
4. Total credit reduction is $11,200 ($4,480 + $6,720).
5. Total 2010 employer tax credit is $22,400 ($33,600 - $11,200).

How is the number of FTEs determined?

An employer’s number of FTEs is determined by dividing the total hours for which the employer pays wages to employees during the year (but not more than 2,080 hours for any employee) by 2,080. The result, if not a whole number, is then rounded to the next lowest whole number. For example, for the 2010 tax year, an employer pays, say, five employees wages for 2,080 hours each, three employees wages for 1,040 hours each, and one employee wages for 2,300 hours. The employer in this example would have FTEs calculated as follows.

Total hours not exceeding 2,080 per employee is the sum of:

1. 10,400 hours for the five employees paid for 2,080 hours each (5 of 2,080)
2. 3,120 hours for the three employees paid for 1,040 hours each (3 of 1,040)
3. 2,080 hours for the one employee paid for 2,300 hours (lesser of 2,300 and 2,080).

Collecting the credit

Employers that are eligible for the tax credit and apply will receive their credits on their tax returns. The IRS will provide further instructions for tax-exempt employers.

Conclusion

Recent economic data are clearly showing an uptick in employment rolls. This is likely to continue as the economy strengthens. Your small group block should benefit the most because of the sheer number of accounts you likely have in this market and the headcount that will surely increase in small employers, where the majority of new jobs are created.

Although a bit complicated, the small employer tax credit represents a terrific selling window for you to get out and talk to prospects and existing clients who may qualify. Do this now before your competition does.

Craig Davidson is a columnist for Employee Benefit Adviser magazine.