Thursday, October 6, 2011

Obamacare’s Effect on Small Business

Unaffordable Care Act | Jobless, Unshared, and Irresponsible -

By: Larry Walker, Jr. -

“An unlimited power to tax involves, necessarily, a power to destroy; because there is a limit beyond which no institution and no property can bear taxation.” ~ Daniel Webster in M'CULLOCH v. STATE, 17 U.S. 316 (1819) -

Although Barack Obama boasts of having implemented 17 tax cuts for small business during his one-term proposition, as I pointed out in Why Congress Shouldn’t Just Pass Obama’s Jobs Bill, Again, not one item on the list actually meets the definition of a tax cut. #1 on the list was the Small Employer Health Insurance Tax Credit, which is found in Internal Revenue Code Section 45R. The goals of the Section 45R credit are supposedly as follows: (1) to help offset the cost to small businesses that offer employee health insurance coverage, and (2) to encourage small businesses not providing health insurance to start offering coverage.

But unfortunately, the overall effect of the Patient Protection and Affordable Care Act, will be to encourage large employers, those with 50 or more full-time employees, to drop health insurance coverage, reduce the number of employees, or cut weekly work hours to less than 30 in order to avoid paying the so-called shared responsibility penalty. Neither will the new legislation encourage smaller companies, those with fewer than 50 full-time employees, to offer health insurance, as it merely provides a six-year subsidy for those with fewer than 25 employees, encouraging them to limit their growth to 24 or fewer full-time employees, and it does absolutely nothing for companies with between 25 and 49 full-time equivalent employees.

Code Section 45R – Small Employer Health Insurance Tax Credit

The tax credit is available from 2010 through 2015. For 2010 – 2013 the maximum credit is 35% of qualified premium costs paid by for-profit companies, and 25% for non-profits. The maximum credit is only available to employers with no more than 10 full-time equivalent employees (FTE’s), who are paid average annual wages of $25,000 or less. A reduced credit is available on a phase-out basis for employers with between 10 and 25 FTE’s, who are paid average wages of $25,000 to $50,000. In effect, the credit is reduced by 6.667% for each FTE in excess of 10, and by 4% for each $1,000 in average annual wages paid above $25,000. For example, an employer with 13 full-time equivalent employees who are paid average annual wages of $45,000 will not receive a tax credit. No tax credit is available for employers with 25 or more FTE’s, or who pay average annual wages of $50,000 or more.

From Unaffordable Care Act

In 2014 through 2015, the credit increases to 50% of the amount of qualified premium costs paid by for-profits, and 35% for non-profits, however by then, the employer must participate in a state insurance exchange in order to obtain the credit. [Note: Each state is required to create an insurance exchange by January 1, 2014 which must include an American Health Benefit Exchange, as well as a Small Business Health Options Program (SHOP) Exchange.]

Full-Time Equivalent Employees (FTE’s) – For purposes of the Code Section 45R Credit, the number of FTE’s is determined by dividing the total number of hours worked by each employee (but not more than 2,080 per employee) by 2,080. This is based on a 40 hour work-week for all 52 weeks of a calendar year. The result is rounded down to the nearest whole number. An employer with 25 or more employees may still qualify for the credit if it employs part-time or seasonal workers. Seasonal workers are disregarded in determining the number of FTE’s as long as they work for less than 120 days during the tax year, however the amount of health insurance premiums paid on their behalf is still counted in determining the amount of the Section 45R credit. The number of FTE’s is calculated by totaling all hours worked by each full-time employee, each part-time employee, and each seasonal employee (working more than 120 days) and then dividing the total hours worked by 2,080.

Example: TEA Corporation has 7 employees who worked 2,000 hours each, and 5 who worked 1,500 hours each, during the tax year. The number of FTE’s is calculated by totaling all the hours worked, and dividing the result by 2,080. In this case, TEA Corporation has 10 full-time equivalent employees.

Average Annual Wages – Average annual wages is calculated by dividing the total amount of wages paid for the year by the number of FTE’s. However, certain employees are excluded from both the FTE and average annual wage calculations as follows: sole proprietors, partners in partnerships, greater than 2% owners of S-Corporations, greater than 5% owners of C-Corporations or other entities, and most family members (including children, step-children, siblings, step-siblings, parents, step-parents, nieces or nephews, aunts or uncles, and in-laws).

Example: TEA Corporation paid total annual wages of $250,000, not including the wages paid to its owner. Since TEA Corporation has 10 FTE’s, its average annual wages are $25,000 ($250,000 / 10).

Premiums – Only health insurance premiums paid by the employer under a qualifying arrangement are counted in calculating the Code Section 45R tax credit. For 2010, employers were allowed to count the total amount of premiums paid for the entire year, even though the health reform plan wasn’t passed until March 23, 2010. However, in order to qualify, the employer must pay at least 50% of the total premium costs. Employers are only allowed to count the amount the company pays and not the amounts paid by employees. Health insurance coverage also includes amounts employers pay for dental, vision, long-term care, nursing home care, home health care, community based care or any combination thereof.

The amount of an employer’s premium payments that counts is capped by the amount of average premiums for the small group market in the state (or an area within a state) in which the employer offers coverage. The average premium for the small group market in a state or area is determined by the Department of Health and Human Services (HHS). The IRS released the average premium for the small group market in each state for 2010 in Revenue Rule 2010-13 (table at left-hand). For example, in 2010, the limits in Georgia were $4,612 for self-only coverage, and $10,598 for family coverage.

Carry Back and Carry Forward – The Section 45R credit is not refundable to for-profit companies. Any unused portion may be carried back 1 year and carried forward for 20 years, however a credit earned in 2010 may only be carried forward. Note: Companies with no tax liability will not receive any immediate assistance from the Section 45R credit. So for example, a company taking advantage of the 100% bonus depreciation provision, or other tax benefits, and the Section 45R credit in the same year may not gain any immediate benefit from the health care credit.

Health Insurance Deduction and Tax Credit – Under Internal Revenue Code Section 162, long before health care reform, employers have generally been allowed to deduct the cost of providing health insurance coverage for employees. However, going forward the IRS has interpreted that the amount that may be deducted must now be reduced by the amount of any Code Section 45R credit.

Example: A Georgia Based Small Business

TEA Corporation is a Georgia based company with a single owner and 10 full-time equivalent employees, average annual wages of $25,000 per year, and it provides self-only health insurance coverage. TEA Corporation pays 50% of the total premium for each employee. These figures were chosen specifically; since in order to qualify for the maximum Section 45R credit an employer can have no more than 10 FTE’s, average wages of no more than $25,000, and must pay at least 50% of its employee’s insurance premiums.

Because the total amount of premiums cannot exceed $4,612 for self-only coverage within the State of Georgia, the total amount of premiums paid by TEA Corporation, for purposes of the tax credit, is limited to be $23,060 (2,306 X 10). Assuming the company is in a 34% income tax bracket (i.e. taxable income is between $75,000 and $100,000 per the table below); the Section 162 deduction would normally save the company $7,840 (23,060 X 34%) in taxes.

Now, since the company qualifies for the maximum Section 45R credit of 35%, it will receive a tax credit of $8,071 (23,060 X 35%), however it will only be allowed to deduct health insurance expenses under Section 162 of $14,989 (23,060 – 8,071). So the Section 162 deduction of $14,989 saves the company $5,096 (14,989 X 34%), in addition to the Section 45R credit of $8,071, for total tax savings of $13,167 (5,096 + 8,071). So in effect, the new tax credit benefits the company by an additional $5,327 (13,167 – 7,840), or by $532 per employee, because the company would have already saved $7,840 (23,060 X 34%) prior to Obamacare.

From Unaffordable Care Act

If in the example above, TEA Corporation was not able to afford health insurance prior to Obamacare, then how does the Section 45R credit change things? Won’t the company still have to shell out an additional $23,060 to cover the employer’s share of health insurance costs? Yes. And although it will be eligible for the Section 45R credit, it won’t realize the $13,167 in tax savings until its tax return is filed in the subsequent year. So in effect, the company’s cost per employee will have risen by $2,306. Adding to the dilemma is the fact that the amount each employee must contribute also increases by $2,306. So both the company and its employees will be poorer at the end of the year, although the employer may have a chance to recoup about 57% (13,167 / 23,060) of its costs through subsequent year tax savings, and its employees will receive health insurance.

Problems: (1) In tax years 2010 through 2013, the federal government is going to somehow magically come up with $13,167 to cover 57% of TEA Corporation’s health insurance premiums, and do the same for potentially thousands of other similar small businesses, but who’s going to pay for this? Won’t the tab simply be added to the seemingly unlimited national debt balance? (2) And since employees will have to pay for potentially half of their own health insurance costs, each one who wasn’t previously covered by health insurance, and more specifically those making less than $25,000 per year, will have to figure out how to live off of approximately $2,306 less in disposable income. Does this sound like a good deal for those making under $25,000 per year, or even $50,000?

More Problems: (1) Of course, if any of the 10 employees in this example require family coverage, the costs for both the employer and employee will go up dramatically, as will the government’s cost of the subsidized tax credit. In the example above, the employer and employee obligation rises from $2,306 to $5,299 per year, or half of the average premium for small group family plans of $10,598. (2) Then in 2014 and 2015, as the Section 45R Credit increases to a maximum of 50%, the federal government’s (i.e. taxpayers) share increases by even more. This additional federal spending, though tax expenditures, will only add to the federal government’s current national debt balance of $14.7 trillion and ticking, until the tax credit well runs dry in 2016. (3) If small companies can't afford it now, how will those who employ fewer than 25 workers be able to afford health insurance after 2015?

Exempt Organizations – Meanwhile, tax-exempt organizations will receive a “refundable tax credit” of up to 25% of the amount of health insurance premiums paid between 2010 and 2013, and 35% in 2014 and 2015. This refundable tax credit is limited to the amount of federal tax withheld from employees’ paychecks, the amount of Medicare tax withheld from employees, and the amount of Medicare tax matched by the employer.

Problem: Since exempt organizations don’t pay income taxes, the cost of the refundable Section 45R tax credit will never be recovered. In effect, individual and for-profit business taxpayers are subsidizing the tax credits granted to small non-profit organizations. Non-profit organizations, which are not even subject to the income tax, are being allowed to receive refundable income tax credits based on the amount of payroll taxes paid essentially by their employees. So in this respect, all Obamacare does is to giveaway more tax expenditures to folks who don’t pay any federal income tax. Wasn’t this already a major problem prior to Obamacare?

Large Employers – “Play or Pay”

Although Obamacare doesn’t mandate small employers to offer health insurance coverage to their employees, it does include play or pay rules which apply after 2013. The provision is intended to encourage employers to offer coverage or to pay a shared responsibility penalty. The play or pay rules only apply to large employers, those with 50 or more full-time employees. [Note: Employers who offer free choice vouchers to qualified employees were supposed to have been exempt from the penalty, but this provision was repealed in 2011.]

Problem: Employers who employ 25 or fewer employees are given an incentive to begin or to continue health insurance coverage, but are not required to provide it; while those with 25 to 49 employees are given no incentive, and are not required to provide insurance; and those with 50 or more employees are given no incentive, but face penalties for not offering adequate and affordable coverage by 2014.

Shared Responsibility Penalty The shared responsibility penalty will apply to two groups of employers after 2013: (1) Large employers that do not offer health insurance coverage. (2) Large employers that offer coverage but have one or more employees receiving premium assistance tax credits or cost-sharing because the coverage is deemed unaffordable. If even one employee receives premium assistance tax credits through a state insurance exchange, then the penalty will be $2,000 per full-time employee (not including the first 30 workers). And if the employer offers what is deemed to be unaffordable coverage, then the penalty will be $3,000 for any employee who receives premium assistance tax credits through a state insurance exchange up to a cap of $2,000 for every full-time employee.

[Note: Unaffordable coverage is defined as when the premium required to be paid by the employee is more than 9.5% of the employees’ household income. In such cases the employee is eligible for a premium assistance tax credit and cost-sharing reductions, but only if the employee declines to enroll in the employer’s coverage and purchases coverage through a state insurance exchange.]

Large Employer Problems:

(1) Large employers need to know how much household income each employee has including all working adults within their households.

(2) For purposes of the shared responsibility penalty, a Large Employer is an employer which employed an average of at least 50 full-time employees during the preceding calendar year. In other words, those with an average of 50 or more full-time equivalent employees in 2013 will be subject to the penalty in 2014, even if they have reduced the number of employees by that time.

(3) Full-Time Equivalent Employees for Large Employers - Unlike the definition of full-time equivalent employee for small employers, for purposes of the shared responsibility penalty, a full-time employee is defined as one who works an average of 30 hours per week. Employers who think they won’t be affected by the penalty or the employer mandate need to read the fine print.

Conclusions

  1. By offering incentives to micro-sized businesses, those with 25 or fewer full-time employees with average wages of less than $50,000, and no incentives to larger companies, Obamacare discriminates against job creators.

  2. Since employers with fewer than 25 employees are not required to provide health insurance coverage, and are not penalized for not providing coverage, most employers who qualify for the tax credit are not taking the bait. Let’s face it, health insurance plans drive up business costs even with a generous tax credit. And since the tax credit expires at the end of 2015, what is the catalyst which will make health insurance more affordable in the future? Will businesses and their customers have more money in their pockets as a result of Obamacare?

  3. Employers with more than 25 full-time employees and fewer than 50 fall between the cracks. For them, there is no incentive to provide health insurance coverage and no penalty for failing to provide it. It’s as if they don’t exist, which clearly displays the discriminatory aspect which Obamacare casts upon job creators.

  4. Meanwhile, large employers, those with 50 or more employees working at least 30 hours per week, receive no incentive to provide coverage, yet will be punished for not providing it. In the end, some large employers are encouraged to reduce the number of full-time equivalent employees to below 50 before 2013, to reduce the number of hours worked for some employees to below 30 per week, or to simply pay the shared responsibility penalty of $2,000 on each employee (excluding the first 30), rather than commit to even more costly health insurance contracts.

If TEA Corporation, in the example above, had 100 employees requiring self-only coverage, and paid 50% of the premiums, then its health insurance expense would be roughly $230,600. However, if TEA Corporation simply opted to pay the shared responsibility penalty of $2,000, on the 70 applicable employees, it would have to pay the IRS a penalty of just $140,000, in lieu of the $230,600 cost of insurance. But, if TEA Corporation is not able to afford $230,600, to pay for health insurance on its employees, it is compelled by the rule of law to hand over $140,000, money that it may or may not have, to the federal government under the play or pay rules. Is this fair?

The way things stand today, if by the year 2014 a large employer can’t afford health insurance, in spite of Obamacare - which does nothing to make it more affordable, or if providing health insurance would jeopardize its ability to continue as a going concern - in the Obama economy, then it still must pay the shared responsibility penalty, even if it means laying off workers, shuttering operations, or filing for bankruptcy. In other words, America’s job creators will either play, pay or be destroyed. If this job killing law is not repealed by 12/31/2012, the unemployment rate will continue to soar, because the companies which will be most affected are compelled to take action before then. In fact, in order to ensure that they are not blindsided by the one year look-back rule which begins on 01/01/2013, many companies are already taking action.

In my humble opinion, the Patient Protection and Affordable Care Act cannot be repealed fast enough. Be sure to sign the White House Petition to Repeal Obamacare. You must cast your Vote by 10/22/11.

Related:

Final: Obamacare | The Macro View

Why Congress Shouldn’t Just Pass Obama’s Jobs Bill, Again

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