If you own a small business and help pay for your employees' health insurance, or you're thinking about starting, there's a federal tax credit you should know about. The Small Business Health Care Tax Credit was created under the Affordable Care Act to make coverage more affordable for smaller employers with modest payrolls. Many owners never claim it, often because they don't know it exists or assume they're too small to bother.
This guide walks through the eligibility rules in plain English, so you can tell quickly whether it's worth a closer look with your tax preparer.
The four basic requirements
According to the IRS, an employer generally must meet all four of these tests to qualify:
- Fewer than 25 full-time-equivalent (FTE) employees. This is a calculated number, not a headcount. Two half-time employees, for example, generally count as one FTE.
- Average annual wages below a set limit. The IRS adjusts this limit for inflation each year, so check the current figure in the instructions for Form 8941.
- You pay at least 50% of the premium for employee-only coverage, at a uniform percentage for each enrolled employee.
- Coverage is purchased through the SHOP Marketplace (the Small Business Health Options Program), with limited exceptions.
That last point trips people up. A small group plan purchased outside SHOP generally doesn't qualify, even if it's otherwise identical. If you're comparing paths, our guide to group plans vs. SHOP vs. ICHRA explains how each one works.
Who counts as an employee?
The FTE count has some rules that surprise owners. Generally, the following people are not counted as employees for the credit, and premiums you pay for them don't count toward it:
- Sole proprietors, partners, and shareholders who own more than 2% of an S corporation
- Owners of more than 5% of the business
- Certain family members of those owners, including spouses
- Seasonal workers who work 120 days or fewer during the year
To estimate FTEs, the IRS method is roughly this: add up the hours of service for all counted employees (capping each person at 2,080 hours), then divide by 2,080. The result, rounded down, is your FTE count. Wages for the average-wage test follow the same exclusions.
How much is the credit?
For eligible small businesses, the maximum credit is 50% of the premiums the employer pays. For tax-exempt employers, the maximum is 35%. Those maximums are set in the law, but most employers receive less, because the credit phases down on a sliding scale:
- The largest credit goes to employers with 10 or fewer FTEs and average wages well below the limit.
- The credit shrinks as your FTE count rises above 10 and as average wages rise, and it phases out completely at 25 FTEs or at the wage limit.
- The premiums used in the calculation can also be capped at the average premium for the small group market in your state.
Because of the phase-outs, two businesses with the same number of employees can receive very different credits. The only way to know your number is to run your actual payroll figures through the calculation.
The two-year window
The credit can be claimed for two consecutive taxable years, starting with the first year you offer coverage through SHOP and claim it. That means timing matters. If your business is still growing and you expect to qualify for a larger credit next year, it may make sense to talk with your tax preparer about when to start the clock. After the two years end, you can keep the coverage, but the credit stops.
Not sure whether your business qualifies?
We'll review your headcount and contribution plan, quote SHOP options in your area, and coordinate with your accountant on the credit. There's no cost to you.
Check my eligibilityHow to claim it
- Enroll through SHOP. SHOP plans are typically purchased through a registered agent or directly from a participating insurer. Availability varies by state and county.
- Keep records of hours worked, wages paid, and premiums you contributed for each employee during the year.
- Complete IRS Form 8941, Credit for Small Employer Health Insurance Premiums, when you file.
- Report it with your return. Most businesses carry the credit to Form 3800 as part of the general business credit. Tax-exempt employers claim it on Form 990-T, where it may be refundable.
One more detail: you generally can't also deduct the portion of premiums equal to the credit, so your premium deduction is reduced by the credit amount. Your tax preparer will handle that adjustment, but it's worth knowing the credit and the deduction work together.
Is it worth it for your business?
For a very small business with lower average wages, the credit can meaningfully offset the cost of starting coverage. For a business near 25 FTEs or near the wage limit, the credit may be small, and a regular group plan or an ICHRA could offer more flexibility. The credit is one factor to weigh, not the only one. Plan design, employee needs, carrier availability, and your budget all matter too.
As an independent agency, Honorbrook can quote SHOP and group plans across carriers in your area and lay out the options next to each other. See our small business benefits page for dental, vision, and other coverage you can add. For the tax calculation itself, we'll work alongside your CPA.
Availability and rules vary by state
Health plans, premiums, enrollment rules and state programs differ by state and sometimes by county, and a given plan may not be available in every state. Honorbrook is licensed in the 11 states below; what we can offer you depends on what carriers sell where you live. Each state’s insurance regulator can verify an agent’s license and answer consumer questions.
- Virginia: Virginia Bureau of Insurance
- Maryland: Maryland Insurance Administration
- North Carolina: North Carolina Department of Insurance
- South Carolina: South Carolina Department of Insurance
- Georgia: Georgia Office of Insurance and Safety Fire Commissioner
- Alabama: Alabama Department of Insurance
- Louisiana: Louisiana Department of Insurance
- Texas: Texas Department of Insurance
- Michigan: Michigan Department of Insurance and Financial Services
- Indiana: Indiana Department of Insurance
- West Virginia: West Virginia Offices of the Insurance Commissioner