Small Employer Health Tax Credit: Limited Use Continues Due to Multiple Reasons
Published: 2016-03-22T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Many small employers do not offer health insurance. The Small Employer Health Insurance Tax Credit was established as part of the Patient Protection and Affordable Care Act to help eligible small employers—businesses or tax-exempt entities—provide health insurance for employees. The base of the credit is premiums paid or the average premium for an employer's state if premiums paid were higher. In 2016, for small businesses, the credit is 50 percent of the base unless the business had more than 10 FTE employees or paid average annual wages over $25,900.
This statement summarizes and updates GAO's prior work in May 2012, November 2014, and March 2015 on the extent to which the credit is claimed, any reasons that limit claims, and changes to the credit proposed by Congress and the administration. To conduct the updates, GAO reviewed 2013 and 2014 IRS data on credit claims and academic and government studies, and summarized proposed legislation related to the credit.
section_title: What GAO Found
paragraphs: Claims of the small employer health tax credit have continued to be lower than thought eligible by government agency and small business group estimates, limiting the effect of the credit on expanding health insurance coverage through small employers. In 2014, about 181,000 employers claimed the credit, down somewhat from 2010 (see figure). These numbers are relatively low compared to the number of employers eligible for the credit. In 2012, GAO reported that selected estimates of the number of employers eligible ranged from about 1.4 million to 4 million. In 2010, claims totaled $468 million compared to initial estimates of $2 billion by the Congressional Budget Office and the Joint Committee on Taxation. Actual claims for the credit in 2013 and 2014 increased slightly to about $511 million and $541 million, respectively.
The small employer health tax credit has not been widely claimed for a variety of reasons, as GAO reported in May 2012. The maximum amount of the credit does not appear to be a large enough incentive for employers to offer or maintain insurance. Also, few small employers qualify for the maximum credit amount. For those employers who do claim the credit, the credit amount “phases out” to zero as employers employ up to 25 full time equivalent (FTE) employees at higher wages. The amount of the credit is also limited if premiums paid by an employer are more than the average premiums for the small group market in the employer's state. Furthermore, the credit can only be claimed for two consecutive years after 2013. GAO also found that the cost and complexity involved in claiming the tax credit was significant, deterring small employers from claiming it. Many small businesses have also reported that they were unaware of the credit. Even so, the Internal Revenue Service (IRS) had been taking steps since April 2010 to raise awareness about the credit and reduce the burden on taxpayers by offering tools to help taxpayers determine eligibility for the credit.
Congress and the administration have proposed a number of changes to the credit. These include expanding the size of eligible employers, altering the phase out rules, and allowing the credit to be claimed in more than two consecutive years. Amending the eligibility requirements or increasing the amount of the credit may allow more businesses to claim the credit. However, these changes would increase its cost to the federal government.
section_title: What GAO Recommends
paragraphs: GAO is not making recommendations in this testimony statement.

section_title: Letter
paragraphs: Thank you for the opportunity to discuss our work on small employers’  use of the health tax credit. The Small Employer Health Insurance Tax  Credit was established as part of the Patient Protection and Affordable  Care Act (PPACA) to help eligible small employers—businesses or tax- exempt entities—provide health insurance for employees. This testimony  updates our work that showed seemingly low usage of the credit and  some of the reasons for this low usage.
The Small Employer Health Insurance Tax Credit is generally available to  eligible small employers and tax-exempt employers who have fewer than  25 full-time equivalent (FTE) employees with average annual wages that  fall below a statutorily-specified cap. For tax year 2016, the wage cap is  $51,800. These small employers must cover at least 50 percent of the  cost of each of their employees’ self-only health insurance coverage. The  credit amount is a percentage of the employer’s contributions to  employees’ health insurance premiums. The percentage varies according  to the number of FTEs, average wage paid by the employer, and whether  the employer is a for-profit or tax-exempt employer. The larger the  average annual wage and the greater the number of FTEs, the lower the  credit percentage the small employer can claim, until the credit is entirely  phased out. Beginning in 2014, small employers who qualify for the credit  generally must purchase coverage through a Small Business Health  Options Program (SHOP) exchange. SHOP exchanges, as established  under PPACA, are marketplaces where small employers can shop for and  purchase health coverage for their employees. All health plans available  through SHOP exchanges must meet certain federally required criteria,  such as providing plans that offer minimum essential health benefits. Our  2014 report noted that a primary incentive for small employers to use  SHOPs has been this tax credit.
The vast majority of small employers do not offer health insurance to their  employees. The Medical Expenditures Panel Survey (MEPS) estimates  that 83 percent of employers who may be eligible for the full credit did not  offer health insurance in 2010 and that 67 percent who could be eligible  for a partial credit did not offer insurance. As we discussed in our 2012  report, various factors have explained why small, low-wage employers  historically tend not to offer health insurance. For example:
For very low-wage employees, health insurance drives up total  compensation costs.
Low-wage employees generally prefer wages over insurance benefits.
While employees pay income and employment taxes on wages,  employees do not pay these taxes on premiums that employers pay  for health insurance. However, the income tax exclusion is worth less  to low-wage employees—being in a lower-income tax bracket— compared to those with higher wages.  Insurers of small employers face higher-average fixed costs for billing  and marketing and are less able to pool risk across many employees.
As a result, plans for small employers are likely to have higher  premiums, less coverage, and higher costs than plans for large  employers.
This statement (1) describes the extent to which the credit is being  claimed by smaller employers (2) describes the reasons, if any, limiting  employer claims, and (3) summarizes legislative proposals on the credit.  It is based on reports we issued from May 2012 through March 2015.  Detailed information about the scope and methodology for this prior work  can be found in each of these reports. Much of this statement discusses  findings from our May 2012 report. For that report, we reviewed Internal  Revenue Service (IRS) data on credit claims for tax year 2010. We  interviewed IRS officials and subject-matter specialists from government,  academia, research foundations, and think tanks. We also interviewed  officials of groups representing employers, tax preparers, and insurance  brokers, and worked with them to assemble discussion groups on the  credit. Finally, we reviewed literature about the credit and health  insurance as well as IRS documentation.
We updated selected data in this statement with 2013 and 2014 data from  IRS on claims of the credit by small employers. To assess the reliability of  the data, we reviewed the data and supporting documentation for obvious  errors, reviewed our prior use of the data, and interviewed IRS officials  about the data. We found the data to be sufficiently reliable for our  purposes. We also reviewed academic and government studies about the  tax credit, including reports from the Congressional Research Service and  the Treasury Inspector General for Tax Administration, and a web page  about the credit from the Taxpayer Advocate Service. We also  summarized proposed legislation on the credit.
The work upon which this statement is based was conducted in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
subsections: section_title: Fewer Small Employers Claimed the Credit Than Were Thought to Be Eligible
paragraphs: Claims of the small employer health tax credit have continued to be lower  than thought eligible by government agency and small business group  estimates, limiting the effect of the credit on expanding health insurance  coverage through small employers. In 2014, about 181,000 employers  claimed the credit, down somewhat from 2010 (see figure 1).
These numbers are relatively low compared to the number of employers  thought eligible for the credit. In 2012, we reported that selected  estimates of the number of employers eligible ranged from about 1.4  million to 4 million. The Council of Economic Advisors estimated 4 million  and the Small Business Administration (SBA) estimated 2.6 million.  Estimates made by small business groups included the Small Business  Majority and the National Federation of Independent Businesses. Their  estimates were 4 million and 1.4 million, respectively.
A similar outcome is seen when the dollar value of credits claimed is  compared to initial estimates. In 2010, claims totaled $468 million  compared to initial estimates of $2 billion by the Congressional Budget  Office (CBO) and the Joint Committee on Taxation (JCT). In March 2012,  CBO and JCT estimated that the credit would cost $1 billion in 2012 and  $21 billion from 2012 to 2021, down considerably from the original  estimate of $5 billion and $40 billion, respectively. The revised  estimates appear overstated as well given that actual claims for the credit  in 2013 and 2014 were about $511 million and $541 million,  respectively.
section_title: Small Employers Have Been Unlikely to Claim the Health Tax Credit for Various Reasons Maximum Small Employer Credit Amount is Too Small
paragraphs: Based on our interviews, discussion groups, and literature review  conducted for the 2012 report, we found the small employer health tax  credit has not provided a strong enough incentive for employers to begin  to offer health insurance for various reasons, as discussed below.
The maximum amount of the credit does not appear to be a large enough  incentive to get employers to offer or maintain insurance. For example,  the maximum amount is available to small businesses with 10 or fewer  FTE employees that pay an average of $25,900 or less in wages in tax  year 2016 (adjusted for inflation in future years). Such an employer  could be eligible for a credit worth up to 50 percent of the premiums  paid. These employers did not consider the maximum credit amount to  generally be high enough, and the amount tended to be less than the  maximum, as discussed below.
subsections: section_title: Few Small Employers Qualify for Maximum Small Employer Credit Amount
paragraphs: Most small employer credit claims are likely to be for less than the  maximum credit percentage. To illustrate, our 2012 report analyzed how  many of the approximately 170,300 small employers making claims for  tax year 2010 could claim the full credit. As figure 2 shows, only  28,100—17 percent—could use the full credit percentage. Usually,  employers could not meet the average wage requirement to claim the full  percentage, as 115,500—68 percent—did not qualify based on wages,  but did meet the FTE requirement.
To the extent that a small employer qualifies to claim the credit, the  employer may not be able to fully claim the credit amount for the tax year.  For tax-exempt employers, the credit amount claimed cannot exceed the  total amount of the employer’s payroll taxes for the calendar year. For  other small employers such as small businesses, the credit is not  refundable but is limited to the actual income tax liability. If a small  business had a year in which it ended up paying no taxes (i.e., it had no  taxable income after accounting for all its other deductions and credits),  then the small business tax credit could not be used for that year as there  would be no income tax for the credit to reduce.
section_title: Certain Credit Design Features Reduce the Amount of Credit That Can Be Claimed
subsections: section_title: Credit Amount is “Phased Out”
paragraphs: The credit amount that can be claimed “phases out” to zero as employers  employ up to 25 FTE employees at higher wages—up to an average of  $51,800 for 2016. Table 1 shows the phasing out of the tax credit amount  we calculated for a tax-exempt employer’s contribution to health  insurance in 2016. Table 2 shows the phasing out for other small  employers in 2016.
The amount of the credit is also reduced if premiums paid by an employer  are more than the average premiums for the small group market in the  state in which the employer offers insurance. The credit percentage is  multiplied by the allowable premium to calculate the dollar amount of  credit claimed. For example, if the state average premium is $4,441 for a  single employee, but a small employer in that state paid $5,000 for an  employee’s health premium, the credit would be calculated using the  state average premium of $4,441 rather than the $5,000. According to  IRS data, this cap reduced the credit for around 30 percent of employer  claims as of 2012.
section_title: Credit is Temporary
paragraphs: Regardless of the allowable credit amount, small employers can claim the  credit for just two consecutive years after 2013, which detracts from the  incentive for small employers to begin offering coverage. Employers are  reluctant to provide a benefit to employees that would be at risk of being  taken away later when the credit is no longer available. As of 2014, the  two consecutive tax years for credit claims starts with the first year a  qualified employer obtains coverage through a SHOP exchange. In other  words, if a qualified employer first obtains coverage through a SHOP  exchange in 2016, the credit would only be available to the employer in  2016 and in 2017. From 2010 through 2013, the credit was available to  qualifying employers that purchased coverage in the small group market  outside of SHOP exchanges, which were first established in 2014.  Receipt of the credit for any years between 2010 and 2013 does not  disqualify an employer from receiving the credit in 2014 and in  subsequent years.
section_title: Costs and Complexity Deter Credit Claims
paragraphs: Small employers have not viewed the credit as a sufficient incentive to  begin offering health insurance because the credit amount may not offset  costs enough to justify the cost for health insurance premiums. In  addition, our 2012 report described how small business owners generally  do not want to spend the time or money to gather the necessary  information to calculate the credit, given that the credit will likely be  insubstantial. Tax preparers told us it could take 2 to 8 hours or possibly  longer to gather the necessary information to calculate the credit and that  the tax preparers spent, in general, 3 to 5 hours calculating the credit. To  the extent that preparers did these tasks, small employers would  generally incur additional cost for these services.
For example, a major complaint we heard in discussion groups with  employers, tax preparers, and insurance brokers centered on gathering  information on FTEs and the related health insurance premiums. Eligible  employers reportedly did not have the number of hours worked for each  employee readily available to calculate FTEs and their associated  average annual wages nor did they have the required health insurance  information for each employee readily available.
Our 2012 report also noted that the complexity involved in claiming the  tax credit was significant, deterring small employers from claiming it. The  complexity arises not only from the various data that must be recorded  and collected (as just described), but also from the various eligibility  requirements in the design of the credit and number of worksheets to be  completed.
To determine eligibility requirements, exclusions from the definition of  “employee” and from other rules make the calculations complex. For  calculating the number of FTEs and their wages, workers excluded from  the definition of employee are seasonal workers (an employee who works  no more than 120 days during the year), a self-employed individual, a 2  percent shareholder in an S-corporation, a 5 percent owner of an eligible  small business, or someone who is related to or a dependent of these  people. While seasonal workers are excluded from FTE counts, insurance  premiums paid on their behalf count toward the tax credit. In determining  premiums paid by the employer, the rules exclude employer contributions  to health reimbursement arrangements, health flexible spending  accounts, or health savings accounts. Similarly, an employer’s premium  payments exclude tobacco surcharges if an issuer charges higher  premiums for tobacco users.
As for the complexity of the worksheets and paperwork to be completed  to claim the credit, in 2012, tax preparers told us that they thought that  IRS did the best it could with the Form 8941 given the credit’s  complexity. IRS officials said they did not receive criticism about Form  8941 itself but did hear that the instructions and its seven worksheets  were too long and cumbersome for some claimants and tax preparers. On  its website, as of 2012, IRS tried to reduce the burden on taxpayers by  offering “3 Simple Steps” as a screening tool to help taxpayers determine  whether they might be eligible for the credit. However, to calculate the  actual dollars that can be claimed, we found in 2012 that the three steps  become 15 calculations, 11 of which are based on seven worksheets,  some of which require multiple columns of information.
Given the effort involved to make a claim and the uncertainty about the  credit amounts, our 2012 report discussed the view that having a way to  quickly estimate employers’ eligibility for the credit and the amount they  might receive would help them decide whether the credit would be worth  the effort. However, we also noted in 2012 that this would not reduce the  complication of finding all the documentation needed to file Form 8941.  Further, some employers may believe they are eligible based on a  calculator, but then turn out to be ineligible, or find they are eligible for a  smaller credit amount when they complete Form 8941 with all the  required information.
IRS’s Taxpayer Advocate Service developed a calculator in 2012 to  quickly estimate an employer’s eligibility, but this still requires gathering  information such as wages, FTEs, and insurance plans. Our analysis  showed that use of this tool peaked in March 2014 with 5,383 uses, and  has declined since then, falling to less than 1,000 uses by February  2016. The Centers for Medicare & Medicaid Services officials said they  launched a SHOP Small Business Health Care Tax Credit Estimator on  the federal exchange website in early 2014 to help employers determine if  they qualify for the tax credit as well as the size of the credit they might  receive.
section_title: Lack of Awareness May Contribute to Low Credit Claims, Although IRS Engaged in Significant Outreach
paragraphs: Many small businesses reported that they were unaware of the credit, as  discussed in our 2012 report. The National Federation of Independent  Businesses Research Foundation and the Kaiser Family Foundation both  estimated that about half of small businesses were aware of the credit as  of May 2011. The extent to which the lack of awareness prevented  eligible employers from claiming the credit is unknown, particularly given  other reasons for not claiming the credit. Further, a number of small  business employers would not be eligible for the credit regardless of their  awareness. Even if employers were unaware, their accountants or tax  preparers may have been aware, but did not inform their clients because  they did not believe their clients would qualify or because the credit  amount would be very small.
To raise initial awareness of the credit, IRS conducted significant  outreach, as discussed in our 2012 report. First, IRS developed a  communication and outreach plan, written materials on the credit, a video,  and a website. Second, IRS officials reached out to interest groups about  the credit and developed a list of target audiences and presentation  topics. IRS officials began speaking at events in April 2010 to discuss the  credit and attended more than 1,500 in-person or web-based events from  April 2010 to February 2012. Discussion of the credit at the events varied  from being a portion of a presentation covering many topics to some  events that focused on the credit.
When we issued our 2012 report, IRS did not know whether its outreach  efforts increased awareness of the credit or were otherwise cost effective.  It would be challenging however to estimate the impact of IRS’s outreach  efforts on awareness with a rigorous methodology. As we reported in  2012, based on feedback they received, IRS officials told us they believe  their efforts have been worthwhile and used this feedback to expand its  outreach to include insurance brokers in 2012. IRS also issued a press  release in 2014 to urge small employers to consider claiming the tax  credit.
section_title: Addressing Factors and Expanding Credit Use Could Require Substantive Design Changes
paragraphs: Our 2012 report discussed ways that the design of the credit could be  altered to spur use of the tax credit. Given that most small employers do  not offer insurance and that the credit may be too small an incentive to  convince employers to provide health insurance, we found that it may not  be possible to significantly expand use of the credit without changing its  design.
Amending the eligibility requirements or increasing the amount of the  credit may allow more businesses to claim the credit, but as we noted in  2012, these changes would increase its cost to the federal government.  Options for changing the design of the credit include the following:  increasing the amount of the full credit, the partial credit, or both;  increasing the amount of the credit for some by eliminating state  premium averages; expanding eligibility requirements by increasing the eligible number of  FTEs and wage limit for employers to claim the partial credit, the full  credit, or both; or  simplifying the credit calculation by (1) using the number of  employees and wage information already reported on the employer’s  tax return, which could reduce the amount of data gathering as well as  credit calculations because eligibility would be based on the number  of employees rather than FTEs; and (2) offering a flat credit amount  per FTE (or per employee) rather than a percentage. A tradeoff  inherent in these changes would be to reduce the precision in  targeting the credit.
section_title: Administration and Legislative Proposals to Change the Design and Status of the Credit
paragraphs: The administration has offered proposals to alter the small employer  health tax credit. The most recent proposal as of February 2016, would  (1) expand eligible employers to include those with up to 50 FTEs; (2)  begin the phase out at 20 FTEs; (3) provide for a more gradual phase-out  based on average wage and number of employees; (4) eliminate the  requirement that an employer make a uniform contribution for each  employee (although nondiscrimination laws will still apply); and (5)  eliminate the limit imposed by the area average premium.
Between 2011 and 2015, Congress has considered more than 20 bills on  the small employer health tax credit. Many offered ways to expand usage  of the credit. For example, the bills sought to increase the number of  eligible small employers (e.g., allowing an employer to have 50 FTEs);  changing the phase out formula; allowing the credit to be claimed in more  than two consecutive years; increasing the average annual wage  limitation; eliminating the requirement that employers contribute the same  percentage of cost of each employee’s health insurance; eliminating the  cap limiting the credit amount to average premiums paid to a state health  insurance exchange; and allowing a partial credit for health insurance  purchased outside of SHOP exchanges. Some of these proposed bills  restricted the use of the credit for abortion coverage. At least one would  have eliminated the credit and a few offered alternatives to the credit.
In closing, the Small Employer Health Insurance Tax Credit was intended  to offer an incentive for small, low-wage employers to provide health  insurance. However, utilization of the credit has been lower than  expected, with the available evidence suggesting that the design of the  credit is a large part of the reason why. While the credit could be  redesigned, such changes come with trade-offs. Changing the credit to  expand eligibility or make it more generous would increase the revenue  loss to the federal government.
Chairman Huelskamp, Ranking Member Chu, and members of the  Subcommittee, this concludes my prepared remarks. I look forward to  answering any questions that you may have at this time.
section_title: GAO Contact and Staff Acknowledgments
paragraphs: If you or your staff have any questions about this testimony, please  contact James R. McTigue, Jr., Director, Tax Issues, Strategic Issues,  (202) 512-9110 or mctiguej@gao.gov. Contact points for our Offices of  Congressional Relations and Public Affairs may be found on the last page  of this statement. GAO staff who made key contributions to this  testimony, or previous related work, are Tom Short, Assistant Director;  Anna Bonelli, Amy Bowser, Leia Dickerson, Ed Nannenhorn, Robert  Robinson, Cynthia Saunders, Lindsay Swenson, and Jason Vassilicos.
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