Small Employer Health Tax Credit: Factors Contributing to Low Use and Complexity
Published: 2012-05-14T00:00:00

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 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 2010, for small businesses, the credit was 35 percent of the base unless the business had more than 10 FTE employees or paid average annual wages over $25,000.
GAO was asked to examine (1) the extent to which the credit is claimed and any factors that limit claims, including how they can be addressed; (2) how fully IRS is ensuring that the credit is correctly claimed; and (3) what data are needed to evaluate the effects of the credit.
GAO compared IRS data on credit claims with estimates of eligible employers, interviewed various credit stakeholders and IRS officials as well as academicians on evaluation, compared IRS credit compliance documents with the rules and practices used for prior tax provisions and IRS strategic objectives, and reviewed literature and data.
section_title: What GAO Found
paragraphs: Fewer small employers claimed the Small Employer Health Insurance Tax Credit in tax year 2010 than were estimated to be eligible. While 170,300 small employers claimed it, estimates of the eligible pool by government agencies and small business advocacy groups ranged from 1.4 million to 4 million. The cost of credits claimed was $468 million. Most claims were limited to partial rather than full percentage credits (35 percent for small businesses) because of the average wage or full-time equivalent (FTE) requirements. 28,100 employers claimed the full credit percentage. In addition, 30 percent of claims had the base premium limited by the state premium average.
One factor limiting the credits use is that most very small employers, 83 percent by one estimate, do not offer health insurance. According to employer representatives, tax preparers, and insurance brokers that GAO met with, the credit was not large enough to incentivize employers to begin offering insurance. Complex rules on FTEs and average wages also limited use. In addition, tax preparer groups GAO met with generally said the time needed to calculate the credit deterred claims. Options to address these factors, such as expanded eligibility requirements, have trade-offs, including less precise targeting of employers and higher costs to the Federal government.
The Internal Revenue Service (IRS) incorporated practices used successfully for prior tax provisions and from IRS strategic objectives into its compliance efforts for the credit. However, the instructions provided to its examiners (1) do not address the credits eligibility requirements for employers with non-U.S. addresses and (2) have less detail for reviewing the eligibility of tax-exempt entities health insurance plans compared to those for reviewing small business plans. These omissions may cause examiners to overlook or inconsistently treat possible noncompliance. Further, IRS does not systematically analyze examination results to understand the types of errors and whether examinations are the best way to correct each type. As a result, IRS is less able to ensure that resources target errors with the credit rather than compliant claimants.
Currently available data on health insurance that could be used to evaluate the effects of the credit do not match the credits eligibility requirements, such as information to convert data on number of employees to FTEs. Additional data that would need to be collected depend on the questions policymakers would want answered and the costs of collecting such data.
section_title: What GAO Recommends
paragraphs: GAO recommends that IRS (1) improve instructions to examiners working on cases on the credit and (2) analyze results from examinations of credit claimants and use those results to identify and address any errors through alternative approaches. IRS agreed with GAOs recommendations.

section_title: Letter
paragraphs: Many small employers do not offer health insurance to their employees.  This is particularly true for small employers paying low wages. According  to data from the Medical Expenditure Panel Survey (MEPS) about 17  percent of employers with less than 10 employees who earn low wages  (50 percent or more of their employees earn $11.50 per hour or less)  offered health insurance to their employees in 2010, while about 90  percent of employers with 100 to 999 employees who earn low wages  did.
Pub. L. No. 111-148, §§ 1421, 10105, 124 Stat. 119 (Mar. 23, 2010), (codified at 26  U.S.C. § 45R). cost $2 billion in fiscal year 2010 and $40 billion from fiscal years 2010 to  2019.
You asked us to review the implementation of the credit. Specifically, we  examined  to what extent the credit is being claimed and what factors, if any, limit  employer claims, and how these factors can be addressed; how fully the Internal Revenue Service (IRS) is ensuring that the  credit is correctly claimed by eligible employers; and what data are needed to evaluate the effects of the credit.
To describe the extent to which the credit is being claimed, we reviewed  IRS data on the claims for tax year 2010. To identify any factors that may  limit credit claims and to assess how they could be addressed, we  interviewed IRS officials as well as groups representing employers, tax  preparers, and insurance brokers, and worked with them to assemble  discussion groups on the credit. To assess how these factors could be  addressed, we analyzed our interview results as well as relevant  documents. Where possible, we identified IRS or MEPS data related to  the factors. To assess how IRS is ensuring that the tax credit is correctly  claimed by eligible employers we reviewed its compliance plans for the  credit and compared them to practices used successfully for prior tax  provisionstheir compliance efforts. To assess what data would be needed to  evaluate the effects of the credit, we conducted a literature review and  interviewed interest groups and subject matter specialists from  government, academia, research foundations and think tanks. We found  the data we used to be sufficiently reliable for the purposes of our report.   and IRS strategic objectives. We interviewed IRS officials on  We conducted this performance audit from July 2011 through May 2012  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. (See app. I for our scope and  methodology.)
subsections: section_title: Background
subsections: section_title: Small Employer Health Insurance Market
paragraphs: Small employers with low-wage employees do not commonly offer health  insurance, compared with large employers with low-wage employees, as  shown in figure 1.
A combination of factors explains why small, low-wage employers tend  not to offer health insurance.
For very low-wage employees, such as minimum wage employees, health insurance drives up total compensation costs for employees.
Low-wage employees working for small employers generally prefer to  receive wages over insurance benefits as part of total compensation.  On one hand, while employees pay both income and employment tax  on wages, employees do not have to pay income or employment  taxes on premiums paid by their employers for health insurance.  However, for low-wage employees, the income tax exclusion is worth  less relative to cash wages than for higher-income employees  because low-wage employees may be in a lower income tax bracket.
In general, the federal minimum wage is $7.25 per hour. Many states also have minimum  wage laws and minimum wages vary from state to state. are likely to have higher premiums or have less coverage and higher  out-of-pocket costs than plans offered to large employers.
section_title: IRS Implementation and Requirements for Calculating and Claiming the Credit
paragraphs: IRS’s Small Business and Self-Employed Division (SB/SE) and Tax  Exempt and Government Entities Division (TEGE) are primarily  responsible for implementing the credit. IRS works with the Department of  Health and Human Services (HHS) and the Small Business  Administration (SBA) on implementation tasks, such as outreach and  communication.
To be eligible, an employer must:
Be a small business or tax-exempt employer located in or having  trade or business income in the United States and pay premiums for  employee health insurance coverage issued in the United States.
Employ fewer than 25 full-time-equivalent (FTE) employees in the  tax year (excluding certain employees, such as business owners and  their family members).
Pay average annual wages of less than $50,000 per FTE in the tax  year.
Offer health insurance and pay at least 50 percent of the health  insurance premium under a “qualifying arrangement.” This means that  the employer uniformly pays at least 50 percent of the cost of  premiums for enrolled employees, although IRS did develop relaxed  criteria for meeting this requirement for tax year 2010.
The President’s fiscal year 2013 budget request contains a proposal for  expanding the credit’s eligibility criteria to include employers with 50 or  fewer FTEs and removing the uniform contribution requirement.
The amount of the credit that employers can claim depends on several  factors. Through 2013, small businesses can receive up to 35 percent  and tax-exempt entities can receive up to 25 percent of their base  payments for employee health insurance premiums; these portions rise to  50 percent and 35 percent, respectively, starting in 2014. Employers can  receive the full credit percentage if they have 10 or fewer FTEs and pay  an average of $25,000 or less in annual wages; employers with 11 to 25  FTEs and average wages exceeding $25,000 up to $50,000 are eligible  for a partial credit that “phases” out to zero percent of premium payments  as the FTE and wage amounts rise. Figure 2 shows the phaseout of the  credit for small businesses; the phaseout for tax-exempt entities follows a  similar pattern, up to 25 percent of health insurance premiums.
Further, the amount of the credit is limited if the premiums paid by an  employer are more than the average premiums determined by HHS 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, in Alabama,  the state average premium was $4,441 for a single employee in 2010. If  an employer claiming the credit in Alabama paid $5,000 for a single  employee’s health premium, the credit would be calculated using the  state average premium of $4,441 rather than the actual premium paid.  Appendix II shows the average premiums by state.
The proposal in the President’s Budget suggests beginning the phaseout  at 21 FTEs, rather than 11, as well as providing for a more gradual  combined phaseout for the credit percentages and removing the state  market limits.
Employers are to calculate the credit amount on IRS Form 8941, “Credit  for Small Employer Health Insurance Premiums.” Small businesses are to  claim the credit as part of the general business tax credit (on Form 3800),  and use it to offset actual tax liability. If they do not have a federal tax  liability, they cannot receive the credit as a refund but may carry the credit  forward or back to offset tax liabilities for other years. Credit amounts  claimed by partnerships and S corporations are to be passed through to  their partners and shareholders, respectively, who may claim their  portions of the credit on their individual income tax returns. Tax-exempt  entities are to claim the credit on Form 990-T, “Exempt Organization  Business Income Tax Return,” and receive the credit as a refund even  though the employer has no taxable income.
Employers that claim the credit can also deduct health insurance  expenses on their tax returns but must subtract the amount of the credit  from the deduction. Employers can claim the credit for up to 6 years—the  initial 4 years from 2010 through 2013 and any 2 consecutive years after  2013 if they buy insurance through the Small Business Health Option  Programs, which are part of the insurance exchanges to be established  under PPACA.
section_title: Fewer Small Employers Claimed the Credit Than Were Thought to Be Eligible Because of Factors Such as Credit Size and Complexity
subsections: section_title: Actual Credit Claims Were Much Lower Than Initial Rough Eligibility Estimates
paragraphs: Fewer small employers claimed the credit for tax year 2010 than were  thought to be eligible based on rough estimates of eligible employers  made by government agencies and small business groups. IRS data on  total claimants, adjusted to account for claims by partners and  shareholders, show that about 170,300 small employers made claims for  the credit in 2010. (See app. III for adjustments to determine claims filed  by employers.) The average credit amount claimed was about $2,700.  Limited information is available on the distribution of claim amounts for  business entities because IRS focuses its data collection on the  taxpayers filing credit claims, who may be partners or shareholders  claiming their portions of a business entity’s credit. Appendix III provides  additional detail.
Selected estimates, made by government agencies and small business  groups, of employers eligible for the credit range from around 1.4 million  to 4 million. However, data limitations mean that these estimates are  necessarily rough. Based on our review of available data sources on the  three basic eligibility rules for the credit—involving wages, FTEs, and  health insurance—it is not possible to combine data from various sources  to closely match these rules. (See app. VI for details.) Though statistical  modeling corrects for imperfect data to match these rules, models are not  precise. While acknowledging the data limitations, several entities  produced estimates of the number of employers potentially eligible for the  credit. The Council of Economic Advisors estimated 4 million and SBA  estimated 2.6 million. Other groups making estimates included small  business groups such as the Small Business Majority (SBM) and the  National Federation of Independent Businesses (NFIB). Their estimates  were 4 million and 1.4 million, respectively.
A similar pattern is seen when the dollar value of credits actually claimed  is compared to initial estimates. The dollar value of claims made in 2010  was $468 million compared to initial cost estimates of $2 billion for 2010  (a CBO and JCT joint estimate).
section_title: Most Small Employer Claims Were Reduced Because of the Phaseout Rules and Some Were Reduced by the State Average Premiums
paragraphs: Most of the claims were for less than the full credit percentage. Of the  approximately 170,300 small employers making claims for tax year 2010,  142,200—83 percent—could not use the full credit percentage. Usually  employers could not meet the average wage requirement to claim the full  percentage, as about 68 percent did not qualify based on wages but did  meet the FTE requirement. (See fig. 3.)
State average premiums also reduced some credit amounts by reducing  the amount of the premium base against which the credit percentage is  applied. This premium base may be reduced when it exceeds the state  average premiums for small group plans, as determined by HHS. If so,  small employers are to use the state average amount, which in essence  caps the premium amount used to calculate their credit. According to IRS  data, this cap reduced the credit for around 30 percent of employer  claims. For example, a nonprofit representative told us that her credit  dropped from $7,900 to $3,070 because of the cap in her state. (See app.  II for small group average premiums in all states.)
section_title: Most Small Employers Could Not Meet the Health Insurance Requirement for the Credit and the Credit Was Not Seen as an Incentive to Start Offering Insurance
paragraphs: As already discussed, small employers do not commonly offer health  insurance. MEPS estimates that 83 percent of employers who may  otherwise be eligible for the full credit did not offer health insurance in  2010 and that 67 percent of employers who could be eligible for the  partial credit did not offer insurance. Our discussion groups and other  interviewees confirmed this, with comments and examples of small, low- wage employers not offering health insurance to employees.
Furthermore, the small employers do not likely view the credit as a big  enough incentive to begin offering health insurance and to make a credit  claim, according to employer representatives, tax preparers, and  insurance brokers we met with. While some small employers could be  eligible for the credit if they began to offer health insurance, small  business group representatives and discussion group participants told us  that the credit may not offset costs enough to justify a new outlay for  health insurance premiums. Related to this concern, the credit being  available for 6 years overall and just 2 consecutive years after 2014  further detracts from any potential incentive to small employers to start  offering health insurance in order to claim the credit.
section_title: Complexity Deterred Small Employer Claims, According to Discussion Groups
paragraphs: Most discussion group participants and groups we interviewed found the  tax credit to be complicated, deterring small employers from claiming it.  The complexity arises from the various eligibility requirements, the  various data that must be recorded and collected, and number of  worksheets to be completed.
A major complaint we heard centered on gathering information for and  calculating FTEs and the health insurance premiums associated with  those FTEs. 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.
Exclusions from the definition of “employee” and other rules make the  calculations complex. For example, seasonal employees are excluded  from FTE counts but insurance premiums paid on their behalf count  toward the employer’s credit. Incorporating the phaseout also complicates  the credit calculation.
In our discussion groups with tax preparers, we heard that 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 their clients from  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. We did hear from a couple of participants— a small business owner and a nonprofit representative—that they did not  find the credit overly burdensome.
Tax preparers we interviewed said 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, 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, the three  steps become 15 calculations, 11 of which are based on seven  worksheets, some of which request multiple columns of information.  Figure 4 aligns IRS’s “3 Simple Steps,” with the seven worksheets in the  instructions for Form 8941 and the lines on Form 8941. (See app. V for  full text for this figure.)
Given the effort involved to make a claim and the uncertainty about the  credit amounts, a few discussion group participants said it would be  helpful to be able to quickly estimate employers’ eligibility for the credit  and the amount they might receive; this would help them to decide  whether the credit would be worth the effort, although this would not  reduce the complication of filing out Form 8941 because, to fill out the  form, full documentation would need to be reviewed. IRS’s Taxpayer  Advocate Service is developing a calculator for IRS’s website to quickly  estimate an employer’s eligibility, but this will still require gathering  information such as wages, FTEs, and insurance plans. We also heard  concerns that a calculator could cause confusion for clients who find they  are eligible when quickly estimating the credit but then turn out to be  ineligible or find they are eligible for a smaller credit when their  accountant fills out Form 8941.
section_title: The Extent to Which Lack of Awareness Is a Factor Limiting More Claims Is Unknown, Although IRS Did Significant Outreach
paragraphs: Many small businesses reported that they were unaware of the credit.  The NFIB Research Foundation and the Kaiser Family Foundation both  estimated that approximately 50 percent of small businesses were aware  of the credit, as of May 2011, or more than 1 year after Congress  authorized this credit.
The extent to which being unaware prevented eligible employers from  claiming the credit for tax year 2010 is not known. Some discussion group  participants raised concerns about unawareness, but they also cited other  factors limiting credit claims for tax year 2010. If 50 percent of small  businesses knew about the credit, then the approximately 170,300 claims  is a relatively small proportion of those that were knowledgeable. This  indicates that other factors contributed to employers not claiming the  credit. Further, it is hard to interpret the impact of awareness on claims  because these surveys included an unknown number of small business  employers that would not be eligible for the credit regardless of their  awareness. For those employers that were unaware, the surveys did not  account for their accountants or tax preparers that may have known about  the credit but did not tell their clients about it because they did not believe  their clients would qualify or because the credit amount would be very  small. In addition, the surveys did not cover tax-exempt entities.
To raise awareness of the credit, IRS did significant outreach. IRS  developed a communication and outreach plan, written materials on the  credit, a video, and a website. IRS officials also 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 over 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 with a dedicated discussion  period.
IRS does not know whether its outreach efforts actually increased  awareness of the credit or were otherwise cost-effective. It would be  challenging to estimate the impact of IRS’s outreach efforts on awareness  with a rigorous methodology; however, based on ongoing feedback they  received from interest groups, IRS officials told us they believe their  efforts have been worthwhile. IRS used some feedback from focus  groups of tax preparers and from other sources to revise its outreach  efforts. For example, IRS modified its outreach from initially focusing on  tax preparers and small employers to including insurance brokers in  2012.
section_title: Addressing Factors and Expanding Credit Use May Require Substantive Design Changes
paragraphs: Given that most small employers do not offer insurance and what we  heard about the size of the credit not being big enough to incentivize  offering health insurance,credit use without changing the credit’s eligibility. Most claims were for  partial credits and many people we spoke with view the credit amount as   it may not be possible to significantly expand  too small and temporary to justify providing health insurance when none  is provided now. In addition, given that IRS has conducted extensive  outreach about the credit, it is not likely that more outreach would  significantly increase the number of businesses claiming the credit.  Amending the eligibility requirements or increasing the amount of the  credit may allow more businesses to take advantage of the credit, but  these changes would increase its cost to the Federal government.  Options 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 number of FTEs  and wage limit allowable for employers to claim the partial credit, the  full credit, or both. This expansion would not, however, likely affect the  smallest employers which do not offer health insurance.
Simplifying the calculation of the credit in the following ways:
Using the number of employees and wage information already  reported on the employer’s tax return. This could reduce the  amount of data gathering as well as credit calculations because  eligibility would be based on the number of employees and not  FTEs. A trade-off with this option would be less precision in  targeting the full and partial credit amount to specific small  employer subgroups.
Offering a flat credit amount per FTE (or number of employees)  rather than a percentage, which would reduce the precision in  targeting the credit.
The data limitations that made it difficult to estimate the number of  businesses eligible for the current credit also make it difficult to estimate  the impact of any design changes.
section_title: IRS Is Implementing Several Practices from Prior Compliance Efforts, but Additional Steps Could Be Taken
subsections: section_title: IRS Incorporated Practices from Strategic Objectives and Prior Compliance Efforts
paragraphs: IRS’s compliance efforts for the credit incorporate practices that have  been shown effective in helping to ensure compliance with other tax  provisions or are consistent with IRS strategic objectives. Some of those  practices were used for the Telephone Excise Tax Refund (TETR) and  Consolidated Omnibus Budget Reconciliation Act (COBRA) subsidies for  health insurance for the unemployed, according to IRS officials.Specifically, IRS is doing the following:
Using computerized filters to review credit claims on Forms 8941 for  certain errors or potential problems that may trigger an examination of  the claim.
Transcribing more lines of data from Form 8941 into IRS computer  systems which should make the filters more effective. Although  transcribing more lines increases processing and data storage costs,  IRS plans to transcribe more lines for tax years 2011 and 2012 claims  to ensure better verification of eligibility.
Freezing refunds of tax-exempt entities whose returns have been  selected for examination, which avoids the costs of trying to recover  funds.
Considering the documentation burden on claimants. IRS did not  require claimants to submit documentation on health insurance  premiums with their Form 8941 because IRS officials said they will  review examination results and may revisit the decision not to require  documentation if results suggest that such documentation would  improve compliance checks.
Modifying filters, as needed, in response to observed trends. For  example, a filter that applies to tax-exempt organization claims was  tripped by about a quarter of claimant organizations, as of   December 31, 2011. IRS officials said some eligible tax-exempt  entities tripped the filter because it was too broad. To address this,  IRS modified the filter to more clearly identify qualifying tax-exempt  organizations.
Completing a risk assessment on compliance issues related to the  credit. The assessment identified risks involving refunds for tax- exempt entities, difficulties verifying employment tax return  information for certain employers, and not using existing Math Error  Authority (MEA).
Considering the costs and benefits of MEA for the credit. IRS  officials identified three filters whose type of errors could be  addressed with MEA. They noted that less than 1 percent of Forms  8941 tripped one or more of those filters, which IRS officials said  does not justify the costs to develop procedures to use MEA, if it were  granted.
section_title: Filters Check Some Eligibility Criteria, but Are Limited by Available Data
paragraphs: IRS developed 21 filters for Form 8941, some of which apply differently to  SB/SE and TEGE taxpayers. The filters cover some of the eligibility  requirements for the credit. Errors on about 3.5 percent (11,763) of Forms  8941 for tax year 2010 tripped 1 or more filters; almost half of those forms  were from tax-exempt entities. According to IRS officials, the filter failure  rate is consistent with other recent tax credits.
The filters do not cover all of the credit’s requirements for several data- related reasons. In one case, data are not included on Form 8941 but  may be included on worksheets required to be retained by claimants  (e.g., information on business owner family members or seasonal  employees included in credit calculations); in another case, certain data  are not transcribed (e.g., the credit amount for certain claimants). For  other requirements, IRS officials stated that reasonable filters cannot  easily be developed because of challenges with matching data.
Some Form 8941 filters also face limitations mainly because of problems  with data or IRS’s systems.
Filters are mutually exclusive, meaning that filters on related  requirements are viewed in isolation. However, according to IRS  officials, IRS has ways to identify whether a form failed more than one  filter, which IRS considers when identifying returns for potential  examination.
Some filters may mistakenly target eligible claimants because the  filters rely on general thresholds in Form 8941 data or, in some cases,  other IRS data (such as employee-level data) that are not exact  matches to data on the Form 8941.
Data on Forms W-2 (employees’ annual Wage and Tax Statement) could  provide additional data for filters once the provision in PPACA is  implemented that requires employers to report the cost—including both  employer and employee contributions—of certain types of health  insurance provided to an employee. IRS officials said the data have  limited use because, among other things, they would not provide details  for determining whether an employer met the credit’s requirements for  health insurance; therefore, IRS officials will not pursue using the data at  this time. Nevertheless, the data could be used in a filter to identify  claimants who reported no health insurance contributions on Form W-2  and therefore may not be offering health insurance. In the absence of  other documentation or third-party reporting on health insurance, using  Form W-2 data in a filter could be a cost-effective, rough indicator of  whether a claimant is paying employee health insurance premiums,  without increasing taxpayer burden. However, IRS provided transition  relief to employers that file fewer than 250 Forms W-2 per year, and  issued guidance stating that these employers will not be required to report  the data until further guidance is issued. As a result, it is unlikely that the  data could be useful before 2014, the year when the credit will only be  available to employers for any 2 consecutive years.
section_title: Examination Instructions Cover Most Eligibility Requirements, but Gaps Exist
paragraphs: After the filters are run, IRS creates lists of claims to consider for further  examination. SB/SE wanted enough examination cases to spot check  different filters and claims from different regions, to enable them to  establish a field presence and to learn about compliance risks with the  credit, according to an SB/SE official. Examination staff in SB/SE and  TEGE are to follow a set of instructions when doing examinations.
SB/SE’s examination instructions address all of the credit’s requirements  for small businesses to claim the credit except that they do not include  specific instructions for examiners on determining eligibility of claimants  with non-U.S. addresses. An employer located outside of the United  States with a business or trade interest in the United States may claim the  credit only if the employer pays premiums for coverage issued in and  regulated by one of the states or the District of Columbia. Without a  prompt in examination instructions, IRS examiners may overlook  claimants that do not comply with the address requirements. An SB/SE  official said IRS has no instructions for examiners to review claimants with  non-U.S. addresses during an examination on the credit because  potential compliance problems with businesses with non-U.S. addresses  exist for other tax credits. This, however, was not IRS’s approach for  another general business tax issue relevant to the credit—whether  claimants that carry back the credit to offset tax liabilities in previous  years did so properly. Near the end of our work, SB/SE added guidance  to one of its examination instruction documents to cover the carry back  issue.
Instructions for TEGE examiners also address most of the eligibility  requirements to claim the credits, but, like SB/SE’s, TEGE examination  instructions do not address how to review claimants with non-U.S.  addresses. Further, TEGE instructions for some of the credit’s  requirements have less detail compared to SB/SE’s instructions. TEGE’s  instructions provide steps on how to determine if an employer’s insurance  premiums paid met “qualifying arrangement” and other criteria, but they  provide less detail than SB/SE instructions. For example, SB/SE  guidance instructs examiners to review health insurance policies and  invoices to confirm premium payments, and to review other  documentation to check whether the employer offers health benefits that  are not eligible for the credit. TEGE instructions do not suggest these  steps and also do not provide a prompt for examiners to ensure that  insurance premiums paid on behalf of seasonal employees are included  in calculations.
According to IRS officials, the TEGE examiners are trained specifically for  doing examinations on the credit and therefore need less guidance than  SB/SE examiners, who work on multiple issues simultaneously. However,  TEGE examination documents contain detailed guidance in a workbook  format for these trained examiners on other credit requirements. Without  detailed guidance for TEGE examiners that instructs them on how to  examine health insurance documents, examiners may not consistently  identify noncompliance, which could lead to erroneous credit refunds.  This could particularly be the case as examining health insurance  documents to check eligibility for this new credit has not been typical work  for these examiners.
section_title: Examinations Under Way, but IRS Needs to Develop a Plan for Efficiently Analyzing Results on Credit Compliance
paragraphs: For tax year 2010, SB/SE plans to conduct over 1,500 examinations  related to the credit, and TEGE anticipates about 1,000 examinations. An  SB/SE official said the number of examinations is expected to provide  initial compliance information and allow IRS to establish a compliance  presence without committing too many resources initially. TEGE selected  its number of examinations based on resource decisions, before tax year  2010 claims began. Neither SB/SE nor TEGE adjusted the number of  examinations once actual claim numbers were known. As a result, the  percentage of TEGE claims being examined is high, according to a TEGE  official. Table 1 summarizes the status of IRS’s examinations on the  credit.
IRS’s database on examination results tracks the aggregate dollar  amount of tax changes as a result of the examination but does not  contain the reason a change is made. Consequently, IRS is not able to  isolate and analyze examination results related to the credit versus other  tax issues. This is particularly a problem for SB/SE examinations, which   Instead, as initial examinations  may cover issues other than the credit.have closed, IRS officials said that management has spoken with  examiners about findings related to the credit. This has been possible  because of the relatively low initial volume of cases, but this approach  may not be feasible as results accumulate. Therefore, it is not clear how  IRS can efficiently analyze results to decide whether changes are  necessary in how it examines the credit or how it educates small  employers about how to comply with the credit’s rules, and whether it  committed too many or too few resources to examinations of the credit.
Furthermore, IRS does not have criteria for deciding whether the  resources spent on examinations of the credit are appropriate, given the  amount of errors found. IRS officials said that for future years they plan to  select the number of credit examinations based on past results, identified  compliance risks, and available resources. However, without criteria to  assess the results in concert with these risks and resources, IRS is less  able to ensure that examination resources target errors with the credit,  rather than examining compliant claimants.
For example, early examination results (as of February 2012) show that  67 percent of the examinations completed were closed without changing  the credit amount. Examinations without a change burden taxpayers and  use IRS resources. We recognize that few of the planned examinations  have been completed and the “no change” percentage could change.  According to IRS officials, cases resulting in “no change” tend to be the  first cases closed because they close more quickly than cases requiring a  change. However, IRS is not using change rate information from prior tax  credits to determine if examinations for the credit have a “high” no-change  rate, which could be one indicator to help decide how many examination  resources to apply to the credit. IRS officials said they do not plan to use  data from examinations of other tax provisions to benchmark measures— such as the no-change rate or length of time an examination is open— because results would not be comparable.
A summary of examination results specific to the credit could also inform  decisions about using additional compliance tools such as soft notices.In the past, IRS has used soft notices to correct errors and collect funds  without initiating an examination.implementing the credit said IRS has not ruled out using soft notices, but  examination results would need to identify an issue that would justify their  use. He said soft notices are not effective for all taxpayers or situations.  He said IRS would consider using soft notices if officials found a series of  returns with mistakes from the same tax preparer or promoter of tax  schemes. Furthermore, soft notices may necessitate follow-up, which  would negate some of the advantages of the notices. If IRS analysis  showed that examinations were not a cost-effective way to pursue certain  errors made in claiming a credit, a soft notice may offer another approach  to improving compliance with lower costs to IRS and less burden on  claimants.
section_title: Data to Evaluate Many Questions about the Effects of the Credit Are Not Available
paragraphs: There are a variety of research questions that could be of interest to  policymakers about the effects of the credit that cannot be evaluated with  data currently available. Figure 5 shows how the credit may influence  employer behavior and, ultimately, employees.
To answer research questions about the credits potential outcomes  shown in figure 5, the following are examples of data that might be  needed: number of small, low-wage employers offering health insurance,  before and after the credit was available; number of employees at small, low-wage employers, who have or  could obtain health insurance through their employers; and amount of annual health insurance premium costs for small, low-wage  employers before and after the credit.
None of these data are readily available or free of limitations, which  complicates an evaluation. For example, the available data on employer- sponsored health insurance do not align with the credit’s eligibility criteria,  according to our interviews with subject matter specialists and our review  of the data (see app. VI for a summary of the data sources), nor could we  identify a data source that tracks when, and why, employers begin  offering insurance. As a result of the limitations with all three types of  data, it would be difficult to precisely measure changes in health  insurance availability, offering, and costs because of the credit, without  collecting additional data. Isolating influential factors—such as those  shown in figure 5—that may contribute to the effects of the credit would  also be a challenge in an evaluation.
IRS officials said they will not collect data on credit claimants, outside of  those collected on Form 8941. IRS’s position on data collection for all  provisions of the tax code is that it only collects data it needs to ensure  compliance with the tax laws.
Collecting additional data needed for policy evaluation would have costs,  and the magnitude of those costs would depend on the type and amount  of data needed, which depends on the research questions being asked.  An additional consideration in thinking about the benefits and costs of  additional data collection for policy evaluation purposes is the time limits  on claiming the credit. The current version of the credit runs through the  end of 2014. Policymakers’ conclusions about the questions to be answered by any evaluations of the credit’s effects would determine the  type of data that would need to be collected.
section_title: Conclusions
paragraphs: 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.
In administering the credit to ensure compliance, IRS employed a number  of practices that were shown effective for other tax provisions or are  consistent with IRS strategic objectives. Nevertheless, we identified  several opportunities for IRS to either improve compliance or perhaps  reduce the resources it is devoting to ensuring compliance. Without  additional guidance for examiners on employers with non-U.S. addresses,  there is a risk of improper credit claims being allowed. Without more  systematic attention to early examination results, IRS could lock itself into  devoting more scarce resources than needed to examinations.
section_title: Recommendations for Executive Action
paragraphs: To help ensure thoroughness and consistency of examinations on the  credit, we recommend that the Commissioner of Internal Revenue take  the following two actions:  1.  Revise the SB/SE and TEGE examination instructions to include  instructions for examiners on how to confirm eligibility for the credit for  small employers with non-U.S. addresses. 2.  Revise the TEGE examination guidance to include more detailed  instructions for examiners on how to confirm that claimants properly  calculated eligible health insurance premiums paid for purposes of the  credit. The SB/SE examination instructions could serve as a model.
To help ensure that IRS uses its examination resources efficiently, we  recommend that the Commissioner of Internal Revenue take the following  two actions:  3.  Document and analyze the results of examinations involving the credit  to identify how much of those results are related to the credit versus  other tax issues being examined, what errors are being made in  claiming the credit, and when the examinations of the credit are worth  the resource investment.  4.  Related to the above analysis of examination results on the credit,  identify the types of errors with the credit that could be addressed with  alternative approaches, such as soft notices.
section_title: Agency Comments and Our Evaluation
paragraphs: In an April 30, 2012, letter responding to a draft of this report (which is  reprinted in app. VII), the IRS Deputy Commissioner for Services and  Enforcement provided comments on our findings and recommendations  as well as information on additional agency efforts related to  implementing the Small Employer Health Insurance Tax Credit in PPACA.  IRS generally agreed with all four of our recommendations. Regarding our  recommendation on examination instructions related to small employers  with non-U.S. addresses, IRS stated that SB/SE will provide additional  guidance in its instructions and that TEGE has added guidance to its  instructions. On May 1, 2012, IRS provided a copy of the TEGE  instructions, which we are reviewing. On our recommendation on revising  TEGE’s examination guidance, IRS’s letter said that on April 13, 2012,  TEGE implemented more detailed instructions in its examination  guidance related to confirming proper calculations of eligible health  insurance premiums paid for purposes of the credit. These instructions  were also included in the TEGE document provided on May 1, 2012.
With regard to analyzing credit examination results to identify compliance  issues specific to the credit, IRS said it regularly analyzes audit results to  determine whether resources are expended efficiently, though its  information systems do not currently capture adjustments by issue, such  as this tax credit. IRS agreed to leverage existing information systems  and, as appropriate, to allocate resources to manually analyze  examination results. IRS said this will include, as feasible, identifying the  types and amounts of errors related to the credit. We reiterate the benefit  of documenting and analyzing the results of examinations involving the  credit. If it does not do so, IRS will not have information for determining  whether examinations of the credit are worth the resource investment.
Regarding our fourth recommendation on using examination results to  determine whether alternative compliance approaches, such as soft  notices, could help address errors with the credit, IRS agreed to continue  to review its compliance efforts to determine whether soft notices would  be appropriate.
As agreed with your offices, unless you publicly announce the contents of  this report earlier, we plan no further distribution until 30 days from the  report date. At that time, we will send copies to the Chairmen and  Ranking Members of other Senate and House committees and  subcommittees that have appropriation, authorization, and oversight  responsibilities for IRS. We will also send copies to the Commissioner of  Internal Revenue, the Secretary of the Treasury, the Chairman of the IRS  Oversight Board, and the Director of the Office of Management and  Budget. In addition, the report will be available at no charge on the GAO  website at http://www.gao.gov.
If you or your staff have any questions or about this report, please contact  me at (202) 512-9110 or at whitej@gao.gov. Contact points for our  Offices of Congressional Relations and Public Affairs may be found on  the last page of this report. GAO staff who made key contributions to this  report are listed in appendix VIII.
section_title: Appendix I: Scope and Methodology
paragraphs: To assess the extent to which the Small Employer Health Insurance Tax  Credit (referred to in this report as the credit) is being claimed, we  obtained and analyzed Internal Revenue Service (IRS) data on the claims  on Form 8941 for tax year 2010. We interviewed responsible IRS staff  and examined background materials. IRS provided a report from the  Form 8941 data and we reviewed the programming code that created that  report. We corroborated the results of this IRS report with a Treasury  Inspector General for Tax Administration (TIGTA) report published in  November and found similarities. The data were found to be sufficiently  reliable for our purposes. We identified estimates of employers that were  potentially eligible to claim the credit by reviewing reports and websites of  government agencies, think tanks, and interest groups. When possible,  we interviewed officials from the government agencies and business  groups that developed estimates.
To identify any factors limiting credit claims, we interviewed groups  representing employers, tax preparers and insurance brokers and to  assess how these factors could be addressed, we analyzed our interview  results as well as relevant documents. Specifically, we spoke with  representatives of the National Federation of Independent Businesses,  the National Council of Nonprofits, the Small Business Majority, the U.S.  Chamber of Commerce, the American Institute of Certified Public  Accountants, America’s Health Insurance Plans, the National Society of  Accountants, the National Association of Enrolled Agents, and the  National Association of Health Underwriters. We worked with some of  these groups to assemble discussion groups with tax preparers, health  insurance brokers, and employers to discuss potential factors and ways  to address them. Discussion groups were, for the most part, telephone  conferences. We also spoke with insurance and tax preparation  companies, specifically, BlueCross Blue Shield of Kansas City,  Independent Health of New York, H&R Block’s Tax Institute, and Jackson  Hewitt Tax Service. We used qualitative analysis software to do a content  analysis of the interviews and discussion group comments.
To provide additional support for discussion group and interview findings  we reviewed documents and, where possible, we identified data from  IRS, the 2010 Medical Expenditure Panel Survey, or the 2011 Kaiser  Family Foundation Health Benefits Survey. At IRS, we interviewed  officials from the Small Business/Self-Employed Division (SB/SE),  including officials in the Communications and Liaison Office; the Tax  Exempt and Government Entities Division (TEGE); the Research and  Analysis for Tax Administration division, and the Taxpayer Advocacy  Service.
To assess how fully IRS is ensuring that the tax credit is correctly claimed  by eligible employers, we reviewed IRS’s compliance plan and filters and  instructions for IRS staff conducting examinations, and compared these  documents with compliance practices used for prior tax provisions and  found in IRS strategic objectives. We also highlighted any gaps between  filters and examination instructions and the credit’s eligibility rules. We  reviewed the filter results for tax year 2010 claims and interviewed SB/SE  and TEGE officials about compliance efforts.
To assess what would be needed to evaluate the effects of credit, we  conducted a literature review and interviewed representatives of the  forenamed groups and subject matter specialists from government,  academia, research foundations and think tanks. We selected the  specialists based primarily on our literature review and spoke with  individuals at the University of Massachusetts, Boston; Massachusetts  Institute of Technology; the Commonwealth Fund; the Urban Institute; the  Kaiser Family Foundation; the American Enterprise Institute; the  Employee Benefit Research Institute; the RAND Corporation; the Small  Business Administration Office of Advocacy; and the Office of Tax Policy  at the Department of the Treasury. We reviewed available data in  commonly cited surveys with questions on employer health insurance,  and identified how the questions and variables match to the eligibility  criteria for the credit.
We conducted this performance audit from July 2011 through May 2012  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.
section_title: Appendix II: State Average Premiums for Small Group Markets for 2010 and 2011
paragraphs: The Small Employer Health Insurance Tax Credit is based on a  percentage of the lesser of (1) the premiums paid by the eligible small  employer for employees during the taxable year and (2) the amount of  premiums the employer would have paid if each employee were enrolled  in a plan with a premium equal to the average premium for the small  group market in the state (or in an area in the state) in which the  employer is offering health insurance. The Secretary of Health and  Human Services determines whether separate average premiums will  apply for areas within a state and also determines the average premium  for a state or substate area. Table 2 shows the average premiums for the  small group market in each state for tax years 2010 and 2011.
section_title: Appendix III: Adjustments in Counting Total Small Employer Claims and Total Credit Amount Claims for Tax Year 2010
paragraphs: Internal Revenue Service (IRS) data for tax year 2010 show 335,600 total  claims filed. This total must be adjusted to avoid counting the 110,800 S  corporation and partnership claims that were passed through to 165,300  respective shareholders and partners who then filed their claims  separately. Excluding the 165,300 shareholder and partner claims filed  leaves 170,300 small employer claims filed. To capture the number of  credit amounts claimed and avoid the amounts that were claimed by the  S corporations and partnerships as well as their respective shareholders  and partners, we excluded the 110,800 S corporation and partnership  claims to arrive at 224,800 credit amounts claimed. (See fig. 6.)
section_title: Appendix IV: Credit Claims by Employer Size and Wages Paid, Tax Year 2010
section_title: Appendix V: Form 8941 and Worksheets for Claiming the Small Employer Health Insurance Tax Credit
paragraphs: This appendix contains the noninteractive Form 8941 and worksheets,  shown in figure 4 in the letter.
section_title: Appendix VI: Publically Available Data on Small Employer Health Insurance
paragraphs: Through our literature review and interviews, we identified several  commonly cited non-Internal Revenue Service data sources on employer  health insurance. Each source has different variables related to the key  eligibility requirements for the Small Employer Health Insurance Tax  Credit. Table 3 summarizes each source, its basic methodology, and  whether its data matches with these requirements for the credit. The table  only considers data that are readily accessible in public-use data sets.
section_title: Appendix VII: Comments from the Internal Revenue Service
section_title: Appendix VIII: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above, Thomas Short, Assistant  Director; Susan Baker; Amy Bowser; Ellen Grady; George Guttman;  Donna Miller, Ruben Montes de Oca, Edward Nannenhorn; Robert  Gebhart; Crystal Robinson; Cynthia Saunders; and Lindsay Swenson  made key contributions to this report.