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. 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. 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). 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.) 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. 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.