Credits for Certain Taxes

You might find it hard to believe, but sometimes the IRS does have a heart. It occasionally gives certain people a break for taxes that might be considered unfair. There are four types of business tax credits that give a "rebate" for certain kinds of taxes: the credit for FICA tax on tips, the gasoline tax credit, the credit for prior year's AMT, and the credit for foreign income taxes.

Credit for FICA tax on tips. Under current law, employees who get $20 or more in tips in a single month must report their tips to their employers. If you have tipped employees, you have to pay Social Security and Medicare (FICA) taxes generally to the tune of 7.65 percent on tips that are reported to you, even though you don't have any control over the amounts. The purpose of the rule is to make sure that tipped employees are adequately covered by Social Security pension, disability, and survivors' benefits. However, the rule was seen to place a particularly heavy burden on the restaurant industry.

So, if your business is one that provides food or beverages for customers to consume on or off the premises, and if your waiters, waitresses, or delivery personnel are customarily tipped by your patrons, you're entitled to a tax credit for any FICA taxes you pay on the tips, whether or not your employee reports the tips.

The upshot of all this? Your workers receive Social Security credits towards their future benefits on account of the tips, but you don't have to pay for these benefits.

Note that there's an exception to the general credit rule: If you pay your employees less than $5.15, with the expectation that tips will bring them up $5.15, you can't claim the credit for FICA on the portion of the tips that is used to bring them up to $5.15. The "minimum wage" for purposes of this credit is frozen at $5.15 an hour.

No double-dipping is allowed. If you are eligible for and decide to claim this credit, you can't deduct the FICA taxes on which the credit is claimed. Because tax credits are generally worth more than deductions, you're generally better off with the credit.

The FICA tax credit is claimed on Form 8846, Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips, and is part of the general business credit.

Gasoline tax credit. You can claim a credit for any federal excise taxes you pay on gasoline and special fuels (like undyed diesel, heating oil, liquefied petroleum gas, and compressed natural gas), when you use the fuel for certain purposes: for farming; for nonhighway purposes of your trade or business; for intercity, local, or school buses; or for export or foreign trade. You can't claim this credit for any personal (nonbusiness) use, so forget about claiming it for your snowmobile or pleasure boat! The credit is claimed on Form 4136, Credit for Federal Tax Paid on Fuels. It is refundable, meaning that the IRS will pay it to you even if you have no tax liability for the year.

Foreign tax credit. You can claim a credit for foreign income taxes, or taxes imposed by possessions of the U.S., that you paid or accrued during the tax year. For example, you might have become liable for foreign taxes on profits from overseas operations or investments. You can elect to deduct these taxes instead of taking the credit, if you prefer, although claiming the credit will generally save you more money. Also, you may be entitled to a carryover of unused credit amounts. The credit is claimed on Form 1116, Foreign Tax Credit. Like most credits, it can't be used to reduce your alternative minimum tax (AMT).

Credit for prior years' AMT. If you paid alternative minimum tax in a prior year, you may be eligible for a credit for a portion of it against your regular tax liability for the current year, and for subsequent years as well. However, the prior AMT credit can't be used to reduce your tax bill below a certain level, namely, your tentative minimum tax for the current year plus any other nonrefundable tax credits for the current year. The credit is claimed on Form 8801, Credit for Prior Year Minimum Tax --Individuals, Estates, and Trusts, or on Form 8827, Credit for Prior Year Minimum Tax --Corporations.

Warning If you have paid AMT in prior years and think you might be eligible for this credit, see a professional tax adviser--someone who specializes in high-net worth or self-employed individuals. The AMT rules are a morass of confusion, and interpretation of them is best left to professionals.

Health care tax credit Small employers, including tax-exempt organizations, that pay some, or all, of the cost for their employee's health care coverage may able to cut their tax bill substantially in 2013 by taking advantage of the new Health Care Tax Credit.

The new health care tax credit is designed to assist small businesses that offer health coverage to their employees. Through 2013, the maximum credit is 35 percent of the employer's eligible premium expenses. Claiming this credit can result in a substantial tax savings. For example, if you paid $50,000 in health care premiums for your employees and you meet all the requirements for the full amount of the credit, you could claim a credit for $17,500 (35% x $50,000).

Work Smart Health insurance premiums paid for an employee are deductible business expenses. However, a tax credit is almost always better than a deduction because a credit cuts your tax bill dollar-for-dollar, while the value of a deduction is tied to your marginal tax bracket. In order to maximize your tax savings, you should claim as large a tax credit as possible, and then deduct the remaining premiums.

There are two tests that you have to meet to qualify for this credit: you must be a "qualified employer" and you must pay the premiums under a "qualifying arrangement."

Qualified Employer

To be a qualified employer, you must have fewer than 25 full-time employees (FTE), regardless of whether or not they are enrolled in your health plan, and their average annual wages must be least then $50,000 per full-time employee.

Full-time employees. To find out how many FTE's you have, you add the total number of hours of service for which you paid wages to employees during the year and, then, divide this number by 2080. If the result is a fraction, it gets rounded to the nearest whole number. To determine the number of the employees, you consider the hours of service of all employees--both full and part-time. You can determine the number of hours your employees worked by any of the following methods:

• using records showing their actual hours of service and of paid leave;
• using a "days-worked equivalency" which credits an 8 hours of service for each day in which the employee actually worked one hour; or
• using "weeks-worked equivalency" which credits an employee with 40 hours of service for each week if he or she actually worked for one hour in the week.

Example For the 2013 tax year, you paid five employees wages for 2,080 hours each, three employees wages for 1,040 hours each, and one employee wages for 2,300 hours. You are using the hours actually worked method to determine FTEs. First you total the hours of all employees, not exceeding 2,080 per employee. This means that you only count 2,080 of the 2,300 hours worked by one employee. The total number of hours is 15,600 hours [(6 x 2,080)+(3 x 1,040)] This total is divided by 2,080, which equals 7.5. A fraction is rounded to the nearest (lowest) whole number, in this case, 7.

There are some caveats. You can't count more than 2080 hours for an employee. Also, you aren't required to count more than 160 hours of service for any single continuous period of paid leave. Seasonal workers are disregarded in determining FTEs and average annual wages unless the seasonal worker works for the employer on more than 120 days during the tax year, although premiums paid on their behalf may be counted in determining the amount of credit.

In addition, you may not be able to count yourself or your family members for any purpose related to the Health Care Tax Credit. If you are a sole proprietor, a partner in a partnership, a shareholder owning more than two percent of an S corporation, and any owner of more than five percent of other businesses, you are not considered an employee for purposes of the credit. Thus, the wages or hours of these business owners and partners are not counted in determining either the number of FTEs or the amount of average annual wages, and premiums paid on their behalf are not counted in determining the amount of the credit.

Similarly, the family member or member of the household of the business owners or partners is not considered an employee for purposes of the credit. Thus, neither their wages nor their hours are counted in determining the number of FTEs or the amount of average annual wages, and premiums paid on their behalf are not counted in determining the amount of the credit. For this purpose, a family member is defined as a child (or descendant of a child); a sibling or step-sibling; a parent (or ancestor of a parent); a step-parent; a niece or nephew; an aunt or uncle; or a son-in-law, daughter- in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law.

Warning Even if you qualify, the amount of your credit may be reduced if you have more than 10 full-time employees and/or the employees' average annual wages exceed $25,000. (See Limits on the Amount of Credit, below.)

Average wages. You determine the amount of average annual wages by dividing (1) the total wages you paid during the year to employees whose hours are included in the FTE computation by (2) the number of your FTEs for the year. The result is then rounded down to the nearest $1,000 (if not otherwise a multiple of $1,000). Wages for this purpose means wages as defined for FICA purposes (without regard to the wage base limitation.)

Qualifying Arrangement

In order to be eligible for the credit, premiums must be paid under a "qualifying arrangement." This means that:

• The premiums must be paid to an insurance company or HMO for health-care coverage
• You must pay a uniform percentage of not less than 50 percent of the premium cost of the coverage for each employee enrolled in the plan. (You must actually pay the premiums directly; amounts paid under a cafeteria plan salary reduction arrangement don't count as paid by the employer.)

You can claim the credit for more than one type of plan (e.g., major medical and dental), but each plan must meet the qualifying arrangement test separately from the others--you can't aggregate the plan types to meet the "qualifying arrangement" requirements.

Limits on the Amount of Credit

Even if you are a qualifying employer and you pay premiums under a qualifying arrangement, the amount of the credit you can claim may be limited by three factors:

• the "average premium for the small market group" in your state;
• the number of employees and their average annual wages; and
• the amount of your taxable income.

Average premium cap. The amount of premium payments that can be counted toward the credit is limited to the smaller of (1) the "average premium for the small group market in the state (or area of the state)" for comparable insurance coverage or (2) the amount you actually paid. The average premium for the small group market in a state (or an area within the state) is determined by the Department of Health and Human Services (HHS). The amounts are listed in the instructions for Form 8941 Credit for Small Employer Health Insurance Premiums, along with examples of total average premium limitation amounts.

This is a cap on the total amount -- for purposes of this test, you can aggregate all your costs under all your qualifying plans.

Reduction based on number of employees and average salary. Once you have determined the total amount of eligible premium costs, you may have to reduce that amount if you have more than 10 employees and/or the average wage is more than $25,000.

If the number of FTEs exceeds 10, the reduction is determined by multiplying the otherwise applicable credit amount by a fraction, the numerator of which is the number of FTEs in excess of 10 and the denominator of which is 15. If average annual wages exceed $25,000, the reduction is determined by multiplying the otherwise applicable credit amount by a fraction, the numerator of which is the amount by which average annual wages exceed $25,000 and the denominator of which is $25,000.

For an employer with both more than 10 FTEs and average annual wages exceeding $25,000, the reduction is the sum of the amount of the two reductions. Note that this sum may reduce the credit to zero for some employers with fewer than 25 FTEs and average annual wages of less than $50,000.

Taxable income limitation. The amount of credit can only offset your actual income tax liability or AMT liability for the year, unless you are a tax-exempt employer (see Special Rules for Tax Exempt Employers, below.) However, any unused credit amount can generally be carried back one year and carried forward 20 years.

Claiming the credit

If you qualify for the credit, and you are not a tax-exempt employer, you claim the credit using Form 8941. The credit amount is reported on Form 3800, General Business Credit, which must be attached to your income tax return.

Special rules for tax-exempt employers

Only 501(c) tax-exempt organizations are eligible to claim the Health Care Tax Credit. For tax years beginning in 2010 through 2013, the maximum credit for a tax-exempt qualified employer is 25 percent of the employer's premium expenses that count toward the credit, as determined above. However, the amount of the credit cannot exceed the total amount of income and Medicare (i.e., hospital insurance) tax the employer is required to withhold from employees' wages for the year and the employer share of Medicare tax on employees' wages for the year.

For a tax-exempt employer, the credit is a refundable credit, so that even if the employer has no taxable income, the employer may receive a refund (so long as it does not exceed the income tax withholding and Medicare tax liability. The tax-exempt claims the refundable credit by filing a Form 990-T with an attached Form 8941.