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One of the provisions of the health care reform bill that has already gone into effect is tax credits for small businesses.  How will these tax credits affect a small business that already provides health insurance for its employees, and one that does not?  Here's an example.

Company 1-- let's call it London Company, for no particular reason -- has 10 low-wage employees, makes a profit before taxes of $200,000 and covers its employees' heath care costs to the tune of $5000 per employee, $50,000 total.

What will happen to it under the new health care reform law?  Here's a summary,
followed by the detailed calculations.

London Company Summary

Pre-tax profit Tax owed Realized profit
Before HCR: $200,000 $61,250 $138,750
After HCR: $200,000 $46,250 $153,750

Net gain: $15,000

Calculations: According the the Corporate Tax table, London Company pays $61,250 in taxes.

Under the new health care reform bill, depending on exactly how 'low-wage' London Company's wages are, the company will receive a tax credit of up to 35% of the amount that they pay for their employees' health insurance.  Let's assume that the wages they pay qualify them for a 30% credit, not quite the full amount, just to be a tad conservative.

Under this assumptions, the company will reap a benefit of $15000.  Instead of paying $61,250 in taxes, leaving the company with an after-tax profit of $138,750, it would end up paying $46250, ending up with $153,750, an increase of 11% in profits without having to do anything except fill in the credit line on its tax return.  Cha-ching.

Company 2 -- which we'll refer to as Paris Company, again for no discernible reason, also has 10 low-wage employees each making the same as their counterpart in London Company, and also makes a profit before taxes of $200,000, but does not cover its employees' health care costs at all.

Paris company pays the exact same amount in taxes, of course, $61,250.  If the company were to decide to pay for health care, at the same rate of $5000 per employee, they would also then receive a 30% tax credit of $15000.

What will happen to Paris Company?  Here's a summary table, followed by the detailed calculations.

Paris Company Summary

Pre-tax profit Tax owed Realized profit
Before HCR, no employee health care: $200,000 $61,250 $138,750
Before HCR, with employee health care: $150,000 $41,750 $108,250
After HCR, no employee health care: $200,000 $61,250 $138,750
After HCR, with employee health care: $150,000 $26,750 $123,250

Net Loss: $15,500, but employees have health care

Calculations: If Paris company shells out an additional $50,000 a year, their before-tax profit will now be $150,000, not $200,000, and the company will now be paying taxes of $41,750, not $61,250 (a dramatic decrease that has to do with the particulars of the marginal tax rate table for corporations).  

If there were no tax credit, the company's net after taxes would be $108,250 ($150,000 profit before taxes - $41,750 taxes) after paying for employees' health care, compared with $138,750 ($200,000 - $61,250) if they didn't.  They would lose a total of $30,500 by providing $50,000 in health care benefits.

Given the health care reform law, they will also get the $15,000 tax credit, so they will end up only paying $26750 ($41750 - $15000) in federal taxes. Paris Company's new net after taxes will now be $123,250 ($150,000 pre-tax profit - $26,750 taxes).

The difference between Paris company's after-tax profit before they started paying for health insurance, $138,750, and their after-tax profit afterwards ($123,250) is $15500.  Instead of losing $30,500 by providing coverage, they would only be losing $15,500, or $1550 per employee.

And if Paris company's owners subscribed to certain theories of employer-employee relationships out of, say, A Christmas Carol, they could, if they so chose, decide to lower their employees' wages by a small amount (around $1/hr) to make up for the $15,500 in lost profit, leaving the company none-the-worse and its employees' with smaller paychecks but health benefits.

Caveat:  It's not completely clear from my investigations, but companies which are eligible for the tax credit may not get to both deduct all their costs for employee premiums as expenses AND use the tax credit.  E.g., if health care costs are $50,000 and the tax credit is $15,000, they may only get to deduct $35,000 as an expense, not the entire $50,000.  This introduces complications into the calculations and makes the effect as I presented it somewhat larger than it would be, but it's not a huge effect even if true and the point remains.

Bottom Line: It seems that the new health care reform bill provides a) a substantial tax break for certain small businesses already covering their employees' health care; and b) brings the cost of providing insurance down significantly for some companies that are not already doing so, depending on their exact circumstances.

(As an aside, if either of these companies failed to turn a profit in a given year, they are not completely out of luck.  According to New York Times columnist Robb Mandelbaum, the tax credit can be carried back one year or forward twenty years!  I assume that means that a company could submit an amended tax return for the previous year, claiming the credit, if it had enough profit to offset it, or use it in any of its next 20 years of tax filings to offset taxes owed).

Originally posted to jpmassar on Fri Apr 02, 2010 at 05:29 PM PDT.

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