Are Small Churches and NPOs Leaving a Valuable Tax Credit on the Table?

Are Small Churches and NPOs Leaving a Valuable Tax Credit on the Table?

Article posted in Income Tax on 1 October 2013| comments
audience: National Publication, Dennis Walsh, CPA | last updated: 24 March 2016
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Summary

Since 2010 the Patient Protection and Affordable Care Act (PPACA) has enabled many small employers that provide health insurance coverage for their employees have been eligible to claim a tax credit for premiums paid. However, many eligible churches and charities have failed to take advantage of the credit, often leaving thousands of dollars on the table. In this article, PGDC contributing author Dennis Walsh, CPA removes the mystery surrounding the credit and calls attention to some issues of special importance to churches and other exempt entities.

by Dennis Walsh, CPA

Under the Patient Protection and Affordable Care Act (PPACA), since 2010 many small employers that provide health insurance coverage for their employees have been eligible to claim a tax credit for premiums paid.  The credit under Section 45R of the Internal Revenue Code includes churches and charities exempt under Section 501(c)(3).

For-profit employers claim the health care credit as a non-refundable credit against their income tax liability, while exempt organizations claim a credit that is directly refundable.

Yet, many eligible churches and charities have failed to take advantage of the credit, often leaving thousands of dollars on the table.  This stems in part from a perception that filing for the credit is burdensome and does not merit resources from a cost/benefit standpoint.

It is important that an eligible employer take prompt action prior to the closing of the statute of limitations for filing for any past year of eligibility.

This article highlights important features of the credit and calls attention to some issues of special importance to churches and other exempt entities.  It should help remove any mystery surrounding the credit.

Who gets the credit?

Employers with fewer than 25 full-time equivalent employees (FTEs), paying an average wage of less than $50,000 a year, and paying at least half of employee health insurance premiums are generally eligible for the credit.  For tax years 2010 through 2013, the maximum credit is 25 percent of premiums paid by tax-exempt employers. 

Employers with 10 or fewer FTEs and that pay average wages of less than $25,000 receive the maximum credit.  For employers above either of these thresholds, the credit is gradually phased out.

In addition, the premiums for any employee included in the credit computation cannot exceed the average premium for single or family coverage in the small group market for the employer’s state, as annually adjusted by the Department of Health and Human Services.

After 2013, the credit for tax-exempt employers is increased to 35%.  But the credit is available to an employer for a single period of two consecutive taxable years only.  And to qualify for the credit after 2013, the employer must pay premiums on behalf of employees enrolled in a health plan acquired through the Small business Health Options Program (SHOP) exchange.

Qualifying arrangement, pre-2014

Under IRS Notice 2010-82, for years 2010 through 2013, an arrangement under which a church employer pays premiums for employees who receive medical care provided through a church-sponsored self insurance arrangement, termed a “welfare benefit plan,” may be treated as a qualifying arrangement.  And a church employer paying for employees’ medical coverage under such a plan may be an eligible employer for purposes of the credit. This is an important exception to the requirement that insurance must be provided by a licensed health insurance issuer.

Effect of Clergy employment status

Clergy performing services in the exercise of ministry within the meaning of IRC § 1402(c) are always considered self-employed for Social Security tax purposes.  But whether such a person is considered an employee or an independent contractor for income tax purposes is determined under the common law employment test.

In fact, the vast majority of clergy serve as common law employees, but because of misunderstanding regarding the distinction between income tax and Social Security tax classification, it is not unusual to see employed clergy reported as self-employed for both purposes.

Of significance to employers claiming the health care credit, this “dual status” results in special treatment that can have a positive impact on employer eligibility and in some cases result in a larger credit amount.

If a minister is an employee (i.e. receives a W-2 form), the minister’s hours worked are taken into account in determining the employer’s FTEs, and premiums paid on behalf of the minister are also taken into account in computing the credit.

However, since a minister performing services in the exercise of ministry is treated as self-employed for Social Security tax purposes, compensation paid is not subject to FICA tax as defined in IRC § 3121(a), and is therefore not taken into account in determining average wages  paid by the employer.

On the other hand, if a minister is properly classified as self-employed for income tax purposes, the minister is not included in the employer’s FTE calculation and premiums paid on behalf of the minister are not taken into account in figuring the credit. 

The following examples help illustrate the importance of this distinction.

Example (1).  Hometown Church has two full-time employees, minister X and administrative assistant Y, each working 2,080 hours per year.  X performs services in the exercise of ministry and receives wages of $60,000, while Y receives wages of $30,000 for non-ministerial services.  Hometown Church also provides health insurance coverage for both employees.

Because X performs services in the exercise of ministry and is a common law employee of Hometown Church, X’s hours worked is taken into account in determining the number of FTEs.  Thus, Hometown Church has two FTEs {(2,080 + 2,080)/2,080}. 

However, since X is treated as self-employed for Social Security tax purposes, X’s wages are not taken into account in determining average wages for purposes of the credit.  Accordingly, average wages paid by Hometown Church are $15,000, calculated by dividing Y’s wages only, $30,000, by two FTEs. 

Since average wages are less than $25,000, Hometown Church will receive the maximum credit, computed on the sum of premiums paid by Hometown Church on behalf of both X and Y.

Example (2).  Assume the same facts as (1), except that X is properly classified as an independent contractor under the common law test.  X’s compensation, consisting of the sum of wages paid to X and insurance premiums paid by Hometown Church on X’s behalf is therefore reported as nonemployee compensation on IRS Form 1099-MISC.

Because X is not considered an employee of Hometown Church, X’s hours worked are not taken into account in determining FTEs, and premiums paid on behalf of X are not taken into account in computing the credit.  Thus, Hometown Church has one FTE, employee Y, and is considered to pay average wages of $30,000, determined by dividing Y’s wages by a denominator of one FTE.

As a result, in addition to the premiums paid on behalf of X not being eligible for the credit, the credit resulting from premiums paid on behalf of Y will be reduced since average wages paid by Hometown Church are more than $25,000.

Churches and other organizations that employ clergy to perform services in the exercise of ministry should assure that such individuals are properly classified for both income and Social Security tax purposes.  For more information about employee status, see IRS Publication 15-A, Employer’s Supplemental Tax Guide.

Payroll tax limitation

For tax-exempt employers, the amount of the credit cannot exceed the sum of federal income and Medicare taxes withheld from employee wages, plus the employer portion of the Medicare tax.

Medicare tax is not withheld from ministerial wages, and income tax is only withheld at the request of the minister.  Accordingly, if no minister employee elects voluntary income tax withholding and there is insufficient tax withheld from non-ministerial employees in a particular year, the credit will be reduced or eliminated.

Claiming the credit

The health care credit is claimed on IRS Form 8941 and Form 990-T.  Employers should keep copies of insurance policies or similar documentation sufficient to evidence premiums paid and employee-specific coverage provided, in the event of an IRS audit.

Although a church is not required to file Form 990, it must nevertheless use Form 990-T to claim the credit.  Similarly, nonprofits must file Form 990-T along with Form 8941 even if not otherwise required to file Form 990-T.

The credit amount from Form 8941 is entered on line 44(f) of Form 990-T.  Follow the Form 990-T instructions for line 44(f) if Form 990-T is being filed only to claim the health care credit. 

Too late to file?

Form 990-T along with Form 8941 should be filed by the 15th day of the 5th month following the close of the organization’s tax year, e.g. May 15th for a calendar year organization.

However, a claim may still be filed at a later date provided the statute of limitations for filing has not closed, which is 3 years from the due date of Form 990-T.  Assuming no unrelated business income tax is owed, no penalty should be assessed for filing a late claim, since late penalties are determined as a percentage of taxes owed.

For additional details as well as specific instructions for filing a claim, see “Small Business Health Care Tax Credit for Small Employers” and the instructions for IRS Form 8941.


About the Author

Through The Micah Project, Dennis Walsh, CPA serves as a volunteer consultant to religious workers and exempt organizations, focusing on financial management, legal compliance, and organizational development. A graduate of the University of Wisconsin, he completed the Duke University certificate program in nonprofit management and is a member of the North Carolina Association of CPAs and the American Institute of CPAs.

Dennis is the author of “Legal & Tax Issues for North Carolina Nonprofits” and has written for various nonprofit publications. He actively volunteers with the Guilford Nonprofit Consortium, the Not-for-Profit Committee of the NCACPA, and for the accounting assistance program of the North Carolina Center for Nonprofits.

Mr. Walsh can be reached at nonprofitcpa365@gmail.com.

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