United States Government Accountability Office GAO Report to Congressional Requesters May 2012 SMALL EMPLOYER HEALTH TAX CREDIT Factors Contributing to Low Use and Complexity GAO-12-549 May 2012 SMALL EMPLOYER HEALTH TAX CREDIT Factors Contributing to Low Use and Complexity Highlights of GAO-12-549, a report to congressional requesters Why GAO Did This Study What GAO Found Many small employers do not offer Fewer small employers claimed the Small Employer Health Insurance Tax Credit health insurance. The Small Employer in tax year 2010 than were estimated to be eligible. While 170,300 small Health Insurance Tax Credit was employers claimed it, estimates of the eligible pool by government agencies and established to help eligible small small business advocacy groups ranged from 1.4 million to 4 million. The cost of employers—businesses or tax-exempt credits claimed was $468 million. Most claims were limited to partial rather than entities—provide health insurance for full percentage credits (35 percent for small businesses) because of the average employees. The base of the credit is wage or full-time equivalent (FTE) requirements. As shown in the figure, 28,100 premiums paid or the average employers claimed the full credit percentage. In addition, 30 percent of claims premium for an employer’s state if had the base premium limited by the state premium average. premiums paid were higher. In 2010, for small businesses, the credit was 35 Number of Small Employers Claiming the Full and Partial Credit Percentages, by FTE and percent of the base unless the Wage Requirements for the Credit, Tax Year 2010 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 Notes: This information is based on the approximately 170,300 small employer claims. Numbers are data are needed to evaluate the effects rounded to the nearest hundred. Numbers don’t add up because of rounding. of the credit. One factor limiting the credit’s use is that most very small employers, 83 percent GAO compared IRS data on credit by one estimate, do not offer health insurance. According to employer claims with estimates of eligible representatives, tax preparers, and insurance brokers that GAO met with, the employers, interviewed various credit credit was not large enough to incentivize employers to begin offering insurance. stakeholders and IRS officials as well Complex rules on FTEs and average wages also limited use. In addition, tax as academicians on evaluation, compared IRS credit compliance preparer groups GAO met with generally said the time needed to calculate the documents with the rules and practices credit deterred claims. Options to address these factors, such as expanded used for prior tax provisions and IRS eligibility requirements, have trade-offs, including less precise targeting of strategic objectives, and reviewed employers and higher costs to the Federal government. literature and data. The Internal Revenue Service (IRS) incorporated practices used successfully for prior tax provisions and from IRS strategic objectives into its compliance efforts What GAO Recommends for the credit. However, the instructions provided to its examiners (1) do not GAO recommends that IRS address the credit’s eligibility requirements for employers with non-U.S. (1) improve instructions to examiners addresses and (2) have less detail for reviewing the eligibility of tax-exempt working on cases on the credit and entities’ health insurance plans compared to those for reviewing small business (2) analyze results from examinations plans. These omissions may cause examiners to overlook or inconsistently treat of credit claimants and use those possible noncompliance. Further, IRS does not systematically analyze results to identify and address any examination results to understand the types of errors and whether examinations errors through alternative approaches. are the best way to correct each type. As a result, IRS is less able to ensure that IRS agreed with GAO’s resources target errors with the credit rather than compliant claimants. recommendations. 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 View GAO-12-549. For more information, contact James R. White at (202) 512-9110 or information to convert data on number of employees to FTEs. Additional data email@example.com. that would need to be collected depend on the questions policymakers would want answered and the costs of collecting such data. United States Government Accountability Office Contents Letter 1 Background 3 Fewer Small Employers Claimed the Credit Than Were Thought to Be Eligible Because of Factors Such as Credit Size and Complexity 9 IRS Is Implementing Several Practices from Prior Compliance Efforts, but Additional Steps Could Be Taken 18 Data to Evaluate Many Questions about the Effects of the Credit Are Not Available 25 Conclusions 27 Recommendations for Executive Action 28 Agency Comments and Our Evaluation 29 Appendix I Scope and Methodology 31 Appendix II State Average Premiums for Small Group Markets for 2010 and 2011 34 Appendix III Adjustments in Counting Total Small Employer Claims and Total Credit Amount Claims for Tax Year 2010 36 Appendix IV Credit Claims by Employer Size and Wages Paid, Tax Year 2010 37 Appendix V Form 8941 and Worksheets for Claiming the Small Employer Health Insurance Tax Credit 38 Appendix VI Publically Available Data on Small Employer Health Insurance 41 Appendix VII Comments from the Internal Revenue Service 43 Page i GAO-12-549 Small Employer Health Tax Credit Appendix VIII GAO Contact and Staff Acknowledgments 46 Tables Table 1: Examination Actions for Form 8941 as of February 2012, for Tax Year 2010 23 Table 2: State Average Premiums for Small Group Markets for 2010 and 2011 34 Table 3: Publically Available Data on Small Employer Health Insurance 41 Figures Figure 1: Percentage of Employers with Low-Wage Employees That Offer Health Insurance, 2000 through 2010, by Employer Size 3 Figure 2: Phaseout of the Credit for Small Businesses as a Percentage of Employer Contributions to Premiums, for 2010 to 2013 7 Figure 3: Percentage and Number of Small Employers Claiming the Full and Partial Credit Percentages, by FTE and Wage Requirements for the Credit, Tax Year 2010 11 Figure 4: Form 8941 and Credit Calculations on Worksheets Related to IRS’s “3 Simple Steps” for Determining Potential Eligibility 14 Figure 5: Model of Potential Outcomes and Influential Factors for the Small Employer Health Insurance Tax Credit 26 Figure 6: Number of Credit Claims by Taxpayer Type, Tax Year 2010 36 Page ii GAO-12-549 Small Employer Health Tax Credit Abbreviations CBO Congressional Budget Office COBRA Consolidated Omnibus Budget Reconciliation Act FTE full-time equivalent HHS Department of Health and Human Services IRS Internal Revenue Service JCT Joint Committee on Taxation MEA Math Error Authority MEPS Medical Expenditure Panel Survey NFIB National Federation of Independent Businesses PPACA Patient Protection and Affordable Care Act SBA Small Business Administration SBM Small Business Majority SB/SE Small Business and Self-Employed Division TEGE Tax Exempt and Government Entities Division TETR Telephone Excise Tax Refund TIGTA Treasury Inspector General for Tax Administration This is a work of the U.S. government and is not subject to copyright protection in the United States. The published product may be reproduced and distributed in its entirety without further permission from GAO. However, because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately. Page iii GAO-12-549 Small Employer Health Tax Credit United States Government Accountability Office Washington, DC 20548 May 14, 2012 The Honorable Olympia J. Snowe Ranking Member Committee on Small Business and Entrepreneurship United States Senate The Honorable Sam Graves Chairman Committee on Small Business House of Representatives 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) 1 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. To provide an incentive for small employers to provide health insurance, and to make insurance more affordable, Congress included the Small Employer Health Insurance Tax Credit (referred to in this report as the credit) in the Patient Protection and Affordable Care Act (PPACA). 2 The credit is available for tax years beginning after December 31, 2009 to certain employers with employees earning low wages— small business and tax-exempt entities—that pay at least half of their employees’ health insurance premiums. The Congressional Budget Office (CBO) and the Joint Committee on Taxation (JCT) jointly estimated that the credit would 1 MEPS is a set of large-scale surveys. MEPS is administered by the Agency for Healthcare Research and Quality in the Department of Health and Human Services. The 2010 Insurance Component survey had a response rate of about 83 percent for private establishments, and 38,409 respondents, including for-profit, and nonprofit employers; government units are excluded from these statistics. 2 Pub. L. No. 111-148, §§ 1421, 10105, 124 Stat. 119 (Mar. 23, 2010), (codified at 26 U.S.C. § 45R). Page 1 GAO-12-549 Small Employer Health Tax Credit cost $2 billion in fiscal year 2010 and $40 billion from fiscal years 2010 to 2019. 3 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 provisions 4 and IRS strategic objectives. We interviewed IRS officials on their 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. 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 3 CBO, letter to the Honorable Nancy Pelosi, Speaker of the U.S. House of Representatives (Washington, D.C.: Mar. 18, 2010). 4 For example, see GAO, Tax Refunds: Enhanced Prerefund Compliance Checks Could Yield Significant Benefits, GAO-11-691T (Washington, D.C.: May 25, 2011). Page 2 GAO-12-549 Small Employer Health Tax Credit 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.) Background Small Employer Health Small employers with low-wage employees do not commonly offer health Insurance Market insurance, compared with large employers with low-wage employees, as shown in figure 1. Figure 1: Percentage of Employers with Low-Wage Employees That Offer Health Insurance, 2000 through 2010, by Employer Size Notes: Figure includes for-profit and nonprofit (tax-exempt) entities but not government entities. A low-wage employer is defined as an employer that has 50 percent or more of its employees earning a low wage (earning $11.50 per hour or less, which is an annual salary of, at most, about $23,920). Data were not collected for the MEPS Insurance Component for 2007. Page 3 GAO-12-549 Small Employer Health Tax Credit A combination of factors explains why small, low-wage employers tend not to offer health insurance. 5 • For very low-wage employees, such as minimum wage employees, 6 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. 7 • Insurers of small employers face higher per-employee fixed costs for billing and marketing 8 and are less able to pool risk 9 across large numbers of employees. As a result, plans offered to small employers 5 For additional description of challenges for small employers providing coverage, see GAO, Private Health Insurance: Small Employers Continue to Face Challenges in Providing Coverage, GAO-02-8 (Washington, D.C.: Oct. 31, 2001). 6 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. 7 See Quantria Strategies/Small Business Administration, Health Insurance in the Small Business Market: Availability, Coverage, and the Effect of Tax Incentives (Cheverly, Md.: September 2011). 8 CBO estimated that for firms with 25 or fewer employees, 26 percent of premiums goes toward insurers’ administration costs, compared with 7 percent for firms with at least 1,000 employees; see CBO, Key Issues in Analyzing Major Health Insurance Proposals (Washington, D.C.: December 2008). 9 Risk pooling spreads risk across a group; a larger pool stabilizes the average insurance costs. Smaller risk pools raise costs because insurers run the risk of insuring those with relatively high health care needs. As a result, insurers may increase premiums to better ensure that they can cover unexpectedly large health care costs. Page 4 GAO-12-549 Small Employer Health Tax Credit are likely to have higher premiums or have less coverage and higher out-of-pocket costs than plans offered to large employers. 10 IRS Implementation and IRS’s Small Business and Self-Employed Division (SB/SE) and Tax Requirements for Exempt and Government Entities Division (TEGE) are primarily Calculating and Claiming responsible for implementing the credit. IRS works with the Department of Health and Human Services (HHS) and the Small Business the Credit Administration (SBA) on implementation tasks, such as outreach and communication. To be eligible, an employer must: • Be a small business 11 or tax-exempt employer 12 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) 13 employees in the tax year (excluding certain employees, such as business owners and their family members). 14 10 The average deductible in 2010 per employee enrolled in a single (employee only) health insurance plan was $1,421 for employers with fewer than 10 employees; $1,420 for employers with 10 to 24 employees, $1,513 for employers with 25 to 99 employees, $1,155 for employers with 100 to 999 employees, and $738 for employers with 1,000 or more employees, according to MEPS. A deductible is the amount of expenses that must be paid out-of-pocket before an insurer will pay any expenses. 11 For purposes of this credit, a business includes those that are corporations in a controlled group of corporations, or members of an affiliated service group, as well as partnerships, sole proprietorships, cooperatives and trusts. A sole proprietor is an individual who owns an unincorporated business but may employ others. 12 The credit is available to tax-exempt employers described in 26 U.S.C. § 501(c) and exempt from tax under 26 U.S.C. § 501 (a). 13 To calculate FTEs, the total hours of service must be determined for all individuals considered employees. There are a number of methods that can be used to determine the hours worked, but the hours are limited to 2,080 per employee. The total number of hours of service is divided by 2,080 to arrive at the FTE number. 14 Other exclusions are seasonal employees, unless they work for the employer on more than 120 days in the tax year, and ministers who are deemed to be self-employed. Leased employees are included in FTE calculations. Page 5 GAO-12-549 Small Employer Health Tax Credit • Pay average annual wages of less than $50,000 per FTE in the tax year. 15 • 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. 16 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. Limits on the Credit Amount 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. 15 Wages for the employees included in the FTE calculations are included in average wage calculations except for minister’s wages which are not subject to Social Security or Medicare tax. 16 IRS offered a transition rule on the “qualifying arrangement” criteria for tax year 2010 and for satisfying the uniformity requirement. IRS Notice 2010-44. Page 6 GAO-12-549 Small Employer Health Tax Credit Figure 2: Phaseout of the Credit for Small Businesses as a Percentage of Employer Contributions to Premiums, for 2010 to 2013 Note: GAO adapted the graphic from Congressional Research Service, Summary of the Small Business Health Insurance Tax Credit Under PPACA (P.L. 111-148) (Washington, D.C.: Apr. 5, 2010). 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 Page 7 GAO-12-549 Small Employer Health Tax Credit combined phaseout for the credit percentages and removing the state market limits. Process for Claiming the Credit 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. 17 Credit amounts claimed by partnerships and S corporations are to be passed through to their partners and shareholders, respectively, 18 who may claim their portions of the credit on their individual income tax returns. 19 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. 20 17 The unused credit for small businesses may be carried back 1 year or forward up to 20 years. Credits cannot be carried back to a year prior to the effective date of the credit; any unused credit amounts for 2010 can only be carried forward. See IRS Notice 2010-44. 18 Owners of S corporations are referred to as shareholders. S corporations are corporations that “pass through” gains and losses to shareholders’ individual tax returns without generally paying taxes at the entity level. Similarly, partners receive pass through income and losses from a partnership. 19 For partners and shareholders, the credit is to be entered on the Schedule K-1 to be filed with an income tax return. 20 PPACA requires the establishment of exchanges in each state by January 1, 2014, which are to help eligible individuals and small employers compare and select insurance coverage from among participating health plans. See Pub. L. No. 111-148, § 1311(b), 124 Stat. 119, 173 (Mar. 23, 2010). Page 8 GAO-12-549 Small Employer Health Tax Credit Fewer Small Employers Claimed the Credit Than Were Thought to Be Eligible Because of Factors Such as Credit Size and Complexity Actual Credit Claims Were Fewer small employers claimed the credit for tax year 2010 than were Much Lower Than Initial thought to be eligible based on rough estimates of eligible employers Rough Eligibility Estimates 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. 21 (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 21 The number of employees who had their premiums paid by employers that claimed the credit was about 770,000. Page 9 GAO-12-549 Small Employer Health Tax Credit estimated 2.6 million. 22 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. 23 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). 24 Most Small Employer Most of the claims were for less than the full credit percentage. Of the Claims Were Reduced approximately 170,300 small employers making claims for tax year 2010, Because of the Phaseout 142,200—83 percent—could not use the full credit percentage. Usually employers could not meet the average wage requirement to claim the full Rules and Some Were percentage, as about 68 percent did not qualify based on wages but did Reduced by the State meet the FTE requirement. (See fig. 3.) 25 Average Premiums 22 The Council of Economic Advisors is an agency within the Executive Office of the President charged with offering objective advice on the formulation of domestic and international economic policy, and SBA is a government agency that offers a variety of programs and support services to help small businesses. 23 The estimate for SBM and SBA included nonprofits. The estimate for NFIB was only for small businesses; it is not known whether the estimate for the Council of Economic Advisors included nonprofits in addition to businesses. 24 CBO and JCT recently reduced their original estimates of the future costs of the credit to a cost of $1 billion in 2012 and a cost of $21 billion from 2012 to 2021. These estimates were previously $5 billion in 2012 and $40 billion from 2012 to 2021. 25 See app. IV for a graph of claimants with fewer than 10 FTEs and the amount of full credits. Page 10 GAO-12-549 Small Employer Health Tax Credit Figure 3: Percentage and Number of Small Employers Claiming the Full and Partial Credit Percentages, by FTE and Wage Requirements for the Credit, Tax Year 2010 Notes: This information is based on the approximately 170,300 small employer claims. Numbers are rounded to the nearest hundred. Numbers and percentages do not add to totals because of rounding. 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, 26 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.) 26 A small group plan is a health coverage plan sponsored by small employers for the employees. Page 11 GAO-12-549 Small Employer Health Tax Credit Most Small Employers As already discussed, small employers do not commonly offer health Could Not Meet the Health insurance. MEPS estimates that 83 percent of employers who may Insurance Requirement for otherwise be eligible for the full credit 27 did not offer health insurance in 2010 and that 67 percent of employers who could be eligible for the the Credit and the Credit partial credit 28 did not offer insurance. Our discussion groups and other Was Not Seen as an interviewees confirmed this, with comments and examples of small, low- Incentive to Start Offering wage employers not offering health insurance to employees. Insurance 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. Complexity Deterred Small Most discussion group participants and groups we interviewed found the Employer Claims, tax credit to be complicated, deterring small employers from claiming it. According to Discussion The complexity arises from the various eligibility requirements, the various data that must be recorded and collected, and number of Groups 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. 27 This MEPS statistic is based on employers—both profit and nonprofit—with fewer than 10 employees that pay annual wages of $24,000 or less to over half of their employees. 28 This MEPS statistic is based on employers—both profit and nonprofit—with 10 to 25 employees that pay annual wages of $24,000 or less to over half of their employees. Because the employers eligible for the partial credit can pay up to $50,000 in wages, this is a less precise estimate than using MEPS to estimate insurance offerings for the full credit. Page 12 GAO-12-549 Small Employer Health Tax Credit 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. 29 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.) 29 The National Society of Accountants conducted a survey in 2008 that estimated the hourly tax preparer fee to be $122 an hour. Tax preparers may not necessarily charge for the credit, according to some discussion group participants. Page 13 GAO-12-549 Small Employer Health Tax Credit Figure 4: Form 8941 and Credit Calculations on Worksheets Related to IRS’s “3 Simple Steps” for Interactive graphic Determining Potential Eligibility Directions: Roll over the buttons below to reveal the worksheets necessary to calculate credit totals needed for lines on IRS Form 8941. Step 1 Step 2 Step 3 Determine the total number Determine the average annual Determine if you pay at least of half Additional calculations of employees (FTEs) wages paid to employees insurance premiums for employees (FTE and wage phase out) Source: GAO analysis of IRS information. Print instructions To view and print full noninteractive versions of IRS Form 8941 and worksheets included in this graphic, go to appendix V. Page 14 GAO-12-549 Small Employer Health Tax Credit 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 30 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. The Extent to Which Lack Many small businesses reported that they were unaware of the credit. of Awareness Is a Factor The NFIB Research Foundation 31 and the Kaiser Family Foundation both Limiting More Claims Is estimated that approximately 50 percent of small businesses were aware of the credit, as of May 2011, or more than 1 year after Congress Unknown, Although IRS authorized this credit. 32 Did Significant Outreach 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 30 The Taxpayer Advocate Service is an independent organization within the IRS that helps taxpayers who are experiencing economic harm; are seeking help in resolving problems with IRS; and believe an IRS system or procedure is not working as it should. 31 The NFIB Research Foundation is a nonprofit affiliated with NFIB. 32 NFIB conducted this survey in April and May 2011 of 750 small employers of firms with 50 or fewer employees. The Kaiser Family Foundation conducted its survey from January through May 2011 of 3,184 public and private firms with 3 or more employees and its questions about the credit were directed to employers with 50 or fewer employees. Page 15 GAO-12-549 Small Employer Health Tax Credit 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 33 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. Addressing Factors and Given that most small employers do not offer insurance and what we Expanding Credit Use May heard about the size of the credit not being big enough to incentivize Require Substantive offering health insurance, 34 it may not be possible to significantly expand credit use without changing the credit’s eligibility. Most claims were for Design Changes partial credits and many people we spoke with view the credit amount as 33 Each focus group in 2011 consisted of 12 tax preparers. IRS issued a report on the focus groups’ results on October 14, 2011. 34 Given the previously discussed lack of knowledge or awareness, it is not clear that increasing outreach would increase credit usage. Page 16 GAO-12-549 Small Employer Health Tax Credit 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, 35 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. 36 • Offering a flat credit amount per FTE (or number of employees) rather than a percentage, which would reduce the precision in targeting the credit. 35 Three bills were recently introduced to amend the small employer health insurance credit to increase the maximum number of FTEs to 50, modify the phase out of the credit amount, and repeal the limitation based on state health insurance premium averages. H.R. 4324, Small Business Employee Health Insurance Credit Expansion Act of 2012, also would repeal the 2-year limit after 2014, making the credit available indefinitely. H.R.4252 and S.2227, both titled Small Business Health Care Tax Credit Improvement Act of 2012, propose to increase allowable average annual salaries paid to employees to $28,500 to claim the full credit. 36 Using the number of employees instead of FTEs would require an increase in the number of eligible employees in order to reach the same population of small employers. For example, two part-time employees working 20 hours per week count as one FTE, making the employer appear larger than if FTEs were counted. Page 17 GAO-12-549 Small Employer Health Tax 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. IRS Is Implementing Several Practices from Prior Compliance Efforts, but Additional Steps Could Be Taken IRS Incorporated Practices IRS’s compliance efforts for the credit incorporate practices that have from Strategic Objectives been shown effective in helping to ensure compliance with other tax and Prior Compliance provisions or are consistent with IRS strategic objectives. Some of those practices were used for the Telephone Excise Tax Refund (TETR) 37 and Efforts Consolidated Omnibus Budget Reconciliation Act (COBRA) subsidies for health insurance for the unemployed, according to IRS officials. 38 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. 37 We found that that IRS’s compliance plans for the TETR were consistent with good management practices in previous reports. See GAO, Tax Administration: Telephone Excise Tax Refund Requests Are Fewer Than Projected and Have Had Minimal Impact on IRS Services, GAO-07-695 (Washington, D.C.: Apr. 11, 2007). 38 We tested IRS’s internal controls for the COBRA unemployment subsidies in the American Recovery and Reinvestment Act and found that IRS was able to identify all five fictitious companies used to fraudulently apply for the subsidies. See GAO Proactive Testing of ARRA Tax Credits for COBRA Premium Payments, GAO-10-804R (Washington, D.C.: June 14, 2010). Page 18 GAO-12-549 Small Employer Health Tax Credit • Freezing refunds of tax-exempt entities whose returns have been selected for examination, which avoids the costs of trying to recover funds. 39 • 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. 40 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, 41 which IRS officials said 39 See GAO, Tax Gap: Complexity and Taxpayer Compliance, GAO-11-747T (Washington, D.C.: June 28, 2011). 40 The Internal Revenue Code provides IRS with MEA to assess additional tax or otherwise correct tax return errors in limited circumstances when an adjustment is the result of mathematical or clerical errors on the return. In these cases, IRS can avoid costly audits and IRS is not required to provide taxpayers a right to appeal MEA assessments, although they may file a claim to ask IRS to reduce the assessment if they believe IRS erred. See 26 U.S.C. § 6213(b). Over the years, Congress has granted MEA for specific purposes and those purposes are listed in section 6213(g)(2). 41 These three IRS filters are to check whether credit claims are consistent with eligibility requirements subject to computation criteria. Page 19 GAO-12-549 Small Employer Health Tax Credit does not justify the costs to develop procedures to use MEA, if it were granted. 42 Filters Check Some IRS developed 21 filters for Form 8941, some of which apply differently to Eligibility Criteria, but Are SB/SE and TEGE taxpayers. The filters cover some of the eligibility Limited by Available Data 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. 43 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. 42 We previously recommended that Congress should consider broadening IRS’s ability to use MEA, with appropriate safeguards against misuse. See GAO, Recovery Act: IRS Quickly Implemented Tax Provisions, but Reporting and Enforcement Improvements Are Needed, GAO-10-349 (Washington, D.C.: Feb. 10, 2010). 43 We do not describe the filters and the eligibility requirements not being covered in detail because of concerns about revealing IRS’s compliance approach and criteria. Page 20 GAO-12-549 Small Employer Health Tax Credit 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. 44 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. Examination Instructions After the filters are run, IRS creates lists of claims to consider for further Cover Most Eligibility examination. SB/SE wanted enough examination cases to spot check Requirements, but Gaps different filters and claims from different regions, to enable them to establish a field presence and to learn about compliance risks with the Exist credit, according to an SB/SE official. 45 Examination staff in SB/SE and TEGE are to follow a set of instructions when doing examinations. 46 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 44 See 26 U.S.C. § 6051(a)(14), which generally requires employers to report the aggregate cost of employer-sponsored coverage they provide for an employee on Form W-2. 45 TEGE established two mandatory filters that if failed, automatically trigger an exam; only 16 forms tripped these two filters, as of December 31, 2011. 46 Examiner instructions consist of several types of documents, such as worksheets and checklists on the credit’s eligibility requirements; we also refer to these documents as examination “guidance.” Page 21 GAO-12-549 Small Employer Health Tax Credit 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. 47 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 47 Tax-exempt entities with non-U.S. addresses must pay health insurance premiums for an employee’s coverage issued in and regulated in one of the states or the District of Columbia. Page 22 GAO-12-549 Small Employer Health Tax Credit 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. Examinations Under Way, For tax year 2010, SB/SE plans to conduct over 1,500 examinations but IRS Needs to Develop related to the credit, and TEGE anticipates about 1,000 examinations. An a Plan for Efficiently SB/SE official said the number of examinations is expected to provide initial compliance information and allow IRS to establish a compliance Analyzing Results on presence without committing too many resources initially. TEGE selected Credit Compliance 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. Table 1: Examination Actions for Form 8941 as of February 2012, for Tax Year 2010 a Number of: SB/SE TEGE Total Examinations initiated 500 570 1,070 Additional examinations anticipated 1,000 430 1,430 Closed examinations 119 88 207 Closed examinations resulting in a change to the credit amount 46 22 68 Sources: SB/SE and TEGE officials. a For examinations, SB/SE does not distinguish between examinations on business or individual claimants. 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 may cover issues other than the credit. 48 Instead, as initial examinations 48 TEGE examinations will only cover the credit, according to IRS officials. Page 23 GAO-12-549 Small Employer Health Tax 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. 49 In the past, IRS has used soft notices to correct errors and collect funds 49 A soft notice is a letter generated to taxpayers that IRS has identified possible errors on the taxpayer’s form. The goal is to increase compliance at minimal costs by educating taxpayers for future compliance without doing an examination and minimizing the taxpayers’ need to respond to the notice. Page 24 GAO-12-549 Small Employer Health Tax Credit without initiating an examination. 50 A senior IRS official who is 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. There are a variety of research questions that could be of interest to Data to Evaluate policymakers about the effects of the credit that cannot be evaluated with Many Questions about data currently available. Figure 5 shows how the credit may influence employer behavior and, ultimately, employees. the Effects of the Credit Are Not Available 50 For example, see GAO, Advance Earned Income Tax Credit: Low Use and Small Dollars Paid Impede IRS’s Efforts to Reduce High Noncompliance, GAO-07-1110 (Washington, D.C.: Aug. 10, 2007), and Tax Gap: IRS Could Do More to Promote Compliance by Third Parties with Miscellaneous Income Reporting Requirements, GAO-09-238 (Washington, D.C.: Jan. 28, 2009). Page 25 GAO-12-549 Small Employer Health Tax Credit Figure 5: Model of Potential Outcomes and Influential Factors for the Small Employer Health Insurance Tax Credit Note: Basic model structure is based on University of Wisconsin Extension Program Development and Evaluation model, as shown in GAO-12-208G. Content and relationships among variables are based on GAO analysis of interviews with subject matter specialists, and literature review. 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 Page 26 GAO-12-549 Small Employer Health Tax Credit 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. 51 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. 52 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. 53 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. The Small Employer Health Insurance Tax Credit was intended to offer an Conclusions 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 51 For details on methods for identifying causation, including experiments and quasi- experiments, using comparison groups, see GAO, Designing Evaluations: 2012 Revision, GAO-12-208G (Washington, D.C.: January 2012). These designs are not feasible for the credit because it was implemented simultaneously across the country. 52 See GAO, Government Performance and Accountability: Tax Expenditures Represent a Substantial Federal Commitment and Need to Be Reexamined, GAO-05-690 (Washington, D.C.: Sept. 23, 2005). 53 Starting in 2014, eligible small employers can claim the credit for the 2 consecutive years beginning when the employer first offers employee health insurance from a state exchange. Page 27 GAO-12-549 Small Employer Health Tax Credit 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. To help ensure thoroughness and consistency of examinations on the Recommendations for credit, we recommend that the Commissioner of Internal Revenue take Executive Action 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. Page 28 GAO-12-549 Small Employer Health Tax Credit In an April 30, 2012, letter responding to a draft of this report (which is Agency Comments reprinted in app. VII), the IRS Deputy Commissioner for Services and and Our Evaluation 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 Page 29 GAO-12-549 Small Employer Health Tax Credit 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 firstname.lastname@example.org. 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. James R. White Director, Tax Issues Strategic Issues Page 30 GAO-12-549 Small Employer Health Tax Credit Appendix I: Scope and Methodology Appendix I: Scope and Methodology 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. 1 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 1 TIGTA, Affordable Care Act: Efforts to Implement the Small Business Health Care Tax Credit Were Mostly Successful, but Some Improvements Are Needed, 2011-40-103 (Washington, D.C.: Sept. 19, 2011). Page 31 GAO-12-549 Small Employer Health Tax Credit Appendix I: Scope and Methodology 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. 2 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 2 For example, see GAO, Tax Refunds: Enhanced Prerefund Compliance Checks Could Yield Significant Benefits, GAO-11-691T (Washington, D.C.: May 25, 2011). Page 32 GAO-12-549 Small Employer Health Tax Credit Appendix I: Scope and Methodology the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. Page 33 GAO-12-549 Small Employer Health Tax Credit Appendix II: State Average Premiums for Appendix II: State Average Premiums for Small Group Markets for 2010 and 2011 Small Group Markets for 2010 and 2011 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. Table 2: State Average Premiums for Small Group Markets for 2010 and 2011 2010 2011 Employee only Employee only (single plan) Family plan (single plan) Family plan Alabama $4,441 $11,275 $4,778 $12,084 Alaska 6,204 13,723 6,729 14,701 Arizona 4,495 10,239 4,614 11,063 Arkansas 4,329 9,677 4,378 9,849 California 4,628 10,957 4,790 11,493 Colorado 4,972 11,437 5,007 12,258 Connecticut 5,419 13,484 5,640 14,096 Delaware 5,602 12,513 5,902 13,411 District of Columbia 5,355 12,823 5,721 14,024 Florida 5,161 12,453 5,218 12,550 Georgia 4,612 10,598 5,085 11,440 Hawaii 4,228 10,508 4,622 11,529 Idaho 4,215 9,365 4,379 10,066 Illinois 5,198 12,309 5,565 13,176 Indiana 4,775 11,222 5,262 12,097 Iowa 4,652 10,503 4,694 11,051 Kansas 4,603 11,462 4,693 11,909 Kentucky 4,287 10,434 4,456 10,560 Louisiana 4,829 11,074 5,143 11,911 Maine 5,215 11,887 5,261 12,255 Maryland 4,837 11,939 5,073 12,530 Massachusetts 5,700 14,138 5,900 15,262 Michigan 5,098 12,364 5,195 12,539 Page 34 GAO-12-549 Small Employer Health Tax Credit Appendix II: State Average Premiums for Small Group Markets for 2010 and 2011 2010 2011 Employee only Employee only (single plan) Family plan (single plan) Family plan Minnesota 4,704 11,938 5,048 12,790 Mississippi 4,533 10,501 4,787 10,860 Missouri 4,663 10,681 4,843 11,379 Montana 4,772 10,212 4,923 10,789 Nebraska 4,715 11,169 5,130 12,057 Nevada 4,553 10,297 4,781 10,836 New Hampshire 5,519 13,624 5,858 14,523 New Jersey 5,607 13,521 5,868 14,093 New Mexico 4,754 11,404 5,146 12,328 New York 5,442 12,867 5,589 13,631 North Carolina 4,920 11,583 5,136 11,949 North Dakota 4,469 10,506 4,545 11,328 Ohio 4,667 11,293 4,706 11,627 Oklahoma 4,838 11,002 4,922 11,200 Oregon 4,681 10,890 4,881 11,536 Pennsylvania 5,039 12,471 5,186 12,671 Rhode Island 5,887 13,786 5,956 14,553 South Carolina 4,899 11,780 5,036 11,780 South Dakota 4,497 11,483 4,733 11,589 Tennessee 4,611 10,369 4,744 11,035 Texas 5,140 11,972 5,172 12,432 Utah 4,238 10,935 4,532 11,346 Vermont 5,244 11,748 5,426 12,505 Virginia 4,890 11,338 5,060 12,213 Washington 4,543 10,725 4,776 11,151 West Virginia 4,986 11,611 5,356 12,724 Wisconsin 5,222 12,819 5,284 13,911 Wyoming 5,266 12,163 5,430 12,867 Source: Department of Health and Human Services and IRS information. Page 35 GAO-12-549 Small Employer Health Tax Credit Appendix III: Adjustments in Counting Total Appendix III: Adjustments in Counting Total Small Employer Claims and Total Credit Amount Claims for Tax Year 2010 Small Employer Claims and Total Credit Amount Claims for Tax Year 2010 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.) Figure 6: Number of Credit Claims by Taxpayer Type, Tax Year 2010 Note: Numbers rounded to the nearest hundred. a Also included in this group are single member owners of disregarded limited liability corporations. Page 36 GAO-12-549 Small Employer Health Tax Credit Appendix IV: Credit Claims by Employer Size Appendix IV: Credit Claims by Employer Size and Wages Paid, Tax Year 2010 and Wages Paid, Tax Year 2010 Page 37 GAO-12-549 Small Employer Health Tax Credit Appendix V: Form 8941 and Worksheets for Appendix V: Form 8941 and Worksheets for Claiming the Small Employer Health Insurance Tax Credit Claiming the Small Employer Health Insurance Tax Credit This appendix contains the noninteractive Form 8941 and worksheets, shown in figure 4 in the letter. Page 38 GAO-12-549 Small Employer Health Tax Credit Appendix V: Form 8941 and Worksheets for Claiming the Small Employer Health Insurance Tax Credit Page 39 GAO-12-549 Small Employer Health Tax Credit Appendix V: Form 8941 and Worksheets for Claiming the Small Employer Health Insurance Tax Credit Page 40 GAO-12-549 Small Employer Health Tax Credit Appendix VI: Publically Available Data on Appendix VI: Publically Available Data on Small Employer Health Insurance Small Employer Health Insurance 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. Table 3: Publically Available Data on Small Employer Health Insurance Medical Expenditure Panel National Compensation Employer Health Benefits Survey Survey (Insurance Component) Survey Sources and methodology Organizations responsible for Kaiser Family Foundation and Department of Health and Human Bureau of Labor Statistics the survey Health Research and Educational Services, Agency for Healthcare Trust Research and Quality Frequency and contact Annual, conducted by phone Annual, generally conducted by Annual, conducted by method phone or mail personal visits, mail, telephone, and e-mail a b Unit of analysis, sample size Employers—2,088 from Dun and Employers —38,409 private sector Employers; 15,566 and source Bradstreet and the Census of establishments from U.S. Census private industry Governments Bureau’s Business Register establishments from state unemployment insurance reports Response rate and most Forth-seven percent in 2011 Eighty-three percent for private Fifty-six percent for private recent data, as of April 2012 establishments in 2010 industry in 2011 Key eligibility requirement for the credit, and whether the source contains data c Employer is a for-profit or tax- Yes Yes Yes exempt entity Employer offers health Yes Yes Yes insurance and pays at least 50 percent of premiums Employer has fewer than 25 No—number of employees No—number of employees No—number of full-time equivalents (FTE) employees, from 1 to 49, and number of full- and part-time employees Average annual wages are No—percentage of full-time No—percentage of employees who No—wages are presented e less than $50,000 per FTE employees who make $23,000 or earned wages in one of three in five percentiles d less per year categories Source: GAO analysis of data sources. a The Medical Expenditure Panel Survey’s Insurance Component sample is drawn at the establishment level; an establishment is a particular workplace or location. b The National Compensation Survey sample is drawn at the establishment level; an establishment is a single economic unit that engages in one, or primarily one, type of economic activity. It is usually a single physical location. c Statistical models used by the National Compensation Survey are able to control for profit/non-profit status. Page 41 GAO-12-549 Small Employer Health Tax Credit Appendix VI: Publically Available Data on Small Employer Health Insurance d The annual wage categories are about (1) $23,920 or less, (2)$23,920 to $54,080, and (3) $54,080 or more. e Wage data are presented in percentile categories in the published data. The annual wage categories, for private industry workers, are about: (1) 10th percentile makes $17,160 or less, (2) 25th percentile makes $22,235 or less, (3) 50th percentile makes $33,009 or less, (4) 75th percentile makes $51,605 or less, and (5) the 90th percentile makes $78,811 or less. Page 42 GAO-12-549 Small Employer Health Tax Credit Appendix VII: Comments from the Internal Appendix VII: Comments from the Internal Revenue Service Revenue Service Page 43 GAO-12-549 Small Employer Health Tax Credit Appendix VII: Comments from the Internal Revenue Service Page 44 GAO-12-549 Small Employer Health Tax Credit Appendix VII: Comments from the Internal Revenue Service Page 45 GAO-12-549 Small Employer Health Tax Credit Appendix VIII: GAO Contact and Staff Appendix VIII: GAO Contact and Staff Acknowledgments Acknowledgments James R. White, (202) 512-9110 or email@example.com GAO Contact In addition to the contact named above, Thomas Short, Assistant Staff Director; Susan Baker; Amy Bowser; Ellen Grady; George Guttman; Acknowledgments Donna Miller, Ruben Montes de Oca, Edward Nannenhorn; Robert Gebhart; Crystal Robinson; Cynthia Saunders; and Lindsay Swenson made key contributions to this report. (450922) Page 46 GAO-12-549 Small Employer Health Tax Credit GAO’s Mission The Government Accountability Office, the audit, evaluation, and investigative arm of Congress, exists to support Congress in meeting its constitutional responsibilities and to help improve the performance and accountability of the federal government for the American people. GAO examines the use of public funds; evaluates federal programs and policies; and provides analyses, recommendations, and other assistance to help Congress make informed oversight, policy, and funding decisions. GAO’s commitment to good government is reflected in its core values of accountability, integrity, and reliability. The fastest and easiest way to obtain copies of GAO documents at no Obtaining Copies of cost is through GAO’s website (www.gao.gov). Each weekday afternoon, GAO Reports and GAO posts on its website newly released reports, testimony, and correspondence. 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Small Employer Health Tax Credit: Factors Contributing to Low Use and Complexity
Published by the Government Accountability Office on 2012-05-14.
Below is a raw (and likely hideous) rendition of the original report. (PDF)