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Tax Implications
 Tax-Deductibility of Employer's Premium Contributions
Tax-Deductibility of Employer's Medical Reimbursements
Taxability of Value of Health Plan to Employee
Taxability of Reimbursements to Employees
Taxability of Employees' Premium Contributions
Generally speaking, any expenses an employer incurs related to health insurance (for employees and employees' dependents, and for the employer and the employer's dependents) are 100 percent tax-deductible as ordinary business expenses, both on California and federal income taxes.
Beyond this general rule, things get a bit more complicated. Below we offer more in-depth information on the tax implications of offering a group plan for your business. Before we get started, it's important to understand a few distinctions up-front. When discussing taxability of health insurance, there are a few main issues:
- For employers:
- Whether an employer's health coverage premium contributions are tax-deductible as a business expense.
- Whether an employer's reimbursements for the costs of coverage and care are tax-deductible as a business expense.
- For employees:
- Whether an employer's premium contributions are taxed as income.
- Whether an employer's medical reimbursements are taxed as income.
- Whether an employee's share of premium is taxed as income.
Keep in mind that the answers to these issues may differ depending on the legal structure of the business. Some employers are considered "self-employed" and are subject to special rules; we'll discuss what "self-employed" means below.
Also, the taxability of health insurance can be affected by how you set up your health plan. For example, with just a little paperwork on the employer's part, an employee can contribute to the cost of health insurance on a pre-tax basis, lowering the amount of the employee's taxable income and increasing the employee's take-home pay. In addition, because taxable income is reduced, related employer-paid payroll taxes are also reduced. We'll explain this in more detail below.
If you find yourself getting confused, just remember that most tax-related questions boil down to one or more of the main issues listed above. They are the main questions employers and employees find themselves asking, and the ones we'll answer below.
No question, tax issues can get complicated, so you should consult with your accountant about your specific circumstances.
Tax-Deductibility of Employer's Premium Contributions
A common question for employers is whether their contributions towards health coverage premiums are deductible as business expenses. In general,
- Employer premium contributions for their employees and employees' spouses, dependent children and domestic partners are 100 percent deductible as business expenses under federal and state tax laws. This is true regardless of business type—sole proprietorship, partnership, LLC, corporation, etc.
- Employer premium contributions for themselves and their spouses, dependent children and domestic partners are 100 percent deductible, but according to different rules for self-employed versus not self-employed employers. If the employer is not self-employed, the contribution is 100 percent deductible as an expense of the business. If the employer is self-employed, the contribution is 100 percent deductible, but as a separate deduction on the owner's tax return.
What does it mean to be "self-employed"? Generally speaking, owners of C corporations and LLCs classified as corporations for tax purposes are not considered to be "self-employed." These business owners are considered to be employees of the business. On the other hand, the following types of employers are considered to be "self-employed" for purposes of health care benefits:
- Owner of a sole proprietorship
- Partner in a partnership
- Member of an LLC classified as a partnership for tax purposes, and
- Shareholder of 2 percent or more of the stock of an S corporation.
As we continue to discuss rules below, keep in mind that employers who are not self-employed are considered to be employees, so any rules that apply to employees apply to the employer as well. If the employer is self-employed, a special rule may apply.
Tax-Deductibility of Employer's Medical Reimbursements
Employers may deduct as business expenses any reimbursements they provide to employees for health coverage and health care expenses, as long as some rules are followed. The employer must have a "plan" in writing that stipulates the employer will provide health coverage by reimbursing its employees for all or part of the cost of coverage purchased directly by the employees. Employers should also obtain documentation of the medical services before reimbursing the employee.
Employers who are self-employed may also deduct the cost of their own and their dependents' health care expenses, but as personal expenses rather than business expenses.
Taxability of Value of Health Plan to Employee
Another issue is whether the value of the health plan—basically, the amount of the premium costs—is taxable to the recipient. Keep in mind that the recipient could be an employee or a self-employed business owner. The general rule is as follows:
- Employees are not taxed on the value of their health coverage. The value of employer-provided health coverage for the employee, the employee's spouse or children is not taxable income to the employee. The coverage is tax-exempt to the employee whether it is provided under a group or individual insurance policy. The value of coverage for unmarried domestic partners, however, is taxable income to the employee, unless the individual is a dependent.
- Business owners who are considered to be self-employed are taxed on the value of their health coverage. As we explained above, the following types of employers are considered to be "self-employed": owners of sole proprietorships, partnerships, LLCs classified as a partnership for tax purposes, and 2% shareholders in an S corporation. These business owners will be taxed on the value of their health coverage, but receive an off-setting deduction on their tax returns.
Taxability of Reimbursements to Employees
If an employee pays the premiums on personally owned health insurance or incurs medical costs and is reimbursed by the employer, the reimbursement generally is excluded from the employee's gross income and not taxed. This includes premiums for spouses and dependent children. However, there are some circumstances in which the reimbursement is taxable income, including the following:
- If an employer simply pays the employee an extra amount and does not specify in writing that the amount must be used to pay the health coverage premium, it will be taxable to the employee as income.
- Employer-paid premiums for coverage for domestic partners or domestic partners' children are taxable to the employee.
- If the employer is self-employed, any reimbursements for their own or their dependents' health care costs are taxable income to the self-employed employer.
It may be difficult to provide reimbursements for individual coverage while complying with California's small group law (AB 1672) and tax law. To further explore these issues, contact a tax professional.
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See "Laws Related to Health Insurance" in the tool box. |
Taxability of Employees' Premium Contributions
Generally speaking, the employee contribution towards health coverage is incurred in their wages unless the employer establishes a special arrangement under Section 125 of the Internal Revenue Code. Without a Section 125 plan in place, taxes are imposed on employees' pay before they pay their share of the premium.
Section 125 plans include:
- Before-tax "premium only" plans. Plans that allow employees to pay their share of the premium with before-tax dollars.
- Flexible spending account plans. Reimbursement plans that, in essence, allow employees to pay for certain eligible out-of-pocket medical expenses with before-tax dollars.
- Cafeteria or flexible benefit plans. Plans that give the employee a choice of taxable pay or nontaxable benefits.
In various ways, these plans allow you and the employee to save on taxes. If employees contribute to the premium with before-tax pay, they will reduce their federal income tax, state income tax, Social Security tax, and other payroll taxes. You will also save employer taxes (FICA and FUTA) on the amount of their before-tax contributions.
There are limits on how you can use Section 125 plans. Premiums paid by employees for individual insurance policies or COBRA coverage, or the employee's share of premiums paid for a non-dependent domestic partner must be paid by the employee with after-tax dollars.
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In the tool box, see "Tax and Business Resources." |
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