Reversing a pretax medical deduction is not as simple as reversing the amount of money you want to give back to the employee. Pretax deductions are taken out of an employee's pay before you tax the balance of the paycheck. When you designate money as a pretax medical deduction, the money is either tax-exempt or exempt from some taxes, but not others. When you refund the money to the employee, the money loses its tax-exempt status, and you must tax the money the same way you would the rest of the employee's taxable income.
Calculate the amount of the previously paid pretax medical deduction you must refund. How you calculate this amount varies depending on why you are giving the refund and how many monthly deductions you are refunding. The easiest way to calculate the refund is to review the employee's record and add up each monthly deduction that you are refunding.
Set up a new special category for the pretax medical deduction refund called Pretax Medical Refund. It is tempting to reverse the deduction using the pretax deduction code, but once you reverse a pretax deduction, it no longer has the tax-exemption status, and you will calculate it differently. This is why you must create a separate code for it.
Review the pretax medical category to see if you took any taxes out of the money you are reversing. Health savings accounts are exempt from federal income tax withholding, FICA and FUTA tax. Health benefit deductions such as medical premiums are exempt from income tax withholding, FICA and FUTA. S corporation employees who are 2 percent shareholders are not exempt from FICA. Also, state medical exemptions vary from state to state.
Tax the new category you set up as regular taxable income if the pretax medical deduction was exempt from all applicable taxes.
Customize the pretax medical refund category so you do not take out any taxes that have already been taken out if the pretax deduction was exempt from some taxes but not from others.
Include the pretax medical refund code with the refund amount on the employee's paycheck.
A payroll service will handle all of these details for you. You simply tell them the amount of the refund.
These instructions assume you use payroll software to process your payroll. The steps can be done manually. Just exclude the codes.
Based in New York, Kate Bluest has been writing for various online publications since 2005. She has participated in several writing workshops, including the MIT Writing Workshop. Bluest holds a Bachelor of Science in business administration from SUNY Empire State College.