In most employer-sponsored group health plans, employees pay their share of the premiums from pretax deductions. That means the amount is deducted from your gross pay, which is money that has not yet been subjected to tax. Such pretax health insurance is a common employee fringe benefit. By deducting the amounts prior to taxation as part of your employee benefits, your total taxable income is reduced.
Tax Implications of Health Insurance
Federal taxes and state taxes are not levied on pretax health insurance amounts. For federal purposes, that includes Federal Insurance Contributions Act (FICA) taxes, comprised of Social Security and Medicare taxes. For 2017, FICA taxes of 6.2 percent are imposed on wages up to $127,200 and up to $128,400 for 2018, and Medicare taxes of 1.45 percent are imposed on all wages in both those years. For example, if your annual pretax health premium is $2,500, you are free from paying ordinary income tax on this money and will save $155 in Social Security tax and $36.25 in Medicare tax.
But there’s a bit of a downside to this. Because these funds are not included in your Social Security wages, the Social Security Administration doesn’t count them when compiling your eventual retirement benefits, so it could reduce those payments. However, the difference between what you save on Social Security taxes and what you lose in potential benefits is likely a wash. When you consider that you’re saving money on federal and state income taxes, along with Social Security and Medicare taxes, it’s definitely a win.
An employer’s health insurance plan must meet the criteria of Section 125 of the IRS code for pretax premium eligibility. Section 125 plans are better known as cafeteria plans, since they offer employees the ability to choose just some of their benefits. Other qualified benefits cafeteria plans may offer under Section 125 include group term life insurance, disability insurance, dependent care assistance and group legal plans.
You can find the value of your pretax health insurance on your W-2 Form in Box 12; the DD code identifies the precise amount. Not every type of coverage requires reporting, but if you're covered for any of the following, you will find the amount on your form: major medical, Health Flexible Spending Arrangement if the value exceeds your cafeteria plan salary reductions for qualified benefit and hospital indemnity paid by employer. Employers can also use Box 14 on the W-2 for additional information, so you may want to check W-2 Box 14 for health insurance premiums or related information not listed elsewhere.
Your employer may opt to report dental or vision plans or health reimbursement plan contributions. If your employer charges a premium for COBRA coverage, your W-2 form will also include the amounts of an Employee Assistance Plan, onsite medical clinics and wellness programs. COBRA, the acronym for the Consolidated Omnibus Budget Reconciliation Act, provides temporary health care coverage at group rates for certain former employees, their spouses and dependent children, as well as some retirees.
Tax Deductions for Self-Employed People
Because these health care coverage premiums are pretax, you cannot take a deduction on your income taxes for them. Your employer pays a substantial amount of your group health care coverage. Health care coverage deductions are primarily available for self-employed people and others who foot the bill for all their own health care costs.
2018 Tax Law Changes
Tax considerations around pre-tax insurance benefits aren't changing much for 2018, but income tax rates are generally shifting, so you may experience less savings from paying for insurance pretax.
Specifically, the standard deduction is greater for taxpayers across the board and many marginal tax rates are coming down, meaning many people will pay less tax on their income even before any deductions or pretax savings.
2017 Tax Law Considerations
Tax rates for 2017 are generally higher than for subsequent years. This means you may save more by paying for insurance with pre-tax dollars.
- IRS: Employee Benefits
- IRS: Form W-2 Reporting of Employer-Sponsored Health Coverage
- U.S. Department of Labor: FAQs on COBRA Continuation Health Coverage
- Journal of Accountancy: Social Security Administration announces large increase in 2017 wage base
- Legal Information Institute: 26 U.S. Code § 125 - Cafeteria plans
- Thomson Reuters: Social Security Wage Base Increases to $128,700 for 2018
- IRS: General Instructions for Forms W-2 and W-3
- Forbes: New: IRS Announces 2018 Tax Rates, Standard Deductions, Exemption Amounts And More
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