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, your total taxable income is reduced.
Federal and State Pretax Health Insurance Exemptions
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 Medicare taxes of 1.45 percent are imposed on all wages. 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.
Eligibility Under Section 125 of the IRS Code
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.
W-2 Form Reporting
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 benefits
- hospital indemnity paid by employer
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.
No Tax Deductions
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 for self-employed people who foot the bill for all their own health care costs.
- 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
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