At face value, any expenses an employer sustains related to health insurance, whether it is for employees or for dependents, are 100% tax-deductible as traditional business expenses. This stands true for both state and federal taxes. However, with more specifications, this becomes more complex.
What needs to be considered?
Are employees’ health coverage premium contributions tax-deductible as a business expense?
- Employer premium contributions for employees and their opposite-sex spouses and tax dependents are 100% deductible as business expenses under federal and state tax law.
- If an employer is self-employed, contributions for the individual and their opposite-sex spouse and tax dependents are 100% deductible as a business expense on the business owner’s tax return.
Are employer reimbursements for the costs of coverage and care tax-deductible as business expenses?
- Reimbursements provided by employers for medical expenses and health care coverage of employees are treated similarly to employer-provided premium contributions if 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 medical expenses or the cost of coverage purchased directly by the employees.
- Employers who are self-employed can also deduct the cost of their own and their tax dependents’ healthcare expenses, but as personal expenses instead of business expenses.
Are the employer’s premium contributions taxed as income?
- Employees are not taxed based on the value of their health insurance coverage. The amount of employer-provided health coverage for the employee and their opposite-sex spouse or tax dependents is not taxable income to the employee under federal and state tax law.
- An employee who also receives coverage for a same-sex spouse, domestic partner, or dependents is subject to federal tax on the value of the coverage provided by the employer for the non-tax dependents,
- Self-employed business owners are taxed on the value of their health coverage.
Are the employer’s medical reimbursements taxed as income?
- Employer reimbursement generally is excluded from the employee’s gross income. It is nottaxed under either federal or state tax law.
Is an employee’s share of the premium paid with pre-tax or after-tax income?
- Generally speaking, the employee’s contribution toward their health coverage is deducted from wages on an after-tax basis – that is, unless the employer establishes a special arrangement under Section 125 of the federal tax code.
As we each know, taxes are not the most straightforward topic, so your legal, insurance, and financial advisors should always be consulted to ensure complete compliance.
What about small businesses?
The Affordable Care Act (ACA) amended the tax code by adding a tax credit for small employers that provide health care coverage for their employees. The credit is available to employers that:
- Have fewer than 25 full-time equivalent (FTE) employees;
- Have an average employee salary of about $56,000 per year or less;
- Pay at least 50% of their full-time employees' premium costs; and
- Offer SHOP coverage to all of their full-time employees; this coverage does not need to be offered to dependents or employees working fewer than 30 hours per week.
Maximum credit amount
The maximum credit is 50% of premiums paid for small business employers and 35% of premiums paid for small tax-exempt employers. The credit is available to eligible employers for two consecutive taxable years.
The amount of the credit is on a sliding scale; smaller employers receive a bigger credit. For employers with more than 10 FTE employees, or an average wage of more than $25,000 (as adjusted for inflation), the amount of the credit will be less.
The credit can result in substantial savings. The IRS uses the following as an example: If you pay $50,000 a year toward employees’ health care premiums, and if you qualify for a $10,000 credit each year, you can save $20,000 over the course of two years.
Flexibility to carry forward or back
The IRS says that even if your small business does not owe tax during the year, you can carry the credit back or forward to other tax years. Also, since the amount of the health insurance premium payments is more than the total credit, eligible small businesses can still claim a business expense deduction for the premiums in excess of the credit.
For more information
The small business tax credit can help you provide the benefits your employees expect while helping you control the associated costs. If you need help calculating FTEs or their wages, talk to your tax adviser. Additional information is also available on the IRS website.
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