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Tax Breaks Tied to Offering Health Benefits

Feb 19, 2024
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Please note that this information is not intended as tax or legal advice. If you have any questions, contact a tax or legal professional.

What you need to know to advise your clients

As a trusted advisor, you can assist your clients in offering healthcare benefits that fit their businesses. Beyond the value of offering benefits to employees, your clients may be able to manage costs through certain tax advantages. For instance, a business can typically deduct 100% of what it pays toward health insurance premiums and contributions to health benefits plans. Such deductions can significantly reduce taxable income and lower overall tax liability.

Tax incentives and advantages associated with providing health benefits — from deductions to tax credits and payroll tax reduction — vary depending on the business's nature, size and location.

Tax incentives and advantages associated with providing health benefits — from deductions to tax credits and payroll tax reduction — vary depending on the business's nature, size and location. Still, they are worth exploring when deciding which employee health benefits suit your clients' organization.

Health benefits options to consider

Several types of health benefits offer employers one or more financial advantages.

Traditional group health insurance may include various benefits options, including budget-conscious HMOs, PPOs, and high-deductible health plans. Premiums may be tax-deductible for the employer, and pre-tax employee contributions can help reduce payroll taxes, as the contributions are exempt from Social Security, Medicare, and federal unemployment taxes.

Small businesses with fewer than 25 full-time equivalent employees and average annual wages below a certain threshold who provide a specific type of group health coverage may be eligible for the Small Business Health Care Tax Credit, offsetting insurance costs.

Premium only plans (POPs)* allow employees to pay a share of traditional group health insurance premiums with pre-tax dollars. Premiums are the only eligible expenses under this type of Section 125 plan. Pre-tax contributions result in immediate tax savings for employees and lower employers' payroll taxes.

Health savings accounts (HSAs) are paired with high-deductible plans (HDHP) to help employees pay for qualified medical expenses. Employees' pre-tax contributions help reduce payroll taxes, and HDHPs typically have lower premiums than other plan types, making this an attractive option for cost-conscious clients.

Flexible spending accounts (FSAs) are often paired with traditional group health plans to help employees pay for healthcare costs. Employees can contribute pre-tax dollars to their FSAs, and depending on how the plan is structured, the employer may also be able to contribute, helping to reduce the payroll tax burden. Another potential advantage of FSAs is that "use-or-lose" rules may apply, wherein unused funds may be returned to the employer.

Health reimbursement arrangements (HRAs) allow employers who meet specific criteria to reimburse employees for eligible medical expenses, including health insurance premiums. Individual coverage health reimbursement arrangements (ICHRAs) and qualified small employer health reimbursement arrangements (QSEHRAs) are common types of HRAs. Employers' HRA contributions are made pre-tax and are deemed an eligible business expense.

State-level tax incentives may also be available to clients that offer HRAs. For example, effective January 2024 in Indiana, employers with fewer than 50 employees may be eligible for a credit against their state tax liability if they’ve adopted an HRA in lieu of traditional group health and their contribution toward the HRA meets a certain standard. Other states may follow Indiana's lead and offer similar tax incentives, so it's worth keeping an eye on legislation in your state. 

*Participants in a Premium Only Plan (POP) can save on federal income taxes, state income taxes in most states, and Social Security/Medicare (FICA) taxes. Employers can save on the matching portion of FICA taxes and federal unemployment taxes and on state unemployment taxes in many states. State income tax rules vary by state. Check with your tax advisor to see how your state treats a POP.


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About the Author
Courtney Warren is the vice president, product marketing & business development at ADP, Inc.

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