Getting health insurance might be simple. However, obtaining a pretax plan is another story. For you to pay your health insurance premiums with pretax money, you must go through a qualified employer. If you’re fortunate enough to have such an employer, you do not pay federal and typically state taxes on your premiums. The Internal Revenue Service enforces federal tax laws for pretax health insurance premiums.
To provide a pretax health insurance program, your employer must establish a plan that meets Section 125 of the Internal Revenue Code. The plan may offer medical, dental, vision, cancer, accident and hospital indemnity insurance. It can also include disability insurance, but you must pay taxes on your disability benefits if you pay your premiums with pretax money.
Income Tax Exclusion
You do not pay federal income tax on your Section 125 health insurance premiums. This means your employer does not add your premiums to your gross pay when withholding federal income tax. This causes a reduction in your gross pay and tax withholding. Most states follow federal treatment of pretax premiums for state tax purposes. The state might exclude types of coverage from state income tax, such as hospitalization, illness and disability.
Social Security and Medicare taxes, also called Federal Insurance Contributions Act taxes, do not come out of your health insurance premiums. You save money on these taxes because your employer does not count your premiums in your gross pay when withholding FICA taxes from your paychecks.
Because pretax premiums are not taxable, your employer does not include the amounts in boxes 1, 3 and 5, which represent your taxable wages, of your annual W-2. Your last pay stub for the year may have your total annual pay, including your pretax premiums. To help you reconcile your last pay stub with your W-2, your employer might put your pretax payments in Box 14 of your W-2. Under the Affordable Care Act, your employer is supposed to report its group health care coverage cost in Box 12, under Code DD, of your W-2. This cost includes any amounts your employer pays toward your health insurance plan plus your portion.
Impact on Social Security
Your employer must file your W-2 with the Social Security Administration, which credits you for future benefits based on the FICA withholding amounts on your W-2s. Because you did not pay FICA taxes on your pretax premiums, the SSA does not include those amounts when computing your benefits. This may reduce your Social Security benefits.
During tax time, you cannot take a tax deduction for your pretax premiums, as you already received a deduction at the time of withholding. If you had opted out of your employer’s pretax plan and paid your premiums with after-tax money instead, then you could claim a deduction on your tax return. After-tax means your employer adds your premiums to your gross pay when calculating taxes (see Reference 5)
You can change your pretax health insurance premium amount only during open enrollment or when you have a qualifying event. In the former case, you must wait until your employer’s next plan year arrives. Qualifying event refers to marriage, divorce, child birth, adoption of a child, death of your spouse or child, or a change in your or your spouse’s employment status (see Reference 6 and 7).
- Sterling Health Services Administration: Premium Only Plan
- IRS.gov: FAQs for Government Entities Regarding Cafeteria Plans
- Pennsylvania Department of Revenue: IRC Section 125 Cafeteria Plans or Flexible Spending Plans
- IRS.gov: Form W-2 Reporting of Employer-Sponsored Health Coverage
- TurboTax: Are My Health Insurance Premiums Deductible?
- Wayne State University: Pre-Tax Medical Insurance FAQ
- Research Foundation for Mental Hygiene: Health Insurance Pre - Tax Contribution Policy (PTCP)
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