Tax Implications of Providing Health Insurance to Employees – 2023 Guide

Providing health insurance to your employees supports their wellbeing and carries tax implications that can benefit your business. Health insurance for employees is a tax-deductible business expense, and small businesses may qualify for tax credits under the Affordable Care Act (ACA).

Main Points to Understand

• Health insurance premiums are considered a business expense, hence they are tax-deductible.
• Most health insurance, including medical, dental, and vision, could be considered business expenses.
• Premiums and other medical expenses can only be deducted if they exceed 7.5% of your Adjusted Gross Income.
• Tax credit programs for small businesses are available through the Small Business Healthcare Tax Credit and American Rescue Plan.

Tax Deductions for Employers Offering Health Insurance

Tax deductions lower your taxable income, thus reducing your overall tax liability. For health insurance premiums, deducting these costs means you can consider the amount you pay towards your employees' health insurance for business expenses, not taxable compensation. 

How does it work in practice? 

1. A business generates $500,000 in gross revenue (all income from sales, services, etc.).
2. The business incurs $200,000 in total business expenses (rent, salaries, supplies, health insurance premiums, etc.).
3. The business subtracts this $200,000 in business expenses from the gross revenue.
4. This leaves $300,000 in profit - the amount that will be used to calculate the business's income tax liability.

For example, if health insurance costs $50,000 out of the $200,000 in expenses, the taxable profit/income would be $350,000 without providing health insurance. 

Does being tax deductible mean businesses can provide health insurance at no cost or a discount? 

While the word tax deductible can be interpreted as an element of financial advantage, in practice, the cost of health insurance is treated similarly to any other business expenses such as office rent or supplies. Technically, providing health insurance only lowers your tax liability because it reduces the profitability you would otherwise have. 

Some misconceptions when it comes to providing health insurance

• It's free - health insurance premiums are treated as expenses, and it lowers your taxes because it lowers your profitability,
• It's a requirement - only if you have more than 50 employees.
• Health insurance is the only qualification - you can also provide health reimbursement like QSEHRA
• If you have less than 50 employees or you have contractors - you can explore non-insurance products like Mira, Mira is also considered a business expense and is tax-deductible.

Health insurance premiums employers pay are fully tax-deductible as business expenses on federal and state income taxes. This is true for all businesses, including those run by self-employed individuals. Employers can also deduct the premium contributions and medical reimbursements of employees’ opposite-sex spouses and dependents. Most dental, vision, and long-term care insurance premiums are eligible for tax deductions, provided they are medically necessary and not cosmetic.

To qualify for these deductions, the insurance plan should be established under the employer’s business name or in your name if you're self-employed. The plan should cover the employees, their spouses, dependents, and any eligible former employees. Detailed instructions and guidelines are available in IRS publication 535 (Business Expenses) and on Form 1040.

To claim deductions for health insurance premiums, employers must include them as business expenses on their annual tax returns. The specific process may vary depending on your business type and structure.

Eligibility for Employee Deductions

If you provide health insurance to your employees, your premiums are exempt from federal income and payroll taxes. However, the criteria for tax deductions vary if you're an employee of a business or self-employed.

Employees under employer-sponsored health insurance can also deduct their medical expenses. To qualify for this deduction:

• Use Schedule A (Form 1040) to list your tax deductions for yourself, your spouse, and your dependents.
• Premiums should be paid post-tax to qualify for medical expense deductions. If your employer provides your health insurance, your premiums are deducted pre-tax from your paycheck and cannot be claimed.
• Premiums and other medical expenses can only be deducted if they exceed 7.5% of your Adjusted Gross Income.

The IRS permits medical care expenses to be deducted if they are paid for during the year and include payments for diagnosis, cure, treatment, or prevention of diseases. However, certain expenses, like funeral or burial costs, nonprescription medicines, cosmetic surgeries, and nicotine replacement therapies that don’t require a prescription, are not deductible.

Health Insurance Tax Credit for Small Employers

Small businesses can receive healthcare tax credits under the Affordable Care Act (ACA) to help lower the cost of health insurance. These credits are on a sliding scale based on the size of the employer. To be eligible, business owners must:

• Pay at least 50% of employees’ healthcare premiums.
• Have 25 or fewer full-time equivalent employees.
• Employees must earn an average of $50,000 or less annually.

To claim this tax credit, use Form 8941 (Credit for Small Employer Health Insurance Premiums). Small businesses can include this amount as a credit on their income tax return. Similarly, tax-exempt organizations can use Form 990-T (Exempt Organization Business Income Tax Return) to receive refundable credit.

Additional tax credits were made available through the American Rescue plan during the COVID-19 pandemic to assist small businesses.

Tax Exclusions for Employees

Tax exclusions reduce your reported annual gross income, hence lowering the taxes you pay. Contributions made by employers towards an employee's health insurance coverage are not subject to federal or state income tax, and health insurance premiums paid by employees are generally excluded from taxable income.

Lowering Employee Taxable Income

Employers with 50 or more full-time equivalent employees must provide health coverage to at least 95% of full-time employees under the Affordable Care Act. Employer contributions to health insurance premiums are generally not considered part of an employee's taxable income.

This means employees see a decrease in their taxable income, lowering their tax liability. This exclusion effectively gives employees tax-free compensation via health insurance benefits. After deducting health insurance premiums, employees only pay taxes on the remaining portion of their income, leading to tax savings.

Benefits of Exclusion for Employees

The exclusion of employer-provided health insurance premiums from taxable income offers several benefits for employees. By excluding health insurance premiums from taxable income, employees see a decrease in overall tax liability, lower income taxes, and less payroll taxes towards Medicare and Social Security. This can result in higher take-home pay, more financial flexibility, and increased disposable income.

Further, tax exclusions on employer-sponsored health insurance encourage accessible healthcare among employees. This reduces the financial burden of high medical expenses and ensures employees can seek necessary medical care without significant financial strain.

Frequently Asked Questions

Understanding tax deductions and exclusions for health insurance can be challenging. Here are some commonly asked questions:

Are health savings accounts (HSAs) tax-deductible for employers?

Yes, contributions made by employers or employees to HSAs are not subject to federal income tax.

What's the difference between a tax credit and a tax deduction?

Tax credits are reductions in the amount of taxes you owe, while tax deductions decrease your taxable income.

Are dental and vision plans also eligible for tax deductions and exclusions?

Yes, medical, dental, and vision plans are tax-deductible according to IRS Publication 502. However, medical expenses can only be deducted when they exceed 7.5% of your annual gross income.

In Summary

Offering health insurance to employees brings tax implications such as tax deductions and exclusions. Employers can declare health insurance as a business expense, making premiums and medical expenses tax-deductible. Employees can also exclude premiums from their taxable income under the Affordable Care Act, leading to lower tax liability.

Source:
IRS Publication 535: Business Expenses - Link
IRS Publication 502: Medical and Dental Expenses - Link
Affordable Care Act Tax Provisions for Employers - Link
Instructions for Form 8941 - Link
Health Savings Accounts - Link
Tax Exclusion for Employer-Provided Health Coverage - Link