Health Insurance Premium Reimbursements to Employees

There have been some significant changes to what can be done by employers in reimbursing insurance premiums for their employees. In prior years, employers were allowed to either pay for, or reimburse, the cost of employees’ individual healthcare premiums on a tax-free basis. New legislation and guidance provided very late in 2014 from the Department of Labor now prohibits this practice. This is effective for the 2014 tax year and affects any employer with 2 or more employees that does not have a group plan. As a result, if you are an employer reimbursing the premiums for your employees’ individual health care premiums, you must now include this reimbursement as taxable income on the employee’s paychecks and W-2. This income is subject to the normal federal income tax, FICA, Medicare, and state withholdings.

If you have a group health plan, nothing changes; the changes are only for employers that reimburse the cost of individual health plans.

Note: If the employer (including an S-Corporation) has only one participant in a health reimbursement arrangement, the corporation is allowed to reimburse that employee on a tax-free basis as before the ACA rule changes. If that person is a more than 2% shareholder of the S-corporation, the rules still require that the cost of the premiums reimbursed be included in wages in order to allow an above-the-line deduction for the shareholder.  FICA and Medicare need not be charged.

Employers with more than one employee that have traditionally reimbursed their employees on a pre-tax basis for their individual health care premiums must now either (1) eliminate their health benefits entirely, (2) establish group health insurance coverage for their employees, or (3) add an amount for health insurance on their paycheck as regular (taxable) compensation.

Penalties for continuing to reimburse employees on a tax-free basis face severe penalties of $100 per day, per employee.

Health Insurance Premiums Paid to 2% Shareholders

For those S-corporations with group plans or are the only employee of the corporation, the Internal Revenue Service still requires health insurance premiums paid by S-corporations for employees owning more than 2% of the corporation and/or their family members (“2% shareholders”), to be treated as additional wages to the employee. These wages are subject to federal income tax withholding, but exempt from FICA, Medicare and FUTA. If health insurance premiums for 2% shareholders are not included on the shareholder’s W-2, they cannot be deducted on the tax returns.

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About Steve Trojan, CPA

Steve Trojan, CPA is owner of SMT & Associates, Inc. (www.smt-associates.com), a Crystal Lake IL based tax and accounting firm. He can be reached at 815-788-5114.
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4 Responses to Health Insurance Premium Reimbursements to Employees

  1. Are premiums paid for 2% S-corp shareholder individual policies included in Illinois STATE wages or just federal wages?
    Thanks!

    • Great question. We include them in both federal and Illinois wage boxes. At the end of the day, it will not matter on the shareholder’s Illinois tax return since Illinois taxable income is derived from federal AGI, and the shareholder will have a corresponding deduction for the insurance premiums.

  2. Sandy says:

    Many recent articles on this topic state that they can not be included as taxable income -rather you can provide all employees with additional compensation but they can spend it as they want. Examples: http://www.forbes.com/sites/anthonynitti/2015/01/18/large-penalties-await-employers-who-reimbursed-certain-employee-health-insurance-premiums-in-2014/

    • Yes, that is yet another nuance that has slowly crept into the discussion as well. In other words, you simply can’t reimburse an exact amount for health insurance and include it in income, but rather provide them additional taxable compensation that they can spend on whatever they want, including health insurance.

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