Jeffrey Wade
Medical and dental insurance can be a costly but necessary expense. Many employers recognise the value of offering health benefits plans to their employees, and these can be either pre-tax or post-tax. Pre-tax health insurance plans are deducted from an employee's paycheck before their employer withholds income taxes or payroll taxes. After-tax plans are an alternative option if an employee doesn't want to participate in their employer's pre-tax plan or if their employer doesn't offer one. There are also tax benefits to be gained from both types of plans.
| Characteristics | Values |
|---|---|
| Pre-tax medical premiums | Health insurance premiums deducted from your paycheck before your employer withholds income taxes or payroll taxes |
| After-tax medical premiums | An alternative option if an individual doesn’t want to participate in their employer's pre-tax plan or if their employer doesn’t offer a pre-tax plan |
| Pre-tax health insurance plans | Health reimbursement arrangements (HRAs), Section 125 cafeteria plans |
| After-tax plans | Accident or disability insurance |
| Self-employed health insurance deduction | An adjustment to income, rather than an itemized deduction, for premiums paid on a health insurance policy covering medical care |
| Medical and dental expenses | Transportation costs, insurance premiums, nutrition, wellness, and general health |
| Medical care expenses | Payments for diagnosis, cure, mitigation, treatment, or prevention of disease, or payments for treatments affecting any structure or function of the body |
| Tax exclusion for employer-sponsored health insurance | Employer-paid premiums for health insurance are exempt from federal income and payroll taxes |
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What You'll Learn
Pre-tax health insurance plans
When considering health benefits plans for employees, employers can opt for either pre-tax or post-tax health insurance options. Pre-tax health insurance plans are deducted from an employee's paycheck before their employer withholds income taxes or payroll taxes. These premiums are usually available for employer-sponsored health insurance plans. They can save individuals up to 40% on income and payroll taxes.
There are several types of pre-tax health insurance plans. One of the most common is a Section 125 cafeteria plan, where participants can choose between two or more benefits, which consist of cash and qualified benefits, and they are not included in gross income. To be eligible for this plan, all participants must be employees. If an employer sets up a Section 125 cafeteria plan, they can deduct insurance premium contributions from their payroll on a pre-tax basis.
Another type of pre-tax health insurance plan is a Premium-only plan (POP), where employers can deduct insurance premium contributions from their payroll on a pre-tax basis.
Health reimbursement arrangements (HRAs) are another pre-tax health insurance option. With HRAs, employees can choose the health plan they want or need. A Qualified Small Employer Health Reimbursement Arrangement (QSEHRA) is available for small employers who are not required to purchase company health insurance under the Affordable Care Act (ACA). With a QSEHRA, employers can reimburse up to $6,350 for single employees or $12,800 for family coverage in 2025. Only small employers can set up and take advantage of a QSEHRA standalone plan. You can reimburse employees for individually-obtained premiums and any qualifying medical expenses (e.g., medication). Individual Coverage Health Reimbursement Arrangements (ICHRAs) are plans that allow employers to reimburse employees without contribution limits.
Additionally, there are healthcare spending account contributions, such as health savings accounts (HSAs) and flexible spending accounts (FSAs). With these, employers can reimburse employees for medical insurance premiums. Employees can open an FSA regardless of the type of health insurance plan they have, but they can only open an FSA if they are an employee, not if they are self-employed.
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After-tax health insurance plans
Health insurance plans are either pre-tax or post-tax, and the distinction is important as it determines how much employees pay in taxes and their eligibility for other employer-sponsored benefits. Pre-tax health insurance plans are deducted from an employee's gross pay and are typically available for employer-sponsored health insurance plans. They can save individuals up to 40% on income and payroll taxes.
After-tax medical premiums are an alternative option if an individual doesn't want to participate in their employer's pre-tax plan or if their employer doesn't offer a pre-tax plan. When filing income taxes, you may be able to deduct these premiums as itemized deductions for all medical expenses and premiums that exceed 7.5% of your income. Additionally, most self-employed taxpayers can deduct health insurance premiums using Schedule 1 for Line 162 on Form 1040.
Individually purchased plans with qualifying after-tax premiums include major medical coverage, such as purchasing individual health insurance through the Health Insurance Marketplace, and supplemental/voluntary coverage, such as accident or disability insurance. You can drop coverage that's paid with after-tax dollars at any time, so a good reason to go this route is if you anticipate dropping the coverage and enrolling in another plan in the middle of the year because you qualify for a special enrollment period.
A standalone HRA (Health Reimbursement Arrangement) is another option for after-tax health insurance. With a qualified small employer HRA (QSEHRA) or individual coverage HRA (ICHRA), you purchase an individual health insurance plan with your own money, and your employer reimburses you for your monthly premiums and other eligible out-of-pocket medical expenses up to the set allowance amount. The reimbursements for medical care are made on a tax-free basis as long as you have minimum essential coverage (MEC), so you get the same tax benefits as you would with a traditional pre-tax plan.
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Self-employed health insurance deduction
Self-employed individuals can deduct the health insurance premiums they pay to help offset the cost of medical expenses. This is a valuable tax break, especially with the rising cost of health insurance. Self-employed people can deduct premiums for medical, dental, and qualifying long-term care insurance coverage for themselves, their spouses, and their dependents. This deduction is available regardless of whether they choose to claim the standard deduction or itemize their deductions.
To be eligible for the self-employed health insurance deduction, you must meet certain Internal Revenue Service (IRS) criteria. For example, if your self-employment activity is a sole proprietorship that generated a tax loss for the year, you are not allowed to claim the deduction because the business did not generate any positive earned income. However, if you are a business partner or LLC member who is treated as a partner for tax purposes, you can deduct the health insurance premiums you pay directly.
If you have a qualifying insurance plan and are an eligible self-employed individual, you can deduct up to 100% of the health insurance premiums you paid during the year on your income tax return. Eligible health insurance includes medical insurance, qualifying long-term care coverage, and all Medicare premiums (Parts A, B, C, and D). You can include a health insurance premium paid for yourself, your spouse, dependents, and any non-dependent child under 27 at the end of the year.
If you didn't include Medicare premiums (or other insurance premiums) on a prior year's return, you can file an amended return to claim or increase your deduction for self-employed health insurance for that year. Your health insurance premiums are tax-deductible if you have a net profit reported on Schedule C or F. You are also eligible if you are a general partner, a limited partner receiving guaranteed payments, or a shareholder owning more than 2% of the outstanding stock of an S corporation with wages from the corporation reported on Form W-2.
It is important to note that if you have access to participate in an employer-sponsored subsidized health insurance plan, you won't be eligible for this tax deduction. This includes situations where either you or your spouse is eligible for an employer-sponsored, pre-tax health plan, even if you decline that coverage.
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Health Reimbursement Arrangements (HRAs)
There are several types of HRAs, including:
- Qualified Small Employer Health Reimbursement Arrangement (QSEHRA): Available for small employers who are not required to purchase company health insurance under the Affordable Care Act (ACA). A small employer under the ACA is defined as having fewer than 50 full-time equivalent (FTE) employees. With a QSEHRA, employers can reimburse up to $6,350 for single employees or $12,800 for family coverage annually.
- Individual Coverage Health Reimbursement Arrangements (ICHRAs): Plans that allow employers to reimburse employees without contribution limits. These can be used to reimburse premiums for individual health insurance chosen by the employee, promoting flexibility for both employees and employers.
- Excepted Benefit HRAs: These HRAs permit employers to finance additional medical care, such as copays, deductibles, or other expenses not covered by the primary plan, even if the employee declines enrollment in the traditional group health plan.
By offering HRAs, employers can provide their employees with a valuable benefit that helps attract and retain talent while also enjoying tax advantages and savings on medical costs.
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Section 125 cafeteria plans
On November 6, 1978, Section 125 was added to the Internal Revenue Code, paving the way for what we now know as cafeteria plans. These plans are a way for employers to offer their employees certain benefits on a tax-free basis.
Cafeteria plans, or Section 125 plans, give employees the option to choose from a variety of benefits, such as health insurance, flexible spending accounts, and dependent care. They are called cafeteria plans because they allow employees to pick and choose benefits like they would items from a cafeteria menu.
The key advantage of these plans is the tax savings they offer to both employees and employers. Employees can lower their taxable income by making pre-tax contributions, which reduces what they pay in income tax and increases their take-home pay. Employers, on the other hand, benefit by saving on payroll taxes, such as FICA, FUTA, and Medicare taxes, as well as other payroll-related expenses.
To satisfy the Section 125 nondiscrimination requirements, cafeteria plans must pass three tests: the eligibility test, the benefits and contributions test, and the key employee concentration test. Firstly, the plan must not discriminate in favour of highly compensated individuals in terms of eligibility. Secondly, the plan must ensure that highly compensated participants do not select more non-taxable benefits than non-highly compensated participants. Lastly, the plan must not allow key employees to receive non-taxable benefits exceeding 25% of the total non-taxable benefits provided to all employees.
Employers offering a cafeteria plan should seek advice from a benefits attorney or TPA experienced in non-discrimination testing to ensure compliance with the complex and varying nondiscrimination rules and requirements.
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Frequently asked questions
You can check your pay stub for a column titled "Deductions" or something similar. If your health premium is listed in this column and your employer deducts it from your gross pay, it's a pre-tax premium.
Pre-tax medical and dental insurance premiums can save individuals up to 40% on income and payroll taxes. Pre-tax premiums are also exempt from federal income and payroll taxes.
If your employer doesn't offer a pre-tax plan, you may be able to deduct your medical and dental premiums on an after-tax basis. You can also list your premiums as an itemized deduction when you file your income taxes.
