Fringe Benefits and Taxes
With the ongoing controversies in Washington D.C. over health care and the tax implications for employer-paid plans, there seems to be some premature concerns about health care plans currently utilized by employers to cover their employees. The following report summarizes key issues around employer paid health, hospitalization, and accident fringe benefits and their taxability. Consult a knowledgeable tax professional to get full details on each corresponding issue.
Are Employer Contributions Taxable?
The existing federal income tax law regarding employer contributions or premium payments for plans on health, hospitalization, and accidents covering the employee, employee spouse, dependents, and children up to age 27, are not taxable.
Pre-Tax, Salary Reduction Contributions by an Employee. When an employee makes a pre-tax, salary reduction contribution to receive coverage under an employer’s “cafeteria” health plan, the employee’s contribution is viewed as an employer contribution. These contributions are unconditionally tax-free.
Employer Contributions for Temporarily Laid-Off Employee(s). In the event of a temporary layoff, when coverage benefits are extended for the duration of the temporary layoff period, the employer share of the contribution is not counted as taxable income.
Employer Contributions for Retirees. Former employers contributing to or paying full premiums for, ongoing coverage plans on retirees are not considered to be paying wages to said recipients. Retirees do not pay federal income tax on their former employers’ contributions for their ongoing coverage.
Employee Survivor Benefit Coverage. Surviving family members who will continue receiving coverage for health, hospitalization or accident plans – following the death of the employee- receive coverage tax free. Under federal tax law, the coverage is classified as an extended continuance of the employee’s benefit package. Tax free status to qualifying survivors is transferrable to include, spouse, children under age 27 whether they qualify as dependents, and dependents.
Taxable Benefits for Companions and Domestic Partners
The 1996 Defense of Marriage Act does not recognize self-identifying gay and lesbian couples as qualifying married couples for purposes of taxation under federal law. Additionally, health, hospitalization, and accidental coverage contributions and premiums, for live-in companions who do not qualify as spouses or dependents, are taxable as income. The taxable amount is measured as the marginal difference between total value of the coverage(s) and the value of the employee contribution to said coverage(s). The employee paid portion of the plan(s) is tax deductible.
Medicare Premiums for Employees Aged 65 and Older. These are wholly non-taxable. If an employee retires, and is option eligible to receive continued coverage(s) and a lump sum pay out of medical/sick leave accrued benefits, the value of the payout is taxable during the tax year the recipient becomes eligible. However, should the recipient elect to continue collecting health benefits, any amount paid out can be claimed as a medical insurance deduction. The recipient must itemize deductions. Coverage for Disabilities. Coverage(s) are tax free when either of the following conditions is satisfied: 1. Employer does not report premiums or contributions as income on employee Form W-2. 2. Employee pays premiums or makes contributions as part of a pre-tax, salary contribution. Benefits are taxable when benefits are received upon becoming disabled. If premiums are paid using after-tax contributions or, employer contributions are reported on the Form W-2 as income, benefits are not taxable.
Health Reimbursement Arrangements (HRAs). Employees are not taxed on employer contributions. Contributions cannot be paid pre-tax as salary reductions. HRA contributions can be used to reimburse employee medical costs, and costs for spouses and dependents. Unused expenses are eligible for carryover into later tax years.
Be sure to consult a knowledgeable tax professional to stay in full and absolute compliance with all federal income tax laws. This article is intended as a quick and useful reference to assist you with your tax planning research, and in no way purports to represent a substitute for professional tax counsel.