Why Employer-Paid Health Insurance Is Tax-Free to Employees
Employer-paid health coverage is generally excluded from an employee’s wages. The employee pays no income tax on the part of the premium the employer covers, and the premium generally avoids Social Security, Medicare and unemployment tax. Owners are treated differently depending on the entity type.
What Is Excluded From Wages
These come from IRS Publication 15-B on fringe benefits.
Employer-Paid Premiums
Employer contributions toward health insurance are generally excluded from the employee’s wages, so they are exempt from income tax withholding, Social Security and Medicare tax, and unemployment tax.
Medical Payments Under the Plan
Payments for medical expenses made under a qualifying employer health plan can also be excluded from the employee’s income.
Employer HSA Contributions
Employer contributions to an employee’s health savings account are excluded from wages as well, when the employee is covered by a qualifying high-deductible plan.
Coverage for Family
The plan can cover the employee’s spouse, dependents and children who are under age 27 at the end of the tax year, and the employer-paid coverage is excluded for them too.
The Employee’s Share, Through Section 125
When employees pay their share through a Section 125 cafeteria plan, that share avoids income tax and payroll tax too. See the Section 125 tax savings calculator.
Compared With a Raise
A premium the employer pays is worth a full dollar to the employee. A raise of the same size is taxed first. See the benefits increase versus raise calculator.
Owners Follow Different Rules
The exclusion above is for employees. An owner’s treatment depends on the entity type.
C Corporation Owners
An owner who is a real employee of a C corporation is treated like any other employee, so the exclusion applies.
S Corporation Owners With More Than 2 Percent
Not treated as an employee for the exclusion. The premium is included in wages for income tax and exempt from Social Security and Medicare tax, and the owner deducts it personally.
Sole Proprietors
Not employees of their own business, so there is no exclusion. The owner takes a personal deduction instead.
Partners and LLC Members
Partners are not employees of the partnership. Premiums are reported as guaranteed payments and the partner takes the personal deduction.
Common Problems With the Exclusion
Employee Share Paid After Tax
Unless employees pay their share through a Section 125 plan, their share is paid from pay that has already been taxed.
Opt-Out Cash Is Wages
Cash paid to an employee who declines coverage is generally taxable wages. It is not excluded the way the premium would have been.
Treating an Owner as an Ordinary Employee
For an S corporation owner with more than 2 percent ownership, a partner or a sole proprietor, the exclusion does not apply in the ordinary way. Use the entity guide.
Employee Exclusion Questions
Are employer-paid premiums really tax-free to the employee?
Generally yes. They are excluded from wages for income tax and payroll tax purposes.
Is the employee’s own share tax-free too?
Only if it is paid through a Section 125 cafeteria plan. Otherwise it is paid from after-tax pay.
Do I report the premium on the employee’s W-2?
Larger employers report the cost of coverage on the W-2 for information only, and that reporting does not make the coverage taxable. A more-than-2-percent S corporation owner is the exception, because the premium is included in wages.
What about my spouse and children?
The plan can cover them, including children under age 27 at the end of the tax year, and the employer-paid coverage is generally excluded.
How does the business deduct the premiums?
Who should confirm my situation?
Your CPA. We can document the plan so the contribution and the employee deductions are recorded the way the rules require.
CFH are licensed insurance brokers, not tax advisors, and this page is general information rather than tax advice. Ownership, family relationships and how the business is taxed all change the result, so confirm your own treatment with your CPA. Our clients also have access to CPAs and attorneys through the firm.
Where These Rules Come From
IRS: Instructions for Form 7206, Self-Employed Health Insurance Deduction · S Corporation Compensation and Medical Insurance Issues · Notice 2008-1 · Publication 15-B, Employer’s Tax Guide to Fringe Benefits
Related Guides
Related reading: Tax Benefits of Group Health Insurance for Owners · C Corporation Owners · S Corporation Owners With More Than 2 Percent · Sole Proprietors · Partners and LLC Members · Small Business Health Care Tax Credit · Section 125 Tax Savings Calculator
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