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Usually, if you have the option as an employee to receive cash or a benefit, and you opt for the benefit, the value of the benefit is included as part of your taxable income. However, cafeteria plans offer a popular exception to that rule that gives you flexibility as to which benefits you want, and which you'd be better off without and receive cash instead.
A cafeteria plan lets your employer give you the choice of receiving cash or putting that money toward qualified benefits, such as health insurance. When you elect to pay for health insurance, the money is taken out of your salary before it gets paid to you. As a result, the amount you pay in premiums is never included in your taxable income, nor is it subject to income tax withholding. For example, say your paycheck is $65,000, but your cafeteria plan premiums are $3,500. If you had taken the cash, you would have $65,000 of taxable income. But, since you opted for the insurance, when your employer reports your income on your W-2, it will say you were paid only $61,500 in taxable income.
Health insurance premiums paid through a cafeteria plan are not deductible as a medical expense unless the cost of the premiums is included as part of your taxable income on your W-2. Since you never had to pay taxes on the money to begin with, the Internal Revenue Service doesn't allow you to double dip and deduct the same pretax dollars.
In certain circumstances, the employer is required to include the health insurance premiums in your taxable income for the year. For example, if you own 2 percent or more of an S corporation, you're not considered an employee and can't take advantage of the cafeteria plan's pretax benefits. Also, if the cafeteria plan is only for a select group of highly compensated employees, and you're in that group, the premiums are included in your taxable income.
If your cafeteria plan premiums are included in your income, they can be used when figuring your medical expenses deduction. The medical expenses deduction lets you write off the portion of your expenses, including health insurance premiums, that exceeds a specified portion of your adjusted gross income. In 2013, the threshold is 10 percent for most people. But, if you're 65 or older, the threshold stays at 7.5 percent until 2016. For example, if you're under 65 and have an adjusted gross income of $100,000, you could deduct only your medical expenses in excess of $10,000.
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