Many employers offer benefits governed by Section 125 of the Internal Revenue Code -- such as retirement accounts and certain health plans -- that employees can pay for with pretax wages. Participating employees elect to have deductions taken from their payroll checks to cover the premium or contribution amount before the Internal Revenue Service takes its share. The results are lower taxable income for the participating employees and fewer federal, state, Social Security and Medicare taxes taken from each paycheck.
One of the most common deductible pretax benefits is health insurance. Medical, dental and vision insurance fall in this category, and the employee's share of premiums can be paid through pretax payroll deductions. Pretax insurance premiums cannot be included as a qualified medical expense on your tax returns because the deductions are already excluded from your taxable income, according to IRS Publication 502.
Employers offering group term life insurance coverage to their workers may allow premiums to be paid through pretax payroll deductions. If you are covered by your company's group term life insurance policy, IRS regulations state that insurance coverage in excess of $50,000 is recognized as regular income and the tax liability lies with the employee. For example, an employee with $150,000 in group term life insurance coverage will be taxed on $100,000 of her coverage amount.
Flexible Spending Accounts
Employees who establish a Health Savings Account, Flexible Spending Account or Dependent Care Flexible Spending Account can fund the accounts with pretax dollars. HSAs and FSAs are used to pay for qualified health-care expenses such as doctor’s office co-pays, prescriptions and medical equipment, while Dependent Care Flexible Spending Accounts are used to pay for day-care expenses. As of 2012, both medical and dependent care accounts have a maximum annual contribution limit of $5,000 per household; effective in 2013, the contribution limit for medical FSAs will drop to $2,500.
Employees may also contribute elective salary deferrals to an employer-sponsored retirement account such as a 401k or 403b on a pretax basis. Although the IRS imposes a maximum annual contribution amount, employers may specify a lesser maximum amount in their summary plan description. Unless an employer's plan states otherwise, employees can contribute up to $17,000 to their retirement account in 2012, though this limit will increase to $17,500 in 2013.
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