The Pretax Health Insurance Deduction for Employees

by Natalie Grace

    A pretax health insurance plan allows you to pay your premiums with before-tax money; your contributions are taken out of your paychecks before taxes are calculated. This results in a reduction of your taxable wages. A pretax health insurance plan must meet some legal criteria to qualify as such.

    Criteria

    To offer you pretax health insurance, your employer must establish a plan that meets Section 125 of the Internal Revenue Code; this type of plan is also called a cafeteria plan. Your employer must develop a written plan document that describes the benefits offered under the plan. It must also distribute a copy of the plan document to all participants and maintain and update the plan according to changing regulations. Some states set laws for employers that offer health insurance. For example, in Connecticut, an employer that offers health insurance to be paid partially via payroll deduction must do so under a cafeteria plan.

    Coverage

    A pretax health insurance plan generally includes medical, dental and vision coverage for you, your spouse and your dependents. Your employer may cover some of the cost. For example, it may cover 70 percent while you pay 30 percent. Your employer may also offer pretax health care reimbursement accounts, which enables you to pay for medical expenses that are not covered by your insurance, such as chiropractic, psychiatric and orthodontic care.

    Federal Taxation

    Premiums paid toward a Section 125 health plan are excluded from federal income tax, Social Security tax and Medicare tax. For example, you earn $1,300 biweekly and pay $100 total toward your pretax family health plan. You would subtract $100 from $1,300 to get $1,200, which would be subject to taxation. If you are subjected to state and local income tax withholding, whether pretax contributions are excluded from those taxes depends on your state and local governments. Consult your state revenue agency for its guidelines tax withholding for Section 125 health insurance deductions.

    W-2 Balancing

    The gross wages on your yearly W-2 form do not include pretax deductions such as Section 125 health care premiums. To arrive at your true annual wages, add your pretax health insurance deductions to your W-2 taxable wages. On your W-2, this applies to Box 1, which shows your federal wages; Box 3, which shows your Social Security wages; Box 5, which reflects your Medicare wages; if applicable, boxes 16 and 18, which reflect your state and local wages. Your last paycheck stub for the year should show your entire gross wages for the year, which includes pretax deductions. When you make the necessary additions to your W-2 wages, the result should balance with your last paycheck stub for the year.

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    About the Author

    Natalie Grace has been writing since 2000, specializing in topics related to employment policies. Grace attended Miami Dade College and has more than 10 years of experience in payroll-and-benefits administration, human resources and accounting. Her corporate experience includes working as a payroll-and-benefits administrator for a petroleum company.

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