When you pay your medical premiums with pretax money, you get a tax break because your payment is deducted before taxes are withheld from your paycheck. When you pay with after-tax money, you don’t get a tax break, because your premiums are deducted after taxes are withheld.
To pay your medical premiums with pretax money, you must be enrolled in your employer-sponsored health insurance plan. To offer its employees pretax health insurance, your employer must establish a plan that meets the requirements of Section 125 of the Internal Revenue Code and, if applicable, the state in which the business is based. The state may require employers who offer health insurance to do so under a Section 125, or cafeteria, plan. The state may offer a tax credit to employers who do not have a Section 125 plan if they establish a fully insured plan under Section 125.
If you do not want to participate in your employer’s pretax plan, you may elect to have your medical premiums deducted on an after-tax basis. Your employer may ask that you submit a written request opting out of the pretax plan. Depending on your employer’s plan, different criteria may apply to pretax and after-tax payments. For example, if you pay with after-tax money, you may be allowed to drop your coverage or enroll in the plan at any time. If you pay with pretax money, you may have to wait until a specific time to enroll in the plan or to drop your coverage.
Pretax medical premiums are excluded from federal income tax, Social Security tax, Medicare tax and usually state and local income tax. Check with your state revenue agency for clarification on whether Section 125 premiums are excluded from state and local income tax, as the state may have specific conditions. For example, in Pennsylvania, Section 125 premium coverage for sickness, hospitalization, death or disability is excluded from state income tax to the same extent that it is excluded from federal income tax.
With a pretax plan, your employer deducts your premiums from your gross wages before calculating taxes. This process reduces your taxable income and results in more take-home pay than if you paid with after-tax money. After-tax premiums do not reduce your taxable income.
If you pay your medical premiums with after-tax money, you may deduct your premiums as a medical expense on Schedule A when you file your tax return with the IRS. Before you can get this tax benefit, your total medical premiums must be more than 7.5 percent of your income. If you paid your premiums with pretax money, you do not qualify for this tax credit since you already received a tax break when your employer deducted the premiums from your paycheck. The pretax option allows you to receive the full tax benefit because all of your premiums are tax free.
- Internal Revenue Service: FAQs for Government Entities Regarding Cafeteria Plans
- Exxon Mobil: Pre-Tax Contributions for Medical, Dental and Vision Plan Coverage
- National Conference of State Legislature: States' Use of "Cafeteria Plans" to Provide Health Insurance
- Pennsylvania Department of Revenue: IRC Section 125 Cafeteria Plans or Flexible Spending Plans
- Fox Business: Are Health Insurance Premiums Tax-Deductible?
Grace Ferguson has been writing professionally since 2009. With 10 years of experience in employee benefits and payroll administration, Ferguson has written extensively on topics relating to employment and finance. A research writer as well, she has been published in The Sage Encyclopedia and Mission Bell Media.