Health insurance isn't cheap, even if you're paying for coverage under an employer plan. However, using pretax dollars to pay for the plan helps you when it comes time to pay your taxes, because the money taken out of your paycheck to cover your premiums isn't counted as taxable income for certain types of taxes.
Federal Taxable Income
Any medical premiums you pay with pretax dollars aren't counted in your taxable income. When your employer prepares your W-2, your employer won't include these premiums in box 1, your income subject to federal income tax. Instead, your employer reports the amount of the premiums in box 12 with the code DD. This figure includes the total of what you and your employer both paid toward health insurance. For example, say your compensation is $50,000, but that includes $4,500 of premiums you paid and $6,000 your employer paid. Your W-2 would show $45,500 in box 1 and $10,500 in box 12 with the code DD.
No Medical Expenses Deduction
Pretax health insurance premiums won't qualify for the medical and dental expenses deduction because the costs are paid with untaxed income. But, don't sweat it too much. The deduction only counts the portion of your expenses that exceed 10 percent of your adjusted gross income and you have to itemize to claim what you can. By having the premiums paid with pretax dollars, you essentially get the deduction without any hoops to jump through.
Your pretax medical insurance premiums are hit with Federal Insurance Contributions Act taxes, also known as FICA taxes. These include the Social Security tax and the Medicare tax. Therefore, when you get your W-2, your box 3, income subject to Social Security taxes, and box 5, income subject to Medicare taxes, will include your pretax health insurance premiums. For example, even though your box 1 income went down to $45,500 because of your premiums, box 3 and box 5 will still show $50,000 of income.
State Income Taxes
On the bright side, you also get to exclude your pretax insurance premiums from your state income tax as well. Depending on where you live, this could be a substantial additional tax break. Of course, if you live in a state without an income tax to begin with, it won't help you -- but you didn't have to pay any state income tax in the first place.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."