Instead of contributing to employer health insurance coverage, small employers are setting up Section 105 Medical Reimbursement Plans to reimburse employees for individual health insurance coverage. In this FAQ article, we’ll answer a common question from small employers: “Are Section 105 Plans tax-deductible?”
Note - This question was asked during our recent webinar, “Can Tax-Free Premium Reimbursement Work for You?” If you'd like to download the on-demand webinar and slides, click here.
Overview of Section 105 Plans
A Section 105 Medical Reimbursement Plan is a formal health plan offered by an employer to reimburse employees for eligible healthcare expenses. Section 105 Plans are named after the tax-code (IRC Section 105) that allows tax-free reimbursements for expenses incurred for medical care as defined in Section 213(d), including reimbursement for individual health insurance expenses.
When used for health insurance reimbursement, the Section 105 Plan must be designed to comply with all applicable rules and regulations, including the new Market Reforms.
Are Section 105 Plans Tax-Deductible for Employers?
Yes. Section 105 Plans are a tax-advantaged employee benefit as outlined in IRC Section 105. For an employer, this means:
Reimbursements are tax-deductible, similar to premiums paid to group health insurance
Payroll taxes (FICA/FUTA) are lowered
To help illustrate the savings of a tax-advantaged Section 105 Plan, compared to offering employees a taxable raise, here is an example.
With a taxable raise, the cost to the business for a $300 per month stipend is $323 per month after FICA/FUTA payroll taxes (7.65%) are factored in. Annually, the business is spending $3,875 to offer a taxable raise of $3,600 per employee.
Using a Section 105 Plan, the cost to the business for a $300 per month healthcare allowance is $300 per month. Annually, the business is spending $3,600 to offer a pre-tax benefit of $3,600.
An additional benefit for employers is that employees are only reimbursed from the Section 105 Plan once they show proof of their premium expense and, employees are only reimbursed up to the amount of their allowance. For example, in the case of a $300 per month allowance, if the employee's health insurance only costs $210 per month, the plan only reimburses $210 per month.
Are Section 105 Plans Tax-Free for Employees?
Yes. By using a Section 105 Plan, employees will also save money on healthcare. For employees:
Reimbursements are received tax-free (not taxable income, not included on W2)
Additional cost savings are available via the premium tax credits, for eligible employees
To help illustrate the savings of a tax-advantaged Section 105 Plan, compared to receiving taxable income, here is an example.
With a taxable raise, employees pay taxes on the income received. Assuming the employee is single and making $35,000+, the employee will pay $1,175 of the $3,600 in taxes ($3,600 x 32.65%*). Annually, the business is spending $3,875 to offer an after-tax ("take home") raise of $2,425.
With a Section 105 Plan, employees do not pay taxes on the reimbursements. Because of this, $1.00 in Section 105 reimbursements is worth approximately $1.50 - $2.00 in a taxable bonus (depending on the employee's tax bracket). With Section 105 Plan, the business is spending $3,600 annually to offer a pre-tax benefit of $3,600, which translates in value to $5,400 - $7,200 to employees.
Reimbursements from Section 105 Plans are tax-deductible to the business and received tax-free by employees. Because of these tax advantages, both small businesses and employees will save on the cost of healthcare by using a Section 105 Plan.
What questions do you have about Section 105 plans or tax-free health insurance reimbursement? Leave a comment below and join the discussion.