When reimbursing employees for their health insurance expenses, there are many options to choose from. Benefit reimbursements are a great way to save businesses money on healthcare expenses and provide employees with a more personalized benefits package. However, some health insurance reimbursements are taxable while others aren’t.
With so many different options, it can be hard to know which health insurance reimbursements are taxable and which aren’t.
We’ll cover two of the most popular types of healthcare reimbursements: health reimbursement arrangements (HRAs) and stipends. Each comes with its own set of tax rules.
Skip to the benefit type you’re most interested in below:
- Is an HRA reimbursement taxable?
- How are healthcare stipends taxed?
Is an HRA reimbursement taxable?
Under IRS rules, employers can reimburse employees for their health insurance in a tax-advantaged way. The most prominent vehicle for doing so is an HRA.
When an HRA is compliant with the IRS rules, employers can reimburse medical expenses such as health insurance premiums with money that's free of payroll taxes for both the employer and employee. An HRA may also be free of income tax for the employee if they have individual health insurance that provides minimum essential coverage (MEC).
To get the tax benefits, however, an HRA must follow IRS procedures, including strict rules about setting up formal plan documents.
The IRS has clear rules that govern how HRAs work and how employers must set them up to be compliant.
To get the tax relief benefits, an HRA must meet the following requirements:
- 100% employer-funded (employees can’t contribute).
- Even if the employee agrees to it, the organization can't fund its contribution through wage deductions.
- Employees must have MEC to get reimbursements free of income tax. If employees don't have MEC, they must report reimbursements as taxable income at the end of the year.
- Formal plan documents must define qualified medical expenses.
Certain types of HRAs, like the qualified small employer HRA (QSEHRA), have annual contribution limits, while others, like the individual coverage HRA (ICHRA) and the group coverage HRA (GCHRA), don’t.
To be compliant, healthcare reimbursement plans must have formal plan documents that describe how the plan is managed, what medical expenses are reimbursable, and what documents are required to demonstrate compliance.
If an employer doesn’t want to set up compliant documents and procedures to receive these pre-tax benefits, they can just give employees a raise or a health insurance benefit stipend. However, the organization will pay payroll tax on these extra wages, and employees will pay payroll and income tax.
How are healthcare stipends taxed?
Unlike an HRA, healthcare stipends are considered taxable income. That’s because stipends don’t have as many regulations and aren’t tax-advantaged. But, similar to bonuses, stipends don’t count as a wage earned by the employee.
When employers reimburse out-of-pocket healthcare costs or health insurance coverage premiums using a stipend, they pay payroll tax on those funds. But, you aren’t required to withhold Social Security or Medicare taxes. Employees are responsible for paying these taxes on top of their income tax.
Because W-2 documents include stipends, employees should set aside the amount needed to pay their taxes.
Why would you choose to offer a taxable health stipend?
Your employees don’t need medical insurance to participate in a health stipend. This allows for stipends to cover an array of healthcare expenses. It also allows your employees who participate in premium tax credits to take advantage of these benefits without reducing their premium tax credit or having it give it up entirely.
For those who already have a group health insurance plan or an HRA, taxable stipends can help employees with additional out-of-pocket health-related costs. They’ll just have to pay taxes on these extra allowances.
The tax-advantaged nature of HRAs makes them a good option for employers that want to offer personalized, flexible health benefits to their employees. Compliance is vital, however. Without it, employers and their employees can miss out on the tax savings.
On the other hand, a taxable healthcare stipend is a great additional benefit that goes hand-in-hand with offering health coverage.
No matter which benefit is best for your business, benefits administration software like PeopleKeep can help. With PeopleKeep, organizations can set up a fully compliant HRA plan or stipend in minutes.
WorkPerks by PeopleKeep allows you to create a completely customizable health stipend for your organization. With our easy-to-use dashboards, you can quickly see who’s using your health stipend benefits, check reimbursement amounts owed to your employees, and track payments.
Ready to offer your employees an HRA or health stipend? Schedule a call with a personalized benefits advisor today.
This blog article was originally published on November 30, 2018. It was last updated on February 22, 2022.