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The Problem with Grossing Up Employees' Salaries for Health Insurance

Written by: Christina Merhar
July 30, 2014 at 11:00 AM

Some small businesses and startups consider grossing up employees' salaries or wages to help with their individual health insurance. For example, a business might offer a taxable raise, stipend, or salary bonus with the hope that employees will use it on health insurance. Why?Problem with Grossing Up an Employee's Salary for Health Insurance

Usually a business considers this approach because they want to offer health benefits to employees, but they cannot afford group health insurance, cannot meet group health minimum participation requirements, and/or do not know they can set up formal, tax-advantaged premium reimbursement program.

On the surface, giving raises to employees for health insurance may seem cheaper and simpler than reimbursing health insurance premiums through a formal premium reimbursement program. 

But, there is one big problem businesses run into when they gross up an employee's salary for health insurance: it is very hard to take back the raise.

Example Problem

It is very hard for a business to informally increase wages for health insurance, and then take it away.

For example, a start-up technology company decides to increase taxable wages for their one employee with the intention that the employee will use it on health insurance. The wage increase is folded into the employee's gross income.

A few months go by, and the startup hires two more employees. At this time, the startup decides to start a formal health benefits program to reimburse employees tax-free for individual health insurance.

For the one employee who received the salary increase for health insurance, it will be very hard for the startup to take back the raise given for health insurance - even though they are replacing it with a formal, tax-free health benefit.

Many businesses in this situation tell us "I wish I would have just started with the formal tax-free premium reimbursement program."

Other Problems with Grossing Up an Employee's Salary for Health Insurance

There are three additional problems small businesses and startups face when giving taxable raises for health insurance.

Business ends up paying more for taxable wage increases

Businesses often think that a taxable wage increase will be cheaper. But the business will spend more on the salary raises than they would for tax-advantaged premium reimbursement. See the breakdown of tax savings in this article.

It's not guaranteed employees will spend the money on health insurance

By increasing taxable wages for employees' health insurance, there is no guarantee that employees will spend the money on health insurance. With a formal premium reimbursement program, employees are required to show proof of health insurance coverage. Any unspent dollars stay with the business.

For example, if the business offers $250/month and the employee's health insurance premium is $200/month, the business only reimburses the employee $200/month.

Businesses lose top candidates to competitors with formal health benefits

While it may sound nice to tell candidates "we offer higher wages so you can buy your own health insurance," most candidates want to work for an employer who offers a formal, tax advantaged health benefits program (vs. a causal, undocumented arrangement).

What problems have you or your clients encountered from grossing up employees' salaries for health insurance? 

The Comprehensive Guide to the Small Business HRA

Topics: Group Health Insurance, Premium Reimbursement, Taxation