Small employers on a tight budget are increasingly finding that reimbursing employees for medical expenses they incur is a great alternative to traditional group health insurance.
There are several ways to go about employee medical expense reimbursement. Some ways offer significant tax savings, which helps stretch every dollar. Here’s a look at the tax treatment for different reimbursement scenarios.
Formal Medical Reimbursement Plans - tax treatment
If you offer a formal medical reimbursement plan, such as a health reimbursement arrangement (HRA), sometimes called a health reimbursement plan, reimbursements are free of payroll taxes (FICA) for both employer and employee and free of income taxes for the employee.
These types of reimbursement plans allow for tax-free reimbursement of expenses incurred for medical care as defined in Section 213(d) or IRS Publication 502, including reimbursement for individual health insurance expenses.
To qualify for these tax advantages, the plan must be designed to comply with federal rules under the Affordable Care Act.
To summarize, formal medical reimbursement plans are:
- Free of payroll taxes (FICA), like premiums paid for group health insurance premiums.
- Tax-free to employees. Reimbursements are not taxable income, and not included on the employee’s W2.
- Must comply with applicable rules and reforms.
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Casual medical expense reimbursement - tax treatment
If you offer employees reimbursement for medical expenses without a formal plan, reimbursements are treated as taxable income.
Examples of scenarios where the reimbursements are taxable include health stipends or direct reimbursement of medical or premium expenses without a formal plan.
Important Note: These types of casual plans are still considered Employer Payment Plans and are subject to the same regulations for nondiscrimination as other plans. Employers should understand what these regulations are and comply with them. For example, if you offer to reimburse one employee for medical expenses, you must offer the same reimbursement to all similarly situated employees.
As a general rule, medical expense reimbursement is tax-advantaged if the employer uses a formal, compliant reimbursement plan. If the business is using a more casual arrangement, reimbursements are taxable. While casual plans seem easier, at first glance, they are still subject to regulatory compliance and it’s important for employers to take care when using them.
This post was originally published on August 20, 2015. It was last updated December 15, 2020.