When Are Health Insurance Benefits Taxable?

Maintaining health insurance is no longer a want. It’s a need. Federal laws and the rising cost of health care make benefits the only thing standing in the way of health and poverty. As a result, most health insurance benefits are tax deductible or tax-free. However, there are certain cases in which health insurance benefits are taxable. This is not a reference to new legislation coming down the pike. It is not an indication of where health insurance is heading. This is the reality of how some companies prefer to handle their insurance obligations.

Your Health Insurance Benefits Are Unlikely to be a Tax Burden

Traditional health insurance benefits are not taxable under any federal or state tax laws. If you pay for your own health insurance, you will be eligible to write off the premiums and out of pocket expenses, most of the time. If your employer pays for your health insurance premiums, it is paid with pre-taxed dollars. If you put money into a health savings account, it is pre-taxed dollars. You even get the opportunity to receive tax benefits from out of pocket expenses that are not covered by your health savings plan. This is because you either do not have a health savings plan or your out of pocket exceeds the money available in your health savings plan. All of these options of paying for health benefits are tax deductible. However, that does not mean that all health insurance benefits are tax deductible. It is just rarer than many people realize.

Your Health Benefits that Are Taxable

So, if the majority of health benefits are tax deductible, how is it possible for your health benefits to be taxed? The method in which health benefits are taxable is not the preferred method for most employers. However, with the rising costs of health care, it has become a true option for many small business owners. It is actually less costly in the long run and may provide better insurance coverage to the employee. This method is known as self-insuring. This type of benefit is when the employer provides the employee with money to purchase their own individual insurance, absent of a group health plan. The employer may only pay a portion of the insurance costs. However, it is still an employer contribution.

This is a rare business practice; however, it is common within the small business community. The employer provides a stipend to the employee. This stipend is to be used to purchase health insurance. As opposed to the group plan, the income of the person as well as the personal details, play a large role in the cost of individual plans. However, if a person’s overall salary makes them eligible for a government credit through insurance within the exchange, this option may prove to be the most beneficial to all involved.

The reason this type of benefit is taxable is that it is seen as salary to the employee.  The stipend provided by the employer will be taxed money. That does not mean the employee will have an added tax burden. However, the employer will not receive the tax benefit of providing health insurance benefits. The employee will have the ability to claim the premium as a tax credit on his or her insurance. The employer, however, will not receive a tax benefit, but will not pay as much towards premiums either.

This method may become a thing of the past, with the passing of The Qualified Small Business Health Reimbursement Arrangement (QSEHRA). This new law allows employers to provide employees with tax-free dollars to purchase individual health insurance plans. This is only available to businesses with fewer than 50 employees that do not offer group insurance policies. The important concepts to note are that the plans purchased must abide by ACA standards and the money must be used for ACA qualified insurance premiums. Otherwise, the money can and will likely be taxed during tax preparation.

Another area in which health insurance benefits may be taxable is when you receive a payout from your insurance. This is mostly seen in disability plans. Although the money paid into a disability plan is non-taxable, the benefits are often taxed as income, assuming they meet specific IRS requirements. For instance, a person who is sick for three months may use disability insurance to help pay daily expenses. This money is seen as income and can be taxed by the federal government. The income must meet or exceed a specified amount based on the lines of poverty. However, that is typically very easy as no one has disability coverage that will pay less than what they are earning daily, unless they rely on their state government disability.

However, if you are seen as completely disabled and retire. As a result, you may be able to claim a tax credit on the benefits from the policy. This can get very complicated. Some people may have other factors that contribute to the money being taxable, such as a litigation payout or other financial issues. Therefore, always talk with your tax professional about when your health benefits are taxed, when they are not taxed, and when they can be used as a deduction or credit on your tax return.