4 Reasons to Offer Employee Health Insurance to Lower Your Taxes

7 minute read

Since 2015, businesses with 50 or more full-time employees have been required to offer health insurance to their employees. Although smaller businesses don’t face this same requirement, many choose to offer health care coverage to their workers for both financial and nonfinancial reasons.

Good health insurance coverage encourages employees to stay with the company longer, which can save on hiring and training costs. And in an economy facing a labor shortage, health insurance can entice competitive prospects to the company. But there’s one more compelling reason to offer health insurance, and that’s for the tax benefits.

Health Insurance Is Tax Deductible

Health insurance costs are a legitimate business expense, which means they are fully deductible at both the state and federal level. Insurance costs include:

  • Insurance premiums subsidized by the business
  • Contributions to employees’ health savings accounts (if applicable)
  • Administrative costs of sponsoring a health care plan

Because this is a deduction rather than a credit, the cost of the health insurance will exceed the tax savings you generate from the deduction. But a lower tax bill combined with the nonfinancial benefits of offering health insurance to your employees may be just the thing to push you over the edge and make it worth your while.

Health Care Tax Credits Are Available

Even with the deduction, health care costs can be expensive. On average, health insurance costs employers $13K per employee in 2021. Fortunately, small businesses may be eligible for a tax credit that can reduce that cash outlay.

The small business health care tax credit can give you back half the costs you paid on employee premiums. To qualify for the full credit, all of the following must be true:

  • You offer coverage to all full-time employees.
  • You have fewer than 10 full-time equivalent (FTE) employees.
    • You’ll receive a reduced credit if you have between 10 and 25 FTE.
  • You pay at least 50% of your employees’ health care premiums.
  • Your average employee salary is $27K or less.
    • You’ll receive a reduced credit if your average annual wages are between $27K and $56K.

Your business can take the small business health care tax credit  for two consecutive tax years, which can help defray at least some of the costs of establishing a new plan.

This is a federal tax credit only, but some jurisdictions provide similar credits at the state level.

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If You Don’t Offer Health Insurance, You May Still Get a Deduction

Even if you don’t sponsor a full-coverage health insurance plan for your employees, you may still be able to deduct medical insurance-related costs.

Employers who can’t afford to sponsor a group health insurance plan can make it easier for their employees to find coverage elsewhere by reimbursing them for the costs of obtaining their own coverage. These reimbursements are deductible, but only if done under an arrangement known as a QSEHRA (pronounced “Q-Sarah”).

Businesses with less than 50 FTE can create a qualified small employer health insurance arrangement (QSEHRA) to reimburse employees who purchase outside health coverage. Typically, QSEHRAs establish a maximum benefit per employee, and throughout the year, employees can submit insurance costs for reimbursement up to those maximums.

Not only are reimbursements deductible to the business, but they are also not treated as W-2 wages to the employees. This means that neither the employee nor the employer will owe payroll taxes on those reimbursements.

QSEHRAs can provide more than just financial benefits, including the following:

  • Employees can select the plan that works best for them. Small employers are often given a limited selection of group plans to choose from. By allowing employees to choose their plans in the open marketplace, they have the freedom to select the plan that’s best for them.
  • QSEHRAs can also reimburse employees for out-of-pocket medical costs. QSEHRAs are flexible. If set up correctly, they can reimburse employees for out-of-pocket medical bills, which can be an added bonus to your overall benefits package.

Employees Save Taxes, Too

The insurance tax benefits to employers are clear, but having employer-sponsored health care plans can provide tax benefits to your employees, too.

Are employee contributions to health insurance taxable?

Health insurance premiums are costly, and even when they are partially subsidized by their employer, premium costs can consume an outsized portion of workers’ incomes. And that’s why employees will be glad to know they can pay health insurance premiums with pretax dollars.

When employees participate in a qualifying employer-sponsored health care plan, their insurance premiums will be paid directly from their paychecks before income or payroll taxes are withheld. Effectively, this means that employees will not be paying tax on health care premiums.

Health Savings Accounts

Health savings accounts (HSAs) (when offered as part of their employer’s high-deductible health care plan) and flexible spending accounts (FSAs) can help employees use pretax money for out-of-pocket medical expenses. Employees can fund their HSA or FSA with pretax dollars and use that money to pay for qualified out-of-pocket medical expenses. Employers can also contribute to their employees’ HSAs, which can make them more competitive to prospective employees.

Determining the Right Time to Offer Health Insurance Isn’t Easy

There may never be a clear-cut sign that offering health care coverage is the best path forward for your business, but you’ll get much closer to making a decision if you inform yourself about the potential tax consequences. Selecting an insurance plan will affect your taxes, but so will not offering health insurance; choosing to operate without offering group health coverage may mean you miss out on valuable tax savings. Talk to your tax planner for help deciding. If your tax advisor uses a tax planning system like ours at Corvee, you can see exactly how a new health insurance plan will change your tax position moving forward.

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