Worksite benefits that employers engage in have come a long way in the past decade. The insurance products have become richer and more straightforward. Insurance carriers have enhanced their billing and administrative capabilities to better serve employers and enrollees. Even the sales and marketing approach has changed, as we’ve seen a softer appeal as more traditional benefits consultants have embraced the portfolio.
Throughout this time there has always a conversation about the taxability of worksite benefits. As a results of the Affordable Care Act, the Internal Revenue Service clarified the tax guidelines for these unique insurance plans in a recent memorandum. The IRS clarified the question of how benefits paid out are treated under the tax code when premiums are paid with pre-tax dollars.
The Memo Told Us the Following:
- Because premiums for fixed indemnity health plans are paid with amounts that are not included in an employee’s gross income and wages, the exclusions under Sections 105(b) and 104 (a)(3) do not apply.
Basically the memo clarified that worksite benefits don’t have an exception under tax law and must be paid for with taxed income or the benefits must be taxed. This clarifies some long-standing debates and makes the decision for employers clear: whether to offer these benefits pre- or post-tax. Let’s explore that question a bit.
- Pre-tax. For employers, offering a worksite plan on a pre-tax basis can have direct monetary appeal. The premium being paid pre-tax can help to reduce the tax liability for the employee and employer, but it does offer the potential for ERISA implications. The obvious downside of this approach is that taxing the benefit can greatly reduce the value to employee, especially in a time of need.
- Post-tax. In this situation, the worksite premium is paid for with after-tax dollars. While this does increase the tax liability for the employee and employer, the potential benefit for an employee is greatly expanded. This scenario allows for the full amount of the benefit for the employee if a valid claim is filed.
For an employer, it really comes down to a question of philosophy versus expense. An employer would be well-served thinking about their rationale for offering worksite benefits such as critical illness, accident and other hospital indemnity plans. If the employer wants to offer a benefit for the lowest cost possible, then pre-tax might be the right solution. Or if an employer believes that these benefits are designed to offer the maximum value in a time of need, then post-tax could be the right fit.
Ultimately the worksite insurance market has evolved a lot over the past decade. With this memo from the IRS, employers now have the opportunity to clearly define for employees and themselves the role that worksite benefits can play within their benefit portfolio.