We meet many small business owners who want to help their employees by giving them a bonus or adding to their salaries to help with health insurance. While this option is easy from a time and administration perspective, the value of these dollars will be greatly diminished because a health insurance stipend is considered taxable income. Let's take a look at the tax implications of health insurance stipends and the better option out there.
The truth is that the benefit of health insurance stipends is diminished by taxes. In fact, payroll and income taxes end up wasting 20-40% of the bonus before an employee ever gets to use it.
For companies that help employees by offering a health insurance stipend, tax-free reimbursement will typically have a huge tax advantage for both employer and employee. Let’s see how HRAs stack up against more traditional options of offering health benefits like health stipends or pay increases.
Health insurance stipends vs Health reimbursement arrangements
Some employers offer a regular, fixed amount of money, or stipend, to their employees to help cover the cost of health insurance. While this option is easy from a time and administration perspective, the value of these dollars will be greatly diminished because they are considered taxable income. Furthermore, simply writing off the stipend as a business expense will have payroll as well as income tax implications.
Health stipends aren’t subject to compliance issues that group plans have, and they can be really easy to administrate through payroll. But they aren’t tax advantaged like an HRA. Not only are small businesses required to pay payroll tax on the reimbursements, employees must claim the stipend as income and there isn’t exactly any accountability for whether or not the money is even used for health insurance.
Another downfall? There's no accountability for what your employees choose to spend their health insurance stipends or salary increases on. Will they spend it on health insurance? Maybe. You'll never know.
With HRAs, employers can make reimbursements without having to pay payroll taxes and employees don’t have to recognize income tax. In addition, reimbursements made by the company count as a tax deduction. Pretty awesome, right?
- Transfers employer responsibility for health risks.
- Transfers health decision making from employer to employee.
- More personalized plan choices for employees. No employee is locked into a plan that might not be a good fit for them. They can also take their plan with them if they leave.
- Simpler and more flexible plan design options.
- Greater budget control.
- No participation concerns.
How does health insurance reimbursement work?
The employer chooses an HRA for her company, sets a budget that works for them, and then lets the employers know they can use it. From there, once an employee pays for a medical expense or premium, they just turn in the receipt and submit for reimbursement.
For companies that help employees with health insurance by offering a health stipend or by adding to employee salaries, tax-free reimbursement will typically have a huge tax advantage for both employer and employee. For example, if a 10-person company offers employees $300/mo ($3,000/mo in total reimbursement) by increasing salaries versus tax-free through an HRA, $1,200 a month ends up going to taxes each month.
Types of HRAs
Sometimes referred to as “401(K)-style” insurance, two recently created HRAs allow an employer to reimburse for medical expenses and/or insurance premiums on a tax-free basis. Under this arrangement, employees purchase their own health insurance on the open market and then submit claims to their employer to get reimbursed for the cost of their premium and if allowed, all qualified medical expenses.
HRAs are based on reimbursing employees for health insurance rather than buying it for them.
- The qualified small employer HRA (QSEHRA) requires your business to be small, with less than 50 Full Time Equivalent employees, and you can't offer a group plan at the same time. If you meet those qualifications, you can use an HRA administration tool (like ours!) to create your QSEHRA, decide how much you’ll reimburse each month (up to the contribution limits), let your employees choose the plan that works best for them, and reimburse them when they submit receipts!
- The individual coverage HRA (ICHRA) is almost like a “super-charged” version of the QSEHRA. Instead of being capped at 50 employees, employers of any size can set up an ICHRA for their teams. There are also no contribution limits with this HRA. Another key differentiator from HRAs in the past? ICHRA allows business owners to customize their reimbursements across different classes of employees. While everyone must be treated fairly within a certain class, reimbursement rates can vary between full time, part time, seasonal, remote, etc.
Reimburse your employees for health insurance! (We're here to help)
We are here to help you think through your benefits solutions this year. Just chat with us in the lower right hand corner of your screen!
Here are a few resources to dive into.