Are health insurance premiums subject to fica?

Pre-tax health insurance deductions are not considered part of an employee's salary and are therefore not subject to Social Security (FICA) taxes. As a result of the reduction in FICA taxes, the amount of Social Security benefits an employee receives upon retirement may be slightly reduced. Additional benefits are generally included in the employee's gross income (there are some exceptions). Benefits are subject to income tax withholding and employment taxes.

Additional benefits include cars and flights on airplanes offered by the employer, free or discounted commercial flights, vacations, discounts on properties or services, memberships to country clubs or other social clubs, and tickets to sports or entertainment events. Employer-paid health insurance premiums are exempt from federal income and payroll taxes. In addition, the portion of premiums paid by employees is generally excluded from taxable income. Excluding premiums lowers tax bills for most workers and thus reduces the cost of coverage later.

This tax subsidy partly explains why most American families have health insurance coverage through employers. However, other factors play a role, in particular the economies of group coverage. Prices are high and variable, and in most states people can be excluded from coverage based on their health status. Also keep in mind that the indefinite nature of the tax subsidy has likely increased health care costs by encouraging the purchase of more comprehensive health insurance policies with lower cost-sharing or less managed care.

The example assumes that the worker with the highest salaries has an income below the maximum amount subject to Social Security taxes. Because excluding employer-sponsored insurance (ESI) premiums reduces taxable income, it is worth more to taxpayers in the higher tax brackets than to those in the lower brackets. However, it also warns that these policies could lead to a significant reduction in insurance coverage. Tax exclusion can also bias people to buy overly generous insurance, as it makes insurance cheaper compared to other assets.

Replacing the exclusion from ESI with a tax credit would equalize tax benefits between taxpayers in different tax categories, as well as between those who get their insurance through their employers and those who get coverage from other sources. The model takes a sample of people from the Current Population Survey and compares it with information on health insurance premiums and health costs. Premiums paid by employees are also exempt if the company has established a cafeteria plan under Section 125; approximately 80 percent of employees with insurance have such a plan. More than sixty percent of people who are not older receive their insurance through their own employer or that of a family member.

One of the most discussed topics during the recent debate on health system reform was the proposal to limit the tax exclusion of employer-sponsored health insurance. In addition, the benefits of tax exclusion reach those at the top of the income distribution disproportionately, as the value of the exclusion increases with the personal income tax rate and richer people are more likely to have insurance and to have more generous plans. Some of the people who lose ESI acquire non-group coverage or switch to government insurance, so the net increase in the number of people without insurance is 11 million, or 22 percent compared to the reference number of insured persons. Specifically, companies make decisions about whether to offer insurance, how to divide premiums between the company and employees, and what the level of insurance spending should be; workers decide whether to accept the insurance offered by the company and whether to buy in the non-group market.


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