Offering group health insurance to employees often seems like a headache that businesses would rather do without. Changes from the Affordable Care Act (ACA, Obama Care) have caused some employers to wonder if there is an easier way to provide benefits for their employees. Perhaps a company could give employees a salary bonus or “taxable discretionary wellness stipend” so that employees can buy their own individual medical coverage. After all, the ACA requires everyone to buy health insurance and it forbids insurance companies from declining coverage. Maybe individual coverage is a viable option. While we don’t give tax advice – you should contact your accountant or CPA – we have done some research on this topic and this article describes what we’ve found.
Other than sponsoring a group health plan, a salary bonus not tied to any medical insurance seems to be the only legal way for an employer to help employees buy health insurance. The IRS explicitly prohibits employers from reimbursing employees for individual coverage. Click on this article to see the pitfalls of reimbursing employees for individual medical insurance coverage.
If you’re considering a salary bonus for employees to purchase their own individual medical insurance you should consider the following:
1. Newly hired employees may not be able to purchase individual health insurance policies. By law, health insurance companies can only sell individual coverage during the “open enrollment period” (November 15, 2014 – February 15, 2015). The only exception is if a person has a special qualifying event. So, if your company hires someone who doesn’t already have health insurance; he/she will not be able to purchase an individual policy until the next open enrollment period. Coverage would begin January 1st of the following year at the earliest. This could be a major drawback for candidates seeking employment who need health insurance coverage for themselves and their families.
2. Individual plans have significantly fewer in-network doctors and hospitals. Except for Kaiser, all of the California health insurance companies use “limited” or “narrow” provider networks for their individual plans. Conversely, group plans offer full, medium and small networks. The LA Times reported that for 2015 “the state’s largest health insurers are staying with their often-criticized narrow networks of doctors, and in some cases they are cutting the number of physicians even more.” Finding doctors in an individual plan’s network is such a big problem that the L.A. Times created its own searchable provider data base. With fewer in-network providers, employees will have difficulty obtaining discount services from their current doctors.
3. Few insurance companies offer individual plans and they offer few plan designs. Unlike group plans where Aetna, Anthem, Blue Shield, Health Net, Kaiser and United Health Care offer PPOs, HMOs, and HSA plans with in and out-of-network benefits throughout the state; only a few insurance companies offer individual coverage and those that do have limited plan choices. For example, Anthem Blue Cross only offers an HMO and an “EPO” (i.e., Exclusive Provider Organization that has NO out-of-network benefit) and to individuals and families in Los Angeles, Orange and San Diego Counties. Similarly, Health Net and Blue Shield offer EPOs or no plans in many parts of California; see Covered California Health Insurance Companies and Plan Rates for 2015.
4. A salary bonus reduces the health insurance tax subsidy to which an employee may be entitled. The government offers subsidies for health insurance to individuals who earn up to $46,680 per year in 2015. The subsidy increases with larger family size. A salary bonus or taxable stipend increases a person’s wages so it reduces any government subsidy.
5. Individual health insurance premium is not tax deductible for employees. The IRS does not allow employees to deduct the premium for individual health insurance from their personal income taxes. (Footnote 1 below) Accordingly, employees must pay for individual health insurance policies with after-tax dollars. In contrast, the IRS allows full tax deductibility of employee paid group health insurance premium through Section 125 of the Tax Code. Federal and California state income taxes are very high and the lack of tax deductibility is a huge draw back for individual coverage. See #7 below.
6. Employers spend more in payroll taxes and worker’s compensation insurance when they pay a wage vs. offering a tax-deductible group health plan. If you have employees then you know that Federal law requires employers to pay FICA payroll taxes for Medicare (1.45%) and Social Security (6.2%) (total 7.65%) on wages paid to W-2 Employees. Additionally, every dollar paid to an employee as a wage is included in the calculation for worker’s compensation premium (likely 3% for service businesses and much higher for more hazardous occupations.) This results in a tax penalty to the employer of over 10% when paying a salary bonus. In contrast, employer and employee paid group health insurance is fully tax deductible as a business expense and not subject to FICA taxes or worker’s comp premium.
7. Employees must pay income taxes and payroll taxes on wages vs. receiving non-taxable group health insurance benefits. This is a huge tax penalty. As an example, in 2015 the marginal Federal income tax rate for a single employee with $100,000 of taxable income is 28%. The marginal California income tax rate is 9.3%. Accordingly, when this employee receives a salary bonus or a taxable wellness stipend to pay for health insurance he/she must deduct 7.65% for FICA taxes, 28% for Federal income taxes, and 9.3% for California state income taxes, totaling 44.95%. This results in a tax penalty to the employee of approximately 45%.
8. Likely, one half of the money paid towards a salary bonus for an employee‘s health insurance would go to taxes or additional worker’s compensation premium. Assume that a company paid employees a $500/month taxable bonus – for which the employer cannot require the employee purchase medical insurance. This would cost the company $550/month ($500 x 10%) or $6,600/year. Depending on the tax bracket, the employees would likely net $275/month ($500 x (1 – 0.45, or 55%) or $3,300/year. It makes no financial sense for a company to pay $6,600/year and have an employee net $3,300/year to pay for health insurance. Tax and worker’s comp savings are THE major reasons that companies sponsor group health insurance plans rather than offering a fully taxable salary bonus.
In the example above, the company would be much better off if it sponsored a group health plan and paid $3,300/year ($275/month) towards the health insurance premium. The company would save $3,300/year ($275/month) and the employees would have access to significantly better group health insurance plans.
An employer sponsored group health insurance plan avoids unnecessary taxes and additional worker’s comp premium. Newly hired employees can join the plan immediately or after a few months and many insurance companies offer a large selection of plans that include the full provider networks. A salary bonus intended for health insurance is extremely tax inefficient and forces employees to purchase inferior health insurance plans in the individual market.
The staff at BenefitsCafe.com can assist you with a group or individual policies. Give us a call at 800-746-0045 Click here to learn more about employer-sponsored medical insurance coverage. Click here to get a quote for group health insurance.
Footnote 1: According to the IRS’ guidelines for the deductibility of medical expenses, you can deduct health insurance premium if your total medical expenses for diagnosis, cure, mitigation, treatment and health insurance premium total more than 10% of your adjusted gross income, then “you may deduct only the amount by which your total medical expenses exceed 10% of your adjusted gross income or 7.5% if you or your spouse is 65 or older.”