Employers typically offer healthcare, dental and short-term disability coverage as part of a benefits package for employees, with premiums being deducted pre-tax from payroll checks.
FSAs can offer employees who pay out-of-pocket medical expenses predictable tax savings by lowering taxable income, which in turn lowers FICA and FUTA payroll taxes.
Fica Tax
FICA (Federal Insurance Contributions Act), created shortly after Social Security was implemented in 1935, withheld from employee paychecks to fund retirement and disability benefits. Employers collect FICA taxes from their employees on behalf of Social Security to fund retirement and disability benefits collected by Social Security; an individual portion of FICA taxes is also taxable and total rate stands at 12.4% when both Social Security and Medicare contributions are combined.
Like other withholding taxes, FICA takes a percentage of gross income before any deductions or tax calculations have been applied. Withholdings on paycheques usually follow federal withholding tables but may be altered based on individual circumstances such as marriage, children or any other unique factors.
FICA tax differs from most withholding taxes in that it does not levy upon investment income, such as rental properties and interest earnings. Instead, its Old-Age, Survivors, and Disability Insurance portion is levied on all earned income while its Medicare portion applies only up to an annual cap set by Congress ($160,200 in 2023).
Self-employed individuals still must pay the Social Security and Medicare portions of the FICA tax, however these payments will no longer be withheld by an employer and they must cover the entire 15.3% amount on their own. They can reduce their overall tax liability by decreasing taxable income with pre-tax deductions.
Pre-tax health insurance premiums, which are often paid through Section 125 Cafeteria Plans – an employee benefit plan allowing workers to reduce their taxable income by contributing money towards retirement accounts or flexible spending accounts and health savings accounts – can lead to considerable tax savings when compared with taxes calculated based on gross income.
Sprintax Calculus tax compliance system enables users to conveniently view and report federal, state, local and payroll taxes for multiple entities on one screen – FICA included! Sprintax Calculus’ user-friendly design offers a clear snapshot of your tax situation at any given moment in time.
Social Security Tax
Employer-sponsored health plans often contain pre-tax plans. This means the premiums paid by employees and employers are deducted before taxes are withheld from gross pay before being used to fund the plan; when this is done, these premiums don’t need to be reported on W-2 forms and therefore are exempt from Social Security taxes. But this doesn’t apply to all benefits provided by an employer.
Employers looking to avoid Social Security tax on pre-tax health benefits need to offer eligible cafeteria plans as a means of dodging this tax. A cafeteria plan allows eligible employees to choose among various benefits options such as healthcare premiums, flex spending accounts and dental and vision plans based on certain criteria set out by rules and regulations of their employer. To be considered qualified plans.
General rules dictate that cafeteria plans must include a list of available benefits with their costs as well as methods for selection. They must be approved by the IRS prior to being implemented and, depending on their type, may also require employers match employee contributions into specific benefit funds.
Social Security payroll tax is calculated as 6.2 percent of an employee’s wages up to a maximum wage base of $90,000. Self-employed workers do not pay Social Security. Wages include salaries, bonuses, commissions, paid vacation or sick time and payments in kind such as lodging, food clothing and services provided. Benefits that do not fall under this umbrella include contributions made to 401Ks and 403Bs by an employer as well as life and accident or health coverage provided for family members of an employee and health savings accounts (HSAs).
Rising employee health insurance costs have contributed to a decrease in money wages below the taxable ceiling, due to an interaction between rising health insurance cost trends that affect workers both above and below the maximum, and growing inequality that causes these trends to have more of an effect on money wages below this ceiling.
Medicare Tax
The Medicare Tax is a payroll tax paid by employees, employers and self-employed workers alike to fund Medicare’s hospital insurance for people 65 or over as well as care in long-term nursing facilities. Employers collect this money through payroll deduction and withhold it accordingly according to FICA (Federal Insurance Contributions Act). Employers must send this money over promptly or face penalties. Employees should check their pay stubs regularly to make sure the appropriate amount of Medicare tax has been withheld from each paycheck.
All taxable wages, such as hourly wages, salaries, bonuses and tips are subject to Medicare tax. Furthermore, this tax applies to severance pay, unemployment compensation benefits and some fringe benefits as well. Furthermore, the IRS imposes an additional Medicare tax on investment income such as dividends, interest, passive income annuities and capital gains.
While payroll taxes and general revenue cover most Medicare expenses, enrollees also help cover a portion by paying monthly premiums. While most people cannot deduct these costs from their taxable income because they are post-tax expenses, some may qualify for an exemption to claim them as pre-tax expenses. However, certain individuals can take advantage of an exception that allows a special tax deduction for Medicare premiums.
Individuals can deduct Medicare premiums if their adjusted gross income (AGI) exceeds 7.5%. Luckily for self-employed individuals and couples with HSAs, their money can work to their advantage when paying Medicare premiums – for instance withdrawing tax-free money to cover those premiums will help lower AGI, making meeting that 7.5% threshold easier.
High-income earners can help keep Medicare premiums affordable by paying an additional Medicare surtax, which applies to investment income and regular wages that surpass certain thresholds (currently $225,000 for married couples filing jointly) such as 2.8% of either their MAGI (modified adjusted gross income) or net investment income. This additional surtax represents 3.8% of whatever income exceeds either threshold – such as investment income or regular wages that surpass these thresholds (for individuals the amount depends on which comes first).
State Tax
As health insurance premiums continue to climb, employees are searching for additional ways to offset out-of-pocket expenses. One effective solution offered by employers is pre-tax benefit accounts – often known as cafeteria plans – which allow employees to set aside pre-tax funds that will then be used towards qualifying expenses such as co-pays and deductibles; they can even include dental or vision coverage! Pre-tax benefit accounts provide employers and employees alike a way of improving employee retention while alleviating out-of-pocket financial costs by both sides simultaneously.
Pre-tax benefits come in various shapes and sizes, often known as cafeteria or section 125 plans. Flexible spending accounts and health savings accounts are among the more prevalent pre-tax benefits. Flexible spending accounts (FSAs) and health savings accounts (HSAs) are two employee benefit options that can easily be added into any company’s benefits program, offering employees another way to cover medical costs that go uninsured. Health savings accounts, however, provide individuals who want to save for future medical expenses with an avenue for doing just that – funded both by employers and employees themselves, these accounts provide funds that can roll over each year as qualified expenses come up.
Flex spending accounts and health savings accounts are common pre-tax benefits offered to employees, but another type can also be provided: traditional health reimbursement arrangements (HRA). An HRA is administered by employers and can be combined with either group medical plans or non-group plans; it typically does not fall under Section 125 restrictions.
Although many employers provide pre-tax deductions for healthcare costs, not all do. This is especially true of small businesses and hourly employees, who may pay their own coverage with pre-tax dollars. To determine whether payroll deductions for health care coverage from employees’ payroll are pre-tax, begin by calculating their gross pay and subtract the cost of their premium from this sum before calculating federal, state, and local taxes on this amount.