Are Health Insurance Premiums Exempt From FICA?

The Federal Insurance Contributions Act, or FICA, mandates contributions from both employees and employers to fund Social Security and Medicare. These payroll taxes are calculated as a percentage of an employee’s wages. A common question for both employees and employers is whether the value of health insurance premiums is considered part of these taxable wages. The tax treatment hinges on several factors, creating different outcomes depending on the specific arrangement.

FICA Exemption for Employer-Paid Premiums

When an employer pays for a portion or all of an employee’s health insurance premiums, those payments are not considered wages. Consequently, these amounts are exempt from FICA taxes for both the employer and the employee. This exclusion is outlined in the Internal Revenue Code and applies to employer contributions made to a qualifying accident and health plan. For most employees, this means the expense of health coverage does not increase their Social Security and Medicare tax liability.

A qualifying plan is a formal group health plan established by the employer to provide medical care for its employees and their dependents. The FICA exemption applies to the amounts the employer pays directly to the insurance carrier on behalf of the employee. The employer benefits by reducing its payroll tax expense, as it does not pay its 7.65% share of FICA on the premium amounts.

This tax structure creates a financial incentive for employers to offer health insurance rather than higher cash wages. If an employer were to give an employee cash to buy their own insurance, that cash would be fully subject to FICA taxes. By contributing directly to a group plan, the value is transferred to the employee without either party incurring additional Social Security or Medicare tax.

Tax Treatment of Employee-Paid Premiums

Many employees share the cost of their health insurance premiums with their employer through payroll deductions. By default, if an employee pays their share with after-tax dollars, those earnings have already been subjected to FICA taxes, meaning they receive no tax benefit on that contribution.

A Section 125 plan, often called a cafeteria plan, provides a mechanism to change this outcome. These plans allow employees to pay for their share of health insurance premiums using pre-tax dollars. When an employee elects to participate, their premium contribution is deducted from their gross pay before any taxes, including FICA and federal income taxes, are calculated.

The use of a Section 125 plan generates tax savings for both the employee and the employer. The employee’s taxable wages are lowered, which reduces their FICA and income tax liability, resulting in higher take-home pay. The employer also benefits because its share of FICA taxes is calculated on a lower wage base for that employee.

Special Rules for Business Owners

For individuals who own more than 2% of an S-Corporation, the premiums paid by the corporation for their health insurance must be included in their wages for income tax withholding purposes. However, these amounts are exempt from FICA and FUTA (Federal Unemployment Tax Act) taxes, provided the insurance plan was established by the S-Corporation.

Health insurance premiums paid by a partnership on behalf of a partner are treated as guaranteed payments. These payments are considered income to the partner and are included in their net earnings from self-employment. Consequently, these amounts are subject to the self-employment tax, which comprises both the Social Security and Medicare components and is functionally equivalent to FICA taxes.

Sole proprietors handle their health insurance premiums on their personal tax returns. They can deduct the amount paid for medical insurance for themselves and their family on Form 1040, using the self-employed health insurance deduction. This deduction lowers their adjusted gross income (AGI) for income tax purposes but does not reduce their net earnings for the calculation of self-employment tax.