How to Reimburse Employees for Health Insurance Premiums

Providing health insurance support to employees helps businesses attract and retain talent. However, not all employers can afford traditional group health plans, leading many to explore reimbursement options. These alternatives allow companies to contribute toward employees’ insurance costs while maintaining flexibility.

Understanding how to structure reimbursements properly is essential to avoid tax and compliance risks. Employers have multiple options, each with specific requirements and implications.

Eligible Reimbursement Methods

Employers can reimburse employees for health insurance premiums through different methods, each with distinct compliance considerations. The right choice depends on company size, budget, and administrative capacity.

Account-Based Arrangements

Health Reimbursement Arrangements (HRAs) allow businesses to allocate funds for employees’ healthcare expenses. Two common types are the Qualified Small Employer HRA (QSEHRA) and the Individual Coverage HRA (ICHRA).

A QSEHRA is available to businesses with fewer than 50 full-time employees and allows reimbursement for medical expenses, including premiums, up to an IRS-set limit. Employees must have individual health insurance that meets minimum essential coverage standards.

The ICHRA has no company size restrictions and offers more flexibility in reimbursement amounts, provided they are applied fairly across employee classes. Unlike QSEHRAs, ICHRAs can be tailored to different groups within a company, such as full-time versus part-time employees. Employees receiving an ICHRA must opt out of any employer-sponsored group health plan.

Both HRAs provide a structured way to assist with healthcare costs without requiring a traditional group plan.

Direct Premium Payments

Some businesses consider paying insurance providers directly on behalf of employees. While this removes upfront costs for workers, it presents regulatory challenges. The Affordable Care Act (ACA) prohibits employers from paying for individual health insurance policies unless done through an HRA or another compliant structure. Violating these rules can result in penalties under IRS Notice 2013-54.

Additionally, some states restrict employer involvement in individual market plans. Employers considering direct payments should consult legal or benefits professionals to ensure compliance.

Salary Adjustments

A simpler but less tax-efficient approach is increasing employee wages to help cover health insurance costs. While easy to administer, this method has drawbacks. Additional wages are taxable, meaning employees pay income tax, Social Security, and Medicare contributions. Unlike HRAs, which allow for tax-free reimbursement, salary increases provide no tax advantages.

There is also no guarantee that employees will use the raise for insurance premiums. While this option offers flexibility, it is generally less efficient from a tax perspective.

Tax and Payroll Implications

The structure of health insurance reimbursements affects tax treatment for both employers and employees.

Reimbursements provided through an IRS-compliant arrangement like an HRA are excluded from an employee’s taxable income, reducing payroll tax liabilities for both parties. Employers lower their taxable payroll, while employees receive the full reimbursement amount without deductions.

If reimbursements are made outside a recognized tax-advantaged structure, the IRS treats them as taxable compensation. For example, if an employer informally reimburses workers for health insurance costs without using an HRA, the amount must be reported as additional wages on Form W-2. This increases taxable income and subjects the employer to payroll taxes, including the 6.2% Social Security tax and 1.45% Medicare tax.

Employers must also consider how reimbursements affect deductions. Traditional employer-sponsored health plans allow premium costs to be deducted as a business expense under IRC Section 162. However, improperly structured reimbursements may not qualify for the same treatment. If classified as wages, they remain deductible as compensation expenses, but the employer loses payroll tax savings.

Noncompliant reimbursement arrangements can also trigger penalties under IRC Section 4980D, which imposes fines of up to $100 per affected employee per day.

Documentation and Filing Requirements

Proper documentation is necessary to comply with IRS regulations and protect both employers and employees in case of an audit. Businesses must maintain records that substantiate each reimbursement, including proof of insurance coverage such as policy statements or payment receipts. A formal reimbursement policy should outline eligibility criteria, submission deadlines, and required documentation.

Employers must also ensure payroll records accurately reflect reimbursement amounts. Tax-advantaged reimbursements should be tracked separately from regular wages to avoid misreporting. If reimbursements are taxable, they must be recorded on Form W-2, and applicable payroll taxes must be withheld and reported on Form 941, the employer’s quarterly federal tax return.

State regulations may introduce additional reporting obligations, particularly in states with individual health coverage mandates. Some states require employers to report whether employees have health insurance coverage on state tax returns. Businesses operating in multiple states must stay informed about varying requirements to ensure compliance.

Coordinating With Other Benefit Plans

Employers offering health insurance reimbursements must consider how they interact with other benefits like retirement plans, wellness stipends, or flexible spending accounts (FSAs). Offering both an FSA and a reimbursement plan could create overlapping coverage, potentially leading to disallowed expenses under IRS rules. Employees cannot seek reimbursement for the same medical expense from multiple tax-advantaged accounts, so clear guidelines on eligible expenses and fund usage are necessary.

If an employer offers a traditional group health plan alongside a reimbursement arrangement, IRS rules prohibit “double dipping,” where employees receive both employer-sponsored coverage and premium reimbursements. This restriction is particularly relevant for businesses using an ICHRA, which disqualifies employees from participating in a group plan. Employers must communicate these limitations clearly to ensure employees make informed benefit decisions.