IRC 106: Employer Contributions to Accident and Health Coverage Explained

Employer contributions to accident and health coverage are a key workplace benefit, offering financial relief for medical expenses. These contributions fall under Internal Revenue Code (IRC) Section 106, which determines their tax treatment. Understanding these rules helps employers and employees maximize benefits while staying compliant with tax laws.

This article examines the tax treatment of employer-funded health coverage, including excludable amounts for employees, employer deductions, interactions with other tax provisions, and reporting requirements businesses must follow.

Employer-Funded Accident and Health Coverage

Employers offer accident and health coverage to help employees manage medical costs while gaining tax advantages. These plans include group health insurance, self-insured medical reimbursement arrangements, and supplemental coverage such as dental and vision insurance. Some employers cover the full cost of premiums, while others require employee contributions.

Under IRC Section 106, employer contributions to accident and health plans are not taxable for employees if the coverage qualifies as a health plan. This allows employees to receive benefits without increasing taxable wages. Employers benefit by attracting talent and potentially reducing payroll tax liabilities.

Some companies provide health reimbursement arrangements (HRAs) to cover specific medical expenses. Unlike health savings accounts (HSAs), which require employee contributions, HRAs are fully employer-funded and reimburse employees for qualified medical costs. These reimbursements remain tax-free if used for eligible expenses.

Excludable Amounts for Employees

Employees can receive employer-provided accident and health benefits without those amounts being included in taxable income, provided certain conditions are met. This applies to direct premium payments and medical expense reimbursements under employer-sponsored plans.

Employer contributions to group health insurance premiums are automatically excludable from income. However, reimbursements under a self-insured plan must comply with nondiscrimination rules under IRC Section 105(h), which prevent highly compensated employees from receiving disproportionate benefits. If a plan fails these requirements, reimbursements for high-earning employees may become taxable.

Flexible spending arrangements (FSAs) also qualify for this exclusion, allowing employees to set aside pre-tax dollars for medical expenses. While FSAs are primarily employee-funded, employer contributions remain excludable if they meet federal guidelines. For 2024, the maximum employee contribution to a health FSA is $3,200. Employer contributions do not count toward this cap if they comply with federal requirements.

Employer-paid long-term care insurance premiums are generally excludable when paid directly. However, reimbursements for long-term care expenses are subject to IRS-imposed annual limits based on the recipient’s age. Employees should be aware of these limits to understand the tax implications of long-term care benefits.

Employer Deductions Under the Code

Employers can deduct the cost of accident and health benefits as a business expense under IRC Section 162. To qualify, expenses must be directly related to the business and paid within the taxable year. Whether covering insurance premiums, funding a self-insured health plan, or contributing to an HRA, these costs reduce taxable income.

For self-insured plans, deductions remain available even if the plan fails nondiscrimination rules and certain reimbursements become taxable for highly compensated employees. Employers must maintain documentation, such as premium invoices or reimbursement records, to substantiate deductions.

The tax treatment of health benefit deductions varies by business structure. C corporations can fully deduct employer-paid premiums, directly reducing taxable income. S corporations must include employer-paid premiums in the taxable wages of shareholders owning more than 2% of the company. These shareholders may still deduct the costs on their personal tax returns under IRC Section 162(l), subject to self-employed health insurance rules.

Sole proprietors and partnerships follow different rules. Sole proprietors can deduct health insurance premiums on personal returns, but the deduction is limited to net business income and cannot create a loss. Partnerships must report health insurance premiums for partners as guaranteed payments, which are deductible at the business level but taxable to the receiving partner.

Coordination With Other Tax Sections

Employer-sponsored health plans interact with multiple tax provisions, requiring careful planning to ensure compliance and maximize benefits.

IRC Section 125 governs cafeteria plans, which allow employees to pay for premiums on a pre-tax basis. To qualify, the plan must comply with nondiscrimination rules that prevent highly compensated employees from receiving disproportionate benefits. If a plan fails these requirements, certain employees may lose the tax exclusion, increasing taxable wages.

The Affordable Care Act (ACA) imposes additional requirements on employer-sponsored health plans, particularly for applicable large employers (ALEs) with 50 or more full-time equivalent employees. Under the employer mandate, ALEs must offer minimum essential coverage that is both affordable and provides minimum value. Failure to do so can result in penalties under IRC Section 4980H.

For 2024, the penalty for failing to offer coverage to at least 95% of full-time employees is $2,970 per employee beyond the first 30. If an employer offers coverage that does not meet affordability or minimum value standards, they may face a $4,460 penalty per affected employee if the employee obtains subsidized coverage through the exchange.

Reporting Obligations

Employers must comply with reporting requirements to document accident and health coverage contributions. These obligations help the IRS track tax-exempt benefits and ensure businesses meet legal standards.

Form W-2 reports employer-sponsored health coverage. Under the ACA, employers filing 250 or more W-2s must report the total cost of applicable health coverage in Box 12 using Code DD. This figure includes both employer and employee contributions but does not affect taxable income. Smaller employers are currently exempt, though voluntary reporting is encouraged.

For self-insured plans, Form 1095-B or 1095-C may be required, depending on employer size and coverage structure. Applicable large employers must file Form 1095-C to report offers of coverage to full-time employees. Insurers and small self-insured employers use Form 1095-B. Employers failing to file or furnish these forms face penalties starting at $310 per return in 2024, with higher amounts for intentional disregard.