Federal Tax Considerations for Accident and Health Insurance

Navigate the complexities of insurance with our guide on Federal Tax Considerations for Accident and Health Insurance. Explore crucial insights into the tax implications of insurance policies, unraveling the intricacies of deductions, credits, and exemptions. Stay informed about the latest federal tax regulations impacting accident and health insurance. Whether you’re an individual seeking tax benefits or a business ensuring compliance, our resource provides expert guidance. Optimize your financial strategy by understanding the federal tax considerations associated with accident and health insurance. Explore the intersection of insurance and taxation for a comprehensive approach to financial well-being. Dive into our guide now!

Personally-owned Health Insurance

Taxation of insurance benefits is often determined by whether or not the premiums were taxed.

1. Disability Income Insurance

Premium payments on personally owned disability income policies are nondeductible by the individual. However, disability income benefits are received income tax free by the individual.

2. Medical Expense and Long-term Care Insurance

In medical expense insurance policies, unreimbursed medical expenses paid for the insured, the insured’s spouse and dependents may be claimed as deductions if the expenses exceed a certain percentage of the insured’s adjusted gross income. The law permits deductions for unreimbursed expenses in excess of 7.5% of the adjusted gross income (AGI).

This provision only applies if the insured itemizes these deductions on his/her tax return.

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Employer Group Health Insurance

1. Disability Income (STD, LTD)

Premiums paid by the employer for disability income insurance for its employees are deductible as a business expense and are not considered as taxable income to the employee.

Benefits received by an employee that are attributable to employer contributions are fully taxable to the employee as income.

When the employer and employee share in disability insurance premium contributions, the employee’s contribution is not deductible; however, benefits received by the employee that are attributable to the employee’s portion of the contribution are not taxable as income. The taxation of income received by the employee would depend on the type of a group plan:

  • Noncontributory – The employer pays the entire cost of the disability insurance premium, so the income benefits are included in the employee’s gross income and taxed as ordinary income.
  • Fully contributory – The employee pays the entire cost of the disability insurance premium, so the income benefits are received income tax free by the employee.
  • Partially contributory – The cost of disability insurance is paid partially by the employer and partially by the employee. The portion paid by the employee is received income tax free and the portion paid by the employer is included in the employee’s gross income and taxed as ordinary income.

For example, if an employee contributes 40% of the premium and receives a benefit of $1,000, only $600 (60% = employer contribution) of the benefit payment will be taxed to the employee as income, while $400 (40% = employee contribution) will be received tax free.

Disability insurance premiums are deductible as business expense; benefits are taxable income for employee.
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Short-term disability (STD) group plans usually have a benefit period of less than 2 years. It is common in this type of disability income plans to place a maximum dollar amount on the benefit that will be provided regardless of earnings, and to have an elimination period (except for disability resulting from accidents).

Long-term disability (LTD) group plans usually pay benefits for 2 years or longer.

Benefits Subject to FICA

Benefits paid to disabled employees that are attributable to the employer’s contribution are subject to Federal Insurance Contributions Act (FICA) withholding for Social Security purposes. Any portion of the benefit paid for and deducted by the employer will be considered taxable income to the employee.

2. Medical and Dental Expense

For group medical, dental, and vision expense insurance any premium paid by the employer is deductible as a business expense. However, any premiums provided by the employee are only deductible to the extent that the employee premium, when added to all other unreimbursed medical expenses, exceeds 7.5% of the taxpayer’s adjusted gross income, if the taxpayer itemizes deductions. Group medical and dental expense benefits are received income tax free by the employee.

3. Long-term Care Insurance

The following general rules apply to taxation of long-term care policies:

  • Premiums may be deductible; 
  • Daily benefits from the LTC policy are received income tax free, as long as they do not exceed the daily cost of long-term care; and
  • Benefits paid in excess of the cost of care received are taxed as ordinary income.

4. Accidental Death and Dismemberment

Premiums for group accidental death and dismemberment policies are deductible to the employer as an ordinary business expense. The benefits of group accidental death and dismemberment are received income tax free.

Medical Expense Coverage for Sole Proprietors and Partners

Sole proprietors and partners may deduct 100% of the cost of a medical expense plan provided to them and their families because they are considered self-employed individuals, not employees. The deduction may not exceed the taxpayer’s earned income for the year.

Business Disability Insurance

1. Key Person Disability Income

Key person disability income premiums are not deductible to the business, but the benefits are received income tax free by the business.

2. Buy-sell Policy

Disability buy-sell insurance is typically written to cover partners or corporate officers of a closely held business. The policy provides funds for the business organization to purchase the business interest of a disabled partner. In a disability buy-sell policy, whether a cross purchase or entity, the premiums are not deductible to the business, but the benefits are received income tax free by the business.

Medical Savings Accounts (MSAs)

A Medical Savings Account (MSA) is an employer-funded account linked to a high-deductible medical insurance plan. The employer raises the medical plan deductible and returns all or part of the premium savings to the employees to contribute to the MSA. The employee then uses the funds from the MSA to cover health insurance deductibles during the year. If there is a balance at the end of the year, the employee may leave in the account and earn interest or withdraw the remaining amount (as taxable income). If a distribution is made for a reason other than to pay for qualified medical expenses, the amount withdrawn will be subject to an income tax and an additional 20% tax.

1. Eligibility

Medical savings accounts are only available to small employers (with 50 or fewer employees) or a self-employed person. Generally, participants in the plan cannot have Medicare or any other health coverage that is not a high deductible health plan (HDHP). The following additional coverages are permitted:

  • Workers compensation;
  • Specific disease or illness;
  • A fixed amount per day of hospitalization;
  • Accidents and/or disability;
  • Dental care;
  • Vision care; and
  • Long-term care.

2. Contribution Limit

Contributions to an MSA must be made in cash or its equivalent. There are 2 limits on the amount the employee and employer can contribute to an MSA: the annual deductible limit, and an income limit. Under the annual deductible limit rule, the maximum amount that can be contributed to an MSA is 65% of the high-deductible plan for individuals or 75% of the family deductible for those with family coverage. Under the income limit rule, a person cannot contribute more than what was earned for the year from the employer through whom the person has an HDHP.

A medical savings account (MSA) is an alternative to the traditional method of purchasing medical insurance for employers with fewer than 50 employees. Under a medical savings account a high deductible major medical health insurance policy is purchased by the business. A portion of the premium savings for the lower cost health insurance is deposited into a medical savings account for the employee.

Employer contributions deposited for the employee are income tax deductible to the business. During the year, the employee may deduct from the MSA to cover out of pocket expenses such as deductibles and coinsurance. Distributions from the MSA to pay appropriate benefits are not income taxable. If there is a balance left in the  account at the end of the year, the balance can be carried over to future years.

Tax-free distributions are available to pay for qualified medical expenses (those that qualify for the medical and dental expenses deduction). Nonqualified distributions will be subject to income tax and may be subject to an additional 20% tax.

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Health Savings Accounts (HSAs)

Health Savings Accounts (HSAs) feature tax-deferred growth, and enable the insured to pay for medical expenses with pre-tax income. Excess funds can be carried over to the next year. Regardless of how income is earned, any money deposited into an HSA is considered an “above-the-line” deduction, giving a 100% write-off against adjusted gross income.

Health Savings Accounts provide a broad range of tax-free withdrawals including

  • Doctors, dentists and hospitals;
  • Artificial limbs;
  • Drugs;
  • Eyeglasses and contacts;
  • Chiropractic;
  • Laboratory expenses;
  • Nursing home costs;
  • Physical therapy;
  • Psychoanalysis;
  • X-rays; and
  • Nursing home insurance premiums.

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Health Reimbursement Accounts (HRAs)

Health Reimbursement Accounts (HRAs) consist of funds set aside by employers to reimburse employees for qualified medical expenses, such as deductibles or coinsurance amounts. Employers qualify for preferential tax treatment of funds placed in an HRA in the same way that they qualify for tax advantages by funding an insurance plan. Employers can deduct the cost of a health reimbursement account as a business expense.

The following are key characteristics of HRAs:

  • They are contribution healthcare plans, not defined benefit plans;
  • Not a taxable employee benefit;
  • Employers’ contributions are tax deductible;
  • Employees can roll over unused balances at the end of the year;
  • Employers do not need to advance claims payments to employees or healthcare providers during the early months of the plan year;
  • Provided with employer dollars, not employee salary reductions;
  • Permit the employer to reduce health plan costs by coupling the HRA with a high-deductible (and usually lower-cost) health plan; and
  • Balance the group purchasing power of larger employers and smaller employers.

1. Contribution Limits

An HRA has no statutory limit. Limits may be set by employer, and rollover at the end of the year based on employer discretion. Former employees, including retirees, can have continued access to unused HRAs, but this is done at the employer’s discretion. HRAs remain with the originating employer and do not follow an employee to new employment.

HRAs allow employees to roll over unused benefits to the following calendar year, in addition to new benefits.
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Federal Tax Considerations for Accident and Health Insurance

Navigate the complexities of insurance with our guide on Federal Tax Considerations for Accident and Health Insurance. Explore crucial insights into the tax implications of insurance policies, unraveling the intricacies of deductions, credits, and exemptions. Stay informed about the latest federal tax regulations impacting accident and health insurance. Whether you’re an individual seeking tax benefits or a business ensuring compliance, our resource provides expert guidance. Optimize your financial strategy by understanding the federal tax considerations associated with accident and health insurance. Explore the intersection of insurance and taxation for a comprehensive approach to financial well-being. Dive into our guide now!

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