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Pre-tax or Post-tax Deductions (aka Pay Now or Pay Later)


Under regulations of Section 125 of the Internal Revenue Code, an employer can implement various Plans which allows employees an opportunity to receive certain benefits on a pre-tax basis.   In this article, we will look at the Premium Only Plan (POP), where employees can elect to pay their portion of insurance premiums on a pre-tax basis, creating a savings for both the employee and the employer.

Setting up a POP is simple and you just need to have a Plan Document and Summary Plan Description in place that describes all benefits and establishes the rules for eligibility and elections.  (If you do not have the required documents in place, PayMaster can create them for your business for just $99 using this link.)  Most plans do not need to file a Form 5500 tax return with the Department of Labor.  However, if the plan provides ERISA benefits, it is a welfare benefit plan and the employer must file a Form 5500 annual if the plan had 100 or more participants in the plan year.

Employees of regular corporations, S corporations, limited liability companies (LLCs), partnerships, sole proprietors, professional corporations, and not-for-profits can all reduce payroll taxes by establishing a POP.  While the Code prohibits a sole proprietor, partner, members of an LLC (in most cases), or individuals owning more than 2% of an S corporation from participating in the POP, owners will still benefit from the savings on payroll taxes by sponsoring the plan for their employees.

What benefits can be deducted pre-tax?  I am glad you asked.

  • Medical Insurance (including plans that are self funded)
  • Dental Insurance
  • Vision Insurance
  • Short Term (STD) or Long Term (LTD) Disability Insurance*
  • Group Term Life Insurance (up to $50,000 of coverage)*

All employees meeting the eligibility requirements established can participate, except those noted in the second paragraph above.  Although employees must be given the opportunity to choose whether or not to participate.   Why would an employee not participate and have a pre-tax benefit?  They may be approaching retirement or want to show a greater income on their W-2, and that may outweigh any immediate tax savings.

There is an exception to the ability to have deductions on a pre-tax basis, and that is in the case of Domestic Partners.  Under federal law, if a domestic partner does not qualify as the employee’s dependent (see IRS Section 152), then the portion of the premiums for the coverage of the partner cannot be deducted pre-tax.

I noted STD, LTD, and Life insurance above with an * as I bring us back to the Pay Now or Pay Later title.  Yes, these items can be paid for with pre-tax dollars, but it may not be a wise decision.  If the deduction is made pre-tax, then any benefit received from disability payments or life insurance proceeds would become taxable.  If the deduction is made post-tax, then any payout would be tax free.

Financially speaking, every business that offers insurance at a cost deducted from the employee, should implement a Premium Only Plan.  Just one employee having $100 deducted biweekly will save the employer just about $200, and the employee may see a savings of over $500, annually.  For a detailed before and after POP, check out our website.

Federal, state, and local laws, regulations, and codes change from time to time, so be sure to consult with your legal, HR, or accounting adviser regarding your your specifics.


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