Is Tax Free Health Care a Thing of the Past?

Friday, July 29, 2011

Representative Sandy Levin, a senior Democrat member sitting on the House Ways and Means Committee recently raised the possibility that tax deductions for health care premiums could be eliminated for high income wage earners as a means to help close the Federal budget deficit.

For the last 30 or so years, most workers have enjoyed health care deductions from employer paid wages on a tax free basis under IRC Section 125. In the mid 1980’s, as new benefits professional I implemented many Section 125 plans for my employers under a so called “cafeteria” arrangement. Today you would be hard pressed to find a large employer who did not offer health care benefits that were not tax free. Included in the 1978 tax reform legislation, the intent was to encourage employers to offer health care benefits tax free, and they did by the thousands. As is the case today, employers received and receive a deduction for their portion of health care costs and as well as other employee benefits (up to certain limits) against earnings as a normal part of “doing business”.

The benefit for employers and employees alike are significant tax savings as it applies to local*, state*, Federal, FICA and; Medicare taxes. The employer gets to forgo the employment related taxes on both the employee’s and the employer’s portion of health care premiums. The employee gets to forgo the employment related taxes on just their own portion of health care premiums. And with current health care premiums running into the hundreds and even thousands of dollars per month, the taxes saved to both parties is significant.  In addition, the value of health care benefits received by the employee and any family members is exempt from being taxed as income.  Even a modest health care procedure could have a value of tens of thousands of dollars if included as taxable income.  The downside to this is the loss of tax revenue to the local*, state*, and Federal governments. It thus becomes clear why Congress might want to look at eliminating this tax provision for at least the high income wage earners.

There are some who perceive that by taxing health care benefits, a semblance of control could be extended over the nation’s rapidly rising health care costs. Does this mean that the value of health care received within a given year would be imputed in the same manner that we currently impute the value of employer provided life insurance in excess of $50,000 annually? Or would we merely eliminate the tax exclusion of the premiums and return to the pre-1978 days? What would be the outcome of taxing the value of employer provided health care? Some employers would choose to drop coverage, some employees would choose to forgo enrolling in coverage; thus a public health care option would be created in de facto as coverage is mandated under PPACA.

*Not all local and state governments exempt premiums from local and state taxation.