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Health Insurance Rebate Payments Subject To Employment Taxes for Some Employees

Thursday, July 19, 2012

Employers distributing health insurance premium rebates directly to employees are required to withhold employment taxes on the amounts when the rebates are for pre-tax premium contributions, the Internal Revenue Service said.

The health insurance rebates to employers and participants of employer-sponsored health plans are required to be disbursed by Aug. 1 under a provision of the Patient Protection and Affordable Care Act (Pub. L. 111-148).

The law requires health insurance companies that issue policies to do this when spending less than 80 percent of premiums on medical care and quality (or less than 85 percent in the large group market) the prior year. The medical loss ratio rebate amount is the portion of premium dollars that exceed these limits.

As a result, employer-sponsored plans could receive more than $700 million in rebates this year for appropriate distribution between the employer contribution amount and employee contributions, according to the Department of Health and Human Services.

Rebate Scenarios for Pre-Tax Premium Contributions

While there is some flexibility in how the rebates are passed on to employees, several scenarios covered in a question-and-answer format by IRS said that 2012 rebate amounts to employees for pre-tax premiums, such as premiums paid under a qualified Internal Revenue Code Section 125 plan, are subject to employment taxes.

How the rebate is paid to employees determines the level of involvement for payroll, said Martin Armstrong, CPP, senior director of payroll shared services for Time Warner Cable and a member of Bloomberg BNA's Payroll Library Advisory Board.

Rebates applied in a manner to reduce the amount of pre-tax employee premium payments would correspondingly increase taxable wage amounts. In this scenario, no special effort is necessary to account for the rebated amounts for payroll tax purposes.

However, if employers determine that the rebates would be distributed as cash payments to employees who have pre-tax premium amounts deducted from pay, then those cash payments are to be included in employee taxable wages, with additional employment taxes withheld.

Role of the Payroll Department

As employer plan administrators determine how to distribute the rebates to the affected employees, payroll professionals should collaborate with their counterparts in benefits to discuss various scenarios, Armstrong said. In addition, transparent communication should be provided to affected employees so that they understand what makes the rebates subject to federal income tax and, from an employer's perspective, wages subject to employment taxes, he said.

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