Part of caring for your employees may include offering benefits such as health insurance, adoption assistance, or life insurance. While it is possible to offer these benefits to employees without them being taxed, there are certain procedures that need to be followed to take advantage of this tax treatment.
This article will help you get up to speed on pretax deductions, the steps you need to take before implementing these benefits, and how your ministry payroll processor can help.
In general, when employees receive compensation from their employer, they must pay taxes on those amounts. However, certain forms of compensation can be offered on a pretax basis, meaning that the employee, and sometimes the employer, will not have to pay taxes on the benefits.
Examples of qualified pretax benefits include:
The way your ministry will need to structure its tax planning depends on the benefits you offer. For example, if you offer group health/dental/vision, then your ministry will need to have a cafeteria plan in order to offer these on a pretax basis. If your ministry doesn’t offer group health but wants to provide money for employees to shop for their own health plan, you’ll need to offer an HRA, which gives employees an allowance to shop for their own health insurance. The allowance is offered on a pretax basis.
A cafeteria plan enables employers to offer certain benefits that don’t count toward an employee’s taxable income. One common benefit is group health insurance. Before employers can offer pretax deductions, they must have a written plan, commonly referred to as a cafeteria plan, that meets the requirements of Section 125 of the Internal Revenue Code. Two of the requirements are that the plan is open to all employees and that employees have the option to choose at least one taxable benefit (e.g., cash, tuition reimbursement, etc.) and one qualified benefit (e.g., group health benefits).
You can find more information about Cafeteria Plans under Section 125 by referring to the Cafeteria Plans FAQs resource published by the IRS. When developing a plan, ministries should work closely with a local attorney that specializes in tax law.
A flexible spending arrangement, or FSA, is a type of cafeteria plan that helps employees with expenses related to dependent care, adoption, or medical care. It works by reimbursing employees for costs related to qualified benefits. This type of plan is subject to annual contribution limits and the funds must be used during the plan year.
Group health benefits aren’t the only way to offer employees tax benefits. Ministries with Health Reimbursement Arrangements (HRA) also can take advantage of pretax deductions.
An HRA is a good option for employers that do not offer group health benefits because it still allows employees to obtain health benefits on a pretax basis. For employees, individual coverage reimbursements do not count toward an employee’s taxable wages and they have the option to shop for a plan that best suits their needs. The employer reimburses premiums for individual health insurance up to a designated amount.
For example, an employer may decide to offer an employee $500 per month to shop for health insurance. It then is up to the employee to obtain their own insurance coverage with that $500. With an HRA in place, the employee would not pay any taxes on that $500.
Two types of HRAs are eligible for pretax deduction: ICHRA and QSEHRA.
ICHRA: Individual Coverage HRA. This plan can be used by an employer of any size to reimburse employees for health plans that they purchase on their own. The funds can be used to pay for expenses including premium payments and related medical costs.
QSEHRA: Qualified Small Employer HRA. This plan is designed for employers with fewer than 50 employees. The same limit for single or family reimbursement must be offered to all employees.
Offering a cafeteria plan or an HRA means you’ll have additional tax requirements to navigate. The team here at MinistryWorks can help. Tax withholding is one of the most common issues MinistryWorks sees with new customers. Our team specializes in helping ministries make sure their payroll and payroll taxes comply with current laws.
The information in this article is intended to be helpful, but it does not constitute legal advice and is not a substitute for the advice from a licensed attorney in your area. We strongly encourage you to regularly consult with a local attorney as part of your risk management program.