I have a client who offers health insurance to certain employees working over 20 hours per week. One employee who does not work over 20 hours a week would like to "buy" into this health insurance by having her premiums deducted directly from her paychecks pre-tax. Essentially, her paycheck would be reduced to almost $0 b/c most of her paycheck would go towards the insurance premium and she would be relieved of most of her tax liability. Does this pose a problem? Is it tax avoidance? Would it really be a fringe benefit considering it constitutes most of her salary? Any guidance would be appreciated. Thanks!

She's not eligible for the plan. Are they planning to amend the plan so she will be eligible? Will they do this for everyone else too? Sounds like a big problem to me.

Two issues:

1. Health plan eligibility terms, as noted in the second post.

2. Cafeteria plan. You did not say how the health benefits are "offered" to other employees, but the descirption implies that no one else "buys" the insurance. An employee can only purchase coverage on a pre-tax basis if participating in a cafeteria plan of the employer, which requires a written plan document.

QDROphile --

Without a cafe plan, can't the co's health coverage policy permit those not covered by the group plan to purchase their own insurance and then have the premium cost of that coverage reimbursed by the company on a tax-free basis? I thought there was a reg covering that somewhere.

I don't think you can make Rev. Rul 61-146 work under the circumstances implied by the question. And if you could, it would not be pre-tax payment. An arrangement under the ruling provides for the employer to fund the cost of coverage, not a tax-advantaged purchase price for the employee.

Thanks for the response. This is exactly what they want to do, to allow this employee to purchase her own insurance and pay the entire premium at the group's rate out of what would otherwise be her taxable income. When you say reimbursed by the company on a tax free basis, is this what you are talking about? Also, do you happen to know the approximate reg section that would potentially cover this? Thanks!

It would help if you clarify the intended insurance coverage. Would the employee obtain coverage under the group policy that covers the others, or an individual policy?

Also, you changed the proposition for tax consequences. An employer does not need a cafeteria plan to allow an employee to pay premiums for group health coverage with after tax dollars. If one is buying an individual policy with after tax dollars, the employer does not need to get involved unless the employer has some buying capacity that is advantageous, such as a lower premium cost.

I agree that Rev Rul 61-146 won't be enough. That Rev Rul was issued under IRC 106, which excludes the value of health coverage provided by ER at its expense, in the absence of giving EE the choice to take cash or other taxable benefit in lieu of the health coverage. For such a choice by EE, you need IRC 125.

Rev Rul 61-146 outlines three mechanisms that the IRS approved by which ER could effect payment of premiums for coverage, and yet be tax free. Those three mechanisms are:
(1) ER reimburses each EE directly once or twice a year for ER's share of the insurance premiums upon proof of prior payment of the premiums by EE if the payments are shown to be in reimbursement of premiums actually paid by EE to the insurer;

(2) ER issues to each EE a check payable to the particular EE's insurance company, EE being obligated to turn over the check to the insurance company; or

(3) ER issues a check as in method (2) except the check is made payable jointly to the insurance company and EE.

Rev Rul 61-146 is yet instructive on the mechanisms that an ER may use to effect payment under a cafeteria plan (where EE has a choice and elected coverage that is provided via an individual health policy) for the insurance premiums. Note, other federal and state laws pose other challenges to reimbursing premiums paid by the EE for individual policies.

The employee obtains coverage under the group policy. Normally, the employer pays 100% of the premiums for any full time employee. This is obviously pre-tax. This specific employee is not full time, therefore the employer is not obligated to pay her premium. She will pay the premium, but she wants to do it from pre tax dollars, as opposed to after tax dollars. From a tax perspective, is this permissible or is really taxable income.

When the employer covers the entire premium, the term "pre-tax" as commonly understood in the industry is not the correct description. The health benefits are provided tax free. No cost to the employee and no taxable income associated with the benefit. Pre-tax means something else.

If the employee wants the benefit and is willing to pay with after tax dollars, that can be done, subject to eligibility terms of the group health coverage.

The employee cannot choose pay for the coverage pre-tax unless the employer has a cafeteria plan. Under the plan, the employee can choose to have the coverage and the employe's pay would be reduced by the premium amount. Since pay would be reduced, the premium amount would not be included in the employee's taxable income (or FICA wages), and that is what is called "pre-tax."

It would be edgy in several respects, but the employer could cut the employee's pay by the amount of the premium and then provide the coverage for "free" like everyone else, but the employee could not choose to start or stop the arrangement. It would have to be a permanent feature of the employee's compensation. That would amount to pre-tax payment.

That is exactly my concern. If the employer "cuts" the employee's pay by the amount of the premium, the employee's pay check would be about $20 per pay period. The entire salary would be shifted to the non taxable health insurance premim and the only taxable (or FICA) income would be the remaining $20. The other $700 would go to the health insurance premium. To me, this just looks like tax avoidance. I thought the employer should pay her salary, and if she wanted to buy into the group insurance she could with her post tax dollars. The employee is insisting that there is nothing wrong with shifting her income to he health insurance premium b/c that is what is done with everyone else who's employer provides a certain percentage of health insurance premiums - the employee's portion comes out of their paycheck and is not taxed.

Reducing base pay to that extreme would result in pure violation of FLSA and minimum wage laws. For it to be "tax advantaged" for the employee, I'd say your only option is to set up a premium-only cafeteria plan and ensure that every similarly situated part-time employee is offered the exact same opportunity.

And you're still supposing that a part-time employee can enroll in the insurance coverage... has the employer explicitly reviewed their plan to ensure it allows part-timers? Many fully insured plans have provisions that exclude part-timers.