Company Reimbursement of Pre-Tax Employee Contributions

[Guest GARNETT]

A client sponsors a medical insurance plan for its employees. The employees pay for a portion of the medical insurance with pre-tax contributions. For example,

Example 1.

Compensation $3,000.00 per month

Medical Insur. 200.00

Net Compensation $2,800.00

FICA 173.60

Medicare Tax 40.60

Federal Withholding 560.00

State Withholding 140.00

Local Withholding 52.50

Total Tax and W/H 966.70

Net Compensation $1,833.30

Take Home Pay $1,833.30

The client has been approached by a consulting firm that claims that the company can shift more of the cost for the medical insurance to the employees by asking the employees to use more of their pre-tax dollars to purchase the insurance while, at the same time, reimbursing the employees (tax-free) for the increase. This is the example the consulting firm uses:

Example 2.

Compensation $3,000.00 per month

Medical Insur. 500.00

Net Compensation $2,500.00

FICA 155.00

Medicare Tax 36.25

Federal Withholding 500.00

State Withholding 125.00

Local Withholding 52.50

Total Tax and W/H 868.75

Net Compensation $1,631.25

Reimbursement 202.05 (tax-free)

Take Home Pay $1,833.30

The employee takes home the same income in Example 1 as she does in Example 2. The consulting firm "pitching" this "scheme" further claims that the employer, incurs the following savings:

Example 3.

FICA/Medicare $45.90

Workers Compensation 3.00

Federal Tax 60.00

State Tax 15.00

Total Savings $123.90/month

Annualized Savings/Employee $1,486.80

Annualized Savings for 100 employees is $148,679.74 (i.e., $1,486.80 times 100).

While this scheme appears to me to be a double-dip not generally authorized by the tax-code, i.e., the first dip is the pre-tax contribution made by the employee and the second dip is the reimbursement of a portion of that pre-tax contribution by the employer (again tax-free), the consulting firm claims that it has set-up this program for a wide-range of clients including a Fortune 500 company.

I have two questions: (1) Has anyone every heard of a program like this and (2) Does anyone else question whether such a scheme is permissible under the tax code?

Thank you for your responses.

[GBurns]

The most likely plan that you would have seen, which includes Fortune 500 companies, does not operate as you think. Mainly the employee is not reimbursed the pre-tax premium, what you see in the illustration is just a mathematical effect of the figures used. Logically if the pre-tax amount is $150 + $15 = $ 160 and the "allowance" is $130, the amounts are different and not the same ??? As for being legal or allowed, there have been apparently 2 PLRs issued so far since June 1999 to users of the Health Incentive Plan.The Plan is "custom" designed to fit each client and could be different each time. The H I Plan was apparently designed after certain plans that have been in use for up to 11 years and some of which have been audited more than once.Some of those plans do have Private Letter Rulings and Tax and District Court cases. Ask the consulting firm for further details if you qualify as a prospect.