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.

[Alf]

It won't happen. You can't legitimately get a tax free reimbursement to the employees to get the example to work. Money you receive from your employer is taxable, plain and simple. Is the reimbursement from the plan for medical benefits? If so, why wouldn't the employees have gotten this anyway. Have the benefits under the plan been increased???

[Guest Phil Cohen]

What is this $202.05 reimbursement? Does the "consulting firm" have a more detailed explanation? On the surface it sounds like someone is going to be visiting Club Fed.....

Phil Cohen

[Guest jlcowden]

My Granmother taught me "if it seems to good to be true it likely not true". While one should never say never this one smells like a dead fish to me . If it realy does work treasury will be all over this soon.

Does anyone remember the 1983 ZEBRA's (Zero Balance Reimbursement Accounts)?

I would caution the client and distance myself as fast as possible from being part of implwmenting this scheme.

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jlcowden

[Lisa Hand]

A more detailed response can be found on the Cafeteria Plans workgroup(Topic is the same), including a transcript from a conversation with Harry Beker at the IRS on this subject provided by the EBIA.

[Guest Phil Cohen]

Thanks Lisa!

Please see the discussion thread under Cafeteria Plans for the final word on this.

Phil Cohen