If the answer is yes, then the company must have a written plan document that complies with IRC Section 125. This section of the tax code provides that an employee will not be taxed on the employee’s cost of coverage even though the employee is given a choice between receiving his full salary or a reduced salary and non-taxable benefits. Besides avoiding federal income tax on the premiums paid for coverage, the premiums are also exempt from both the employee’s and the employer’s share of the Social Security and Medicare taxes. Employees’ contributions to a health savings account are also exempt from Federal income tax, and Social Security and Medicare taxes if these contributions are part of a Section 125 plan.
If a company has been allowing these pre-tax payments for a number of years, it’s time to pull out the plan document and confirm that it reflects the current operations of the company. A Section 125 plan may be labeled as a “premium conversion plan”, or a “cafeteria plan” or a “flexible benefits plan”. It may include flexible spending accounts or be limited to allowing pre-tax premium contributions. The document should have been adopted by the company prior to the date that employees were allowed to make pre-tax premium payments.