There's More Than One Way   to Provide Health Care Benefits

If rising health care costs have sent your company searching for ways to reduce expenses, you should know there are alternatives to standard medical insurance plans. Your choices are not limited to either paying the higher costs yourself or transferring the burden to your employees. Tax-advantaged strategies are available that can mitigate the effect of rising costs for you and your staff members. Here are three ideas to consider.

1. Establish a Health Insurance Premium-Only Plan (POP)

This super-simple option is often a good choice for small employers. With a POP, your employees are charged via payroll withholding for their share of health premiums. These withholdings are considered salary reductions for federal income tax, Social Security tax, and Medicare tax purposes. In other

How Much Can You Save?     For every employee who diverts $1,000 to a Premium Only Plan or a Flexible Spending Account, your payroll tax costs will generally be reduced by $76.50 (or 7.65 percent of the actual amount). The more employees who participate in these plans, the higher your potential savings.     This is apart from the tax savings collected by your employees, which are even greater because they save Social Security and Medicare tax, as well as income tax.

"Use it or Lose It" Rule Relaxed In a welcome move for employers and employees, the IRS relaxed the rules involved in tax-saving flexible spending accounts. In guidance, the tax agency announced that employees may be able to get an extra 2 1/2 months after year-end to spend the money set aside in their accounts before they lose it. (IRS Notice 2005-42)     In order to take advantage of the grace period, however, employers must amend FSA plans by December 31 to permit the extra 2 1/2 months -- through March 15 of the following year (assuming the plan operates on a calendar-year basis, which is usually the case). Employees can use unspent year-end balances to reimburse themselves for qualified expenses incurred within the grace period.     Essential to understand: The use-it-or-lose-it rule still exists, but the grace period greatly softens the blow by allowing employees more time to use their unspent FSA balances.

words, the POP allows your employees to pay their share of health insurance premiums with pretax dollars, which can save them a substantial amount of taxes over the course of a year.

At the same time, your company's taxes are also reduced. Reason: the salary reduction amounts are exempt from the employer's share of Social Security tax and Medicare tax. For 2008, the employer's share of these taxes is 7.65 percent of the first $102,000 (up from $97,500 in 2007) of each employee's salary, including bonuses, plus 1.45 percent of compensation above $102,000.

Because a POP is considered a "cafeteria benefit plan," it's governed by Section 125 of the Internal Revenue Code. This means your business will need to install a written plan and employee enrollment procedures when setting up the program. The POP cannot discriminate in favor of highly compensated employees or key employees. Despite these restrictions, it's generally easy and inexpensive to establish a POP with professional help.

Basic cost-reduction strategy: First, shift a higher percentage of premiums for employee health coverage to your employees. This reduces your company's costs. Then set up a POP to give your employees an offsetting benefit in the form of reduced income tax, Social Security tax, and Medicare tax. The same strategy also cuts the company's tab for Social Security and Medicare taxes.

2. Set Up a Flexible Spending Account Plan

Setting up and operating a Flexible Spending Account (FSA) is more complicated than the POP option. Therefore, these plans are probably best suited to businesses with a larger number of employees.

Here's how FSAs work: Your company sets up a health care flexible spending account for each participating employee. Then, the employee makes an annual election to contribute a specified dollar amount of his or her salary to the FSA and these contributions are withheld from the employee's paychecks. To be reimbursed, the employee submits a claim for his or her share of health insurance premiums and uninsured medical expenses (up to the annual amount contributed to the FSA). The reimbursements are tax-free to the employee.

Employee FSA contributions are considered salary reductions, which means they are exempt from federal income tax, Social Security tax, and Medicare tax. So they allow your employees to pay out-of-pocket medical expenses (including their share of health premiums) with pretax dollars. Your company's taxes are also reduced, because the salary reduction amounts are exempt from the employer's share of Social Security and Medicare taxes.

Like POPs, FSA plans are considered "cafeteria benefit plans" under Section 125 of the Internal Revenue Code. Therefore, your business will need to install a written plan and employee enrollment procedures. The plan cannot discriminate in favor of highly compensated employees or key employees. An FSA plan also requires significant administrative effort to enroll employees, handle the necessary payroll withholding, and process reimbursement claims. Many companies find it cost-effective to hire a third-party plan administrator to take care of all the details.

Finally, many companies place a $3,000 annual lid on the amount an employee can contribute to the health care FSA. This is important, because employees can request reimbursement for expenses up to their annual contribution long before the contributions have actually been collected through the payroll withholding.

Basic cost-reduction strategy: First, shift a higher percentage of employee health premiums to your employees, or increase the insurance plan deductibles. Or take both actions. Your company's costs will be reduced. Then, set up an FSA plan to give your employees an offsetting benefit in the form of reduced income, Social Security, and Medicare taxes. The FSA also cuts the company's Social Security and Medicare tax bills.

The option to set up an HRA can be attractive to larger employers. Here's how it works: Every year, the company agrees to contribute a fixed amount to each eligible employee's account. Employee contributions are not allowed. The company deducts the HRA pay-ins. However, the contributions are tax-free to employees (no federal income tax, Social Security tax, or Medicare tax). Your employees can then submit claims to be reimbursed for uninsured medical expenses, including their share of health insurance premiums, if applicable. Reimbursements are tax-free. In effect, the employee is able to pay for out-of-pocket medical expenses with pretax dollars, up to the amount contributed to the employee's HRA account.

Since your company must pay for all HRA contributions, this arrangement only saves money when it's combined with a much-less-generous employee health insurance program. The idea is that your company's health insurance costs will be drastically reduced, which allows you to return some of the cost savings to employees in the form of HRA contributions.

Basic cost-reduction strategy: First, switch your health insurance plan to one that greatly reduces your company's premium costs, which of course, means it provides less benefits to employees. Then, return a portion of the savings to employees via the tax-favored HRA arrangement.

Conclusion: These are just some of the tax-saving ways to reduce employee health costs. Your tax adviser can explain more.

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