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Proper treatment of pre-tax benefit deductions

I thought I knew the answer to this, but maybe not. We started with ADP on 1/1, and while we've been working on getting the benefits module set up, another product has been feeding the benefit deduction amounts. Our company contributes to the employees' costs, and that line is shown as a separate reimbursement amount - a negative deduction. I assumed that for taxation purposes, that reimbursement was netting with the deductions to get the amount that is deducted from gross pay for taxes.

The other day, ADP accidentally turned on our benefits module, and the resulting payroll netted the employer contribution against the employee deductions. I expected everyone's net pay to be unchanged, but that was not the case, which indicated that previously the employer contribution was not getting deducted from the employees' contributions before calculating taxes. As I see it, the taxes should be unchanged regardless of how the benefits/employer contribution are being reported.

So the question is - should the entire employee contribution be deducted from gross before taxes are calculated, or just the net? If employer contributions to health insurance are non-taxable, it would seem that if we net the employee contributions with the employer contribution, the employees are effectively getting a reduced tax break, or conversely are getting taxed on the amount the employer is contributing.

Any guidance on this would be appreciated. I asked our payroll rep how ADP has set this scenario up for other customers, and she said that in talking with her tech people, there's a mix of customers that are set up like us, along with others that are taxing that amount, so that only confuses things further.



  • CaroleNJ
    CaroleNJ ✭✭✭

    I have not dealt with this in a few years, however, my understanding is if the company sets aside a certain amount per employee for benefits and the employee chooses the type and level of benefits, than the amount given by the employer is taxable income for the employee. All benefit choices the employee makes are pre-tax. Yes, healthcare is non-taxable for federal, but once the employee receives a set amount, and the employee can choose to take benefits or not, then the amount from the employer becomes taxable.

  • Hello ckaye99ckaye99

    I'm having a little trouble understanding what is going on. I take it this is a cafeteria (section 125) plan where the employee has the option to specify the benefits or receive cash. If the cash allowance is provided as part of the 125 plan, then it is taxable. However, the idea of the 125 plan is that the employee can have the option to receive cash in lieu of non taxable or partially taxable benefits without causing otherwise non-taxable benefits from becoming taxable.

    In the case of employer provided health care, under a section 125 plan, applying the cash allowance (which is part of the 125 plan) does not make the amount applied to health care taxable. The employee has elected a benefit that may be excluded from gross income. That will affect the employee's taxable (or net) pay where the payment replaces some or all of the employee's salary reduction amount.

    For example, if the employee's share of the cost of health care coverage is $250 a month, the employee can cover that through a pretax deduction of $250 from wages. Say the employer also offers a $60 per year cash allowance for employees to use to help pay benefits under the cafeteria plan. The employee could use $5 per month as part of the employee contribution to the health coverage. The $5 remains pre-tax and the amount of the employee's pre-tax deduction from wages is reduced to $245. Either way, $250 is excluded from income.