Small business health insurance: health coverage options and tax-saving opportunities

Healthy and happy employees can make your work environment more joyful and productive. But when you own a small business, there's a never-ending juggling act of balancing expenses with employee benefits - and few benefits get as much consideration as health insurance.

If you had fewer than 50 full-time employees last year, you don't need to offer your employees group health insurance. But if you had more than 50 and didn't offer group health insurance, you may have to pay a penalty.

Regardless of whether or not you have to pay the penalty, you may still want to provide health insurance to your employees as an incentive to attract and retain workers and keep your workforce healthy. Offering group health insurance could also save your employees (and yourself) money on healthcare costs and qualify you for small business tax incentives.

Plus, because insurance payments and medical expense reimbursements aren't subject to Social Security or Medicare taxes, you can offer your employees a higher total compensation package while limiting your business expenses. In other words, a $50,000 salary with a $5,000 annual health insurance benefit will cost your business less than paying a $55,000 salary without healthcare coverage.

Here's an overview of the types of health coverage you might want to offer your employees, and the tax benefits you could receive for doing so.

Choosing health coverage for your employees

You may be able to choose from several options if you want to start offering your employees health benefits. These four arrangements are some of the most common:

• Group health insurance. Group health insurance is the traditional option that you probably think of when it comes to employer-sponsored health plans. You can purchase a group insurance plan directly from an insurance company, with an insurance broker, or from the Small Business Health Options Program (SHOP) marketplace (if your business qualifies).
  
  Your business will pay your employees' health insurance premiums, although you could require they cover some of the cost. The premiums can vary each year and depend on the employees' demographics.
  
  Your employees may be able to choose from several plans, and they will be responsible for any non-covered medical expenses, such as the deductible or out-of-pocket costs.  
• Qualified small employer health reimbursement arrangements (QSEHRAs). A QSEHRA is a relatively new option (it became law in Dec. 2016) for businesses with fewer than 50 full-time employees that don't offer group health insurance to their employees.
  
  With a QSEHRA, you can offer to reimburse your employees' eligible medical expenses (the linked list doesn't name QSEHRAs, but the same eligible medical expenses apply). Unlike with some other types of accounts, the QSEHRA reimbursements can also cover employees' health insurance premiums. Your reimbursements won't be subject to payroll taxes, and your employees won't need to pay taxes on the money, either.  
  
  It's up to you to decide how much you want to reimburse each year and whether unused funds roll over to the next year. However, there are IRS-set annual limits. As of 2019, you can spend up to $5,150 for reimbursements to employees who purchase health insurance coverage for themselves, and up to $10,450 for reimbursements to employees who purchase health insurance for their families. The limit is per employee and includes funds that are rolled over from a previous year.
  
  Because your business isn't responsible for buying health insurance, using a QSEHRA could help you manage costs and predict future expenses. However, you must offer every full-time employee the same benefit, and your costs could still vary if you reimburse a percentage of the employees' health insurance costs rather than a predetermined amount each month or year.
  
  Also, employees must have health insurance coverage that meets federal minimum essential coverage requirements and submit reimbursement requests to participate in your QSEHRA.  
• Group health insurance and an HRA, FSA, or HSA. Another option is to offer a group health insurance plan along with a health reimbursement arrangement (HRA), flexible spending account (FSA), or health savings account (HSA).
  
  • HRAs are similar to a QSEHRA, but they don't have federal annual contribution limits. You can still choose whether you want to allow unused funds to roll over to the next year, and as with a QSEHRA, you can also decide which of the eligible medical expenses you want to cover.
  • FSAs differ from HRAs in that employees also contribute to the accounts, there are annual maximum contribution limits ($2,700 for individuals to $5,000 for families in 2019), and employees' unused funds may expire at the end of the year. Although you can allow employees to roll over up to $500 each year, this could be troubling to employees who contributed to their account and might lose the money. Employees can use FSA funds for any eligible medical expense, but they can't use it to pay their portion of health insurance premiums.
  • HSAs allow you and an employee to contribute money toward an employee's account (up to $3,500 for individuals to $8,000 for families in 2019) if the employee has an HDHP (defined below). The business still doesn't need to pay Social Security or Medicare taxes on the contribution, but the employees own their HSAs. As a result, you can't limit how the money is used. However, in general, HSA funds can't be spent on health insurance premiums. The funds also always roll over from one year to the next, and the employee gets to keep the money even if they leave the company.

• Health insurance stipend. Rather than setting aside money specifically for medical expense or health insurance, some businesses offer employees a raise or stipend as part of their wages. However, this approach isn't great for the employer or employee. Employers will need to pay payroll taxes on the higher wages, and employees also have to pay taxes on the money. You also can't be sure that your employees are using the money for health coverage.

Small businesses may want to use a combined option when they're trying to limit costs by only offering group high deductible health plans (HDHP), which have lower premiums but a high deductible. As a result, they may cover fewer expenses than non-HDHP insurance plans. You could then help cover some of those potential additional costs, such as copays or prescriptions, with an HRA, FSA, or HSA.

Some businesses also self-fund health insurance for their employees by setting aside money to pay for healthcare costs. Such an arrangement probably isn't an affordable option for small businesses on its own. However, starting in 2018, small businesses may be able to work together to purchase group-rate coverage or create a larger, more sustainable, self-insured network with an Association Health Plan.

The Small Business Health Care Tax Credit

Your business may qualify for the Small Business Health Care Tax Credit if you purchase group insurance through the SHOP marketplace Or, you may still be eligible if you purchase a non-SHOP plan and there isn't a SHOP plan available in your area.

The credit may be worth up to half of the premiums you pay, and you could receive the credit for up to two consecutive years. However, it starts to phase out for employers who have more than 10 full-time employees, or the equivalent with part- and full-time employees. It also phases out if you pay employees more than an average annual salary of $27,100 (as of 2019, the number is adjusted for inflation).

It's therefore worth the most for businesses with 10 or fewer employees and that pay them an average annual salary of $27,100 or less.

To qualify, your business must:

• Have fewer than 25 full-time employees (or the equivalent between your part- and full-time employees).
• Pay employees an average of $54,200 a year or less, as of 2019. The annual amount may increase or decrease each year.
• Offer coverage to every full-time employee.
• Cover at least half of the cost for employee-only health insurance.

You don't consider yourself, family members, or people who own over 5 percent of a business (including other businesses) when determining whether you'll qualify.  

If you want to quickly see whether you qualify and how much you could receive in tax credits, you can use the estimator tool on HealthCare.gov.

Small business healthcare tax deductions

Many healthcare expenses can also be deducted from your business' revenue, which can lower your profits and taxes for the year.

Deductible expenses could include:

• The portion of the premiums you pay for employees
• Matching contributions to employees' Health Savings Accounts (HSAs)
• Contributions to reimbursement accounts, such as qualified small employer health reimbursement arrangements (QSEHRAs) or health reimbursement arrangements (HRAs)

Be careful if you want to directly reimburse employees for the cost associated with purchasing health insurance or medical costs if you're not doing so through a QSEHRA.

Direct reimbursements without proper coverages and documentation could lead to a $100-per-employee daily penalty. So, it's generally best to create a similar arrangement with a QSEHRA if you want to offer a reimbursement rather than purchase a group plan for your employees.

Some states also offer small businesses additional tax credits or deductions that could make your healthcare costs more affordable.

Self-employed business owners can benefit, too

Self-employed business owners might not be able to participate in their business' FSA, HRA, or QSEHRA. However, if you're self-employed, you may still be able to deduct your health insurance premiums from your income if you bought coverage for yourself, a spouse, and your dependents. If you bought an HDHP plan, you may also be eligible for an HSA.

To qualify, you can't be eligible for employer-sponsored health insurance from a different employer (if you have a part-time job, for example), or from your spouse's employer. You also can't deduct more than you earned in net business income for the year.

Some special rules apply to self-employed S corporation owners, but they're generally eligible for a tax deduction based on their health insurance premium payments as well. They might just have to jump through a few extra hoops.

Finding what works best for your business

Cost isn't the only factor you should consider when deciding whether to offer health benefits to employees. Some business owners value helping their employees (and employees' families) stay covered and healthy over earning as much profit as possible. However, you will need to find the right balance of coverage and affordability to maintain a positive cash flow and build a successful business.

Knowing about the savings that can come from lower turnover, more competitive job offers, healthier employees, and tax benefits can help you make a well-informed decision about the net costs of offering healthcare benefits.

Funding Circle believes informed consumers are better consumers. We strive to provide informative and educational content useful for you and your business. However, please note that tax laws and regulations are complex and subject to change. We strongly recommend consulting your financial or tax professional regarding your specific circumstances.