What Is Medical Pre-Tax?

What Does Medical Pre-Tax Mean?

Medical pre-tax means a portion of your paycheck is withheld to pay for eligible medical benefits before federal income tax is calculated. Whether Social Security and Medicare taxes apply depends on the type of benefit and plan. Because these deductions are excluded from your taxable wages, they lower your overall taxable income and reduce how much tax you owe.

In practice, medical pre-tax deductions typically include employer contributions to employer-sponsored health insurance plans and certain tax-advantaged medical accounts. Since the money is deducted before federal income tax is applied, it is generally excluded from taxable wages reported in Box 1 of Form W-2. Treatment in other boxes depends on the benefit type.

You may also see the term medical EE pre-tax, which refers specifically to the employee-paid portion of a health plan that’s deducted on a pre-tax basis. These deductions are commonly offered through a Section 125 Cafeteria Plan, which allows employees to use pre-tax dollars for benefits such as health insurance premiums or flexible spending account (FSA) contributions.

While plan details vary by employer, all qualifying medical pre-tax deductions work the same way: they reduce employees' taxable wages upfront, helping them save on taxes throughout the year.

Sources:

• IRS Pub 15 (Circular E) 
• IRS Pub 502

So What?: If you make medical pre-tax contributions, they reduce your overall taxable income, providing major tax and health benefits.

How Medical Pre-Tax Deductions Work

When employees opt for a cafeteria plan, or another type of medical savings account, pre-tax medical payments are automatically deducted from their gross pay. These funds are deducted from the check before federal income tax withholding. Some plans also reduce Social Security and Medicare benefits, but this depends on the specific benefit.

Employees do not need to take any action to contribute to a health insurance pre-tax plan, since the withdrawals will occur before they receive their checks. Pre-tax medical deductions generally reduce wages reported in Box 1 of Form W-2. Whether they reduce Box 3 wages depends on the plan and IRS rules. Medical pre-tax funds are never included in these totals.

For instance, let’s say a taxpayer contributes $200 per month to a pre-tax medical plan. That equates to around $2,400 a year. When the employee files their income taxes, they will experience a $2,400 reduction in their reportable wages. At a 22% federal income tax rate, this could reduce federal income tax by about $528. Actual savings vary based on payroll tax treatment and state taxes.

Contribution limits apply to medical accounts like HSAs and FSAs and change annually.

Source: IRS Pub. 15, Fringe Benefits

So What?: Since medical pre-tax deductions reduce your overall tax liability, it may be worth considering investing into throughout the year to offer maximum tax savings when you file.

Common Medical Expenses That Qualify as Pre-Tax

The most common pre-tax medication contributions go toward health, dental, and vision insurance premiums.

Employer contributions to tax-advantaged medical accounts, such as flexible spending accounts, HSAs, or health reimbursement arrangements, are typically made with pre-tax payroll deductions, reducing the taxpayer’s overall taxable income. Medical pre-tax deductions typically include health insurance premiums and certain medical accounts.

Next Step: Use our guide to determine which types of medical expenses are considered pre-tax and which ones can be deducted from your tax return.

Source: IRS Pub. 969

After-Tax Medical Expenses That Don’t Qualify

In general, if your health insurance or medical expenses are paid for with after-tax dollars, then they won’t qualify for a reduction in your taxable income. You may be able to deduct qualifying medical expenses that exceed 7.5% of your adjusted gross income if you itemize deductions on Schedule A.

In other words, if you receive your paycheck and use money that’s already been subject to income and payroll taxes, then that expense may or may not be deductible depending on how much you spend on medical expenses throughout the year and the sum of your AGI. You will need to calculate your AGI, multiply it by 7.5%, and then determine if the sum of all your medical expenses exceeds that amount. If so, then you can itemize your medical expenses and deduct them. If not, you will not be eligible for an income reduction or a tax deduction for those costs.

Generally, if you pay for health insurance on the marketplace with your own out-of-pocket money, then those health insurance premiums will only be deductible if they exceed 7.5% of your AGI.

Next Step: Identify your after-tax medical expenses and calculate the total sum. From there, multiply your AGI by 7.5%. If your medical expenses exceed that figure, then you can itemize each expense and deduct them on your return.

Source: IRS Pub. 502, Medical Expenses

Where to Find Medical Pre-Tax Deductions on Your W-2

Identifying pre-tax withholding amounts and your overall gross pay can feel overwhelming and complex, but once you receive your official W-2 from your employer, it will be a lot easier.

To see your total taxable wages, you need to look at your W-2 Box 1 total. This sum excludes all your pre-tax contributions, meaning it already includes the taxable wages reduction. This is the amount that you will report on your federal income tax return.

Form W-2 Box 12 Codes DD & W are also important. The amount shown in Box 12 Code DD reveals the total coverage cost for the employer, and Box 12 Code W shows your total overall HSA contribution amount.

Box 3 on your W-2 form shows your total overall wages that are subject to Social Security tax. This total may slightly differ from the amount you see in Box 1 due to the medical pre-tax contributions and any other pre-tax deductions. Comparing Box 1 and Box 3 can sometimes highlight the impact of pre-tax deductions, but differences depend on the specific benefits you elected.

So What?: Understanding the taxable difference it makes to contribute to a pre-tax health plan can help you make more informed decisions on how to handle your healthcare expenses now and in the future.

Source: IRS Form W-2 Instructions

What is Medical Pre-Tax? A Summary

Medical pre-tax deductions reduce your taxable income and increase take-home pay, but cannot be claimed again as medical deductions. If you want to learn more about medical expenses and taxes, check out our Medical Event Guide.