Level-funded health plans have become a popular option for businesses seeking cost-effective ways to provide health benefits. Combining the financial predictability of fully insured plans with some of the cost advantages of self-funded plans, these plans offer a middle ground that appeals to many employers.
However, understanding the tax implications of level-funded health insurance plans is crucial for businesses, particularly HR professionals and small business owners. This knowledge can guide better decisions about structuring health insurance benefits while ensuring compliance with tax laws and maximizing financial savings this 2025.
What Are Level-Funded Health Insurance Plans?
Level-funded health plans are a hybrid approach to health insurance, blending features of both fully insured and self-funded plans. With these plans, employers pay a fixed monthly amount that covers administrative expenses, stop-loss insurance, and a claims reserve.
The claims reserve is used to pay for actual employee medical claims, and any unused funds may be refunded at the end of the year. To protect against unexpectedly high claims, stop-loss coverage acts as a financial safety net, ensuring that employers aren’t overwhelmed by large medical bills.
For small and medium-sized businesses, level-funded plans offer an attractive balance of cost savings and predictability. Employers benefit from the transparency of claims costs and the potential for refunds, while employees enjoy comprehensive health coverage. Additionally, these plans provide financial predictability, making them a practical matter for businesses seeking to manage healthcare expenses efficiently.
Tax Benefits of Level-Funded Health Insurance Plans
One of the key advantages of level-funded health insurance plans is the potential for tax savings. For employers, these plans can provide a range of financial benefits that extend beyond predictable costs and healthcare flexibility.
- Tax-Deductible Premiums and Administrative Costs: Payments made toward premiums and administrative tasks are generally tax-deductible, reducing the business’s taxable income and easing the financial burden.
- Surplus Refunds and Tax Implications: If claims are lower than expected, the employer may receive a surplus refund. While these refunds enhance cost savings, they may be treated as taxable income, depending on IRS guidelines.
- Lower Taxable Income Through Employer Contributions: Contributions to employee health plans reduce taxable income, providing businesses with significant tax savings while supporting employee well-being.
These tax benefits, combined with the cost predictability of level-funded plans, make them an excellent option for businesses looking to optimize their financial strategy while maintaining robust health coverage.
Compliance Considerations and IRS Regulations
Employers offering level-funded health plans must adhere to specific compliance requirements and IRS regulations. Understanding these obligations is essential to avoid penalties and ensure smooth operation.
IRS Reporting for Health Plan Contributions: Employers with level-funded plans are required to report contributions and claims fund details through annual tax filings. These filings, such as Forms 1095-B and 1094-B for non-ALEs (Applicable Large Employers), detail employee coverage and are submitted to the IRS. ALEs, typically those with over 50 full-time employees, use Forms 1095-C and 1094-C to fulfill reporting requirements.
ACA Requirements and Reporting Obligations: The Affordable Care Act mandates that both ALEs and non-ALEs sponsoring self-funded or level-funded plans file accurate tax forms. Non-ALE employers must report enrollment information, even if they mistakenly believe they are exempt. These filings ensure compliance with ACA rules and help the IRS determine individual eligibility for health insurance tax credits.
Penalties for Non-Compliance: Failure to file accurate ACA tax forms can result in significant federal penalties. Non-compliance with reporting obligations, such as furnishing statements to employees or submitting required forms to the IRS, can attract fines that are separate from the shared responsibility penalties for ALEs.
Employers must remain diligent in completing and distributing ACA filings each year, including ensuring that employees receive copies of relevant forms. Additionally, smaller businesses with fewer than 250 filings can take advantage of IRS allowances for manual filing but are encouraged to e-file for efficiency.
Managing Surplus Funds and Tax Implications
Surplus refunds from level-funded health plans can be a valuable financial benefit for employers, but they come with specific tax considerations. As mentioned, if the claims fund has unused money at the end of the plan year, the employer may receive a refund. The IRS typically treats these refunds as taxable income unless the funds are directly reinvested into the health plan.
To maximize tax advantages, employers should plan how to allocate surplus funds effectively. Options include using the refund to reduce future premiums, reinvesting it in employee health benefits, or covering administrative costs.
Tax Implications for Employers and Employees
The tax implications of level-funded health plans vary depending on whether you’re an employer managing the plan or an employee benefiting from it. Employers can capitalize on deductions for premium payments, administrative costs, and contributions to employee health benefits, which effectively reduce taxable income and support overall financial health. This makes level-funded plans particularly appealing for small and medium-sized businesses seeking cost-effective ways to provide robust health coverage.
For employees, pre-tax contributions toward health premiums lower their taxable income, making comprehensive healthcare more affordable. Additionally, these plans often mimic fully insured plans, meaning employees receive predictable coverage without the complexities of traditional self-funded plans.
Common Tax Pitfalls to Avoid
Managing the tax aspects of level-funded health plans requires careful attention to detail. Mistakes can lead to penalties, audits, and financial losses, so it’s important for employers to be proactive in avoiding common pitfalls. Here are some common pitfalls and how to avoid them:
- Reporting errors on ACA forms, such as Forms 1095-B and 1094-B, can lead to penalties if information is incomplete or inaccurate.
- Mishandling surplus refunds may create unexpected tax liabilities, so proper documentation of their use is essential.
- Failing to distribute required forms like Form 1095-B to employees on time can result in fines.
- Overlooking ACA filing obligations, especially for small businesses with level-funded plans, can cause compliance issues.
To mitigate these risks, employers should maintain accurate records, consult tax professionals for guidance, and use reliable third-party administrators to manage the administrative tasks associated with level-funded plans. Taking these steps ensures compliance and minimizes the likelihood of IRS audits or penalties.
Steps to Maximize Tax Benefits of Level-Funded Plans
To make the most of the tax benefits offered by level-funded health plans, businesses should take a strategic and collaborative approach. Working with brokers or third-party administrators (TPAs) can significantly lighten the burden of tax responsibilities. These professionals handle much of the complex reporting and compliance requirements, ensuring your business stays on track with IRS and ACA regulations.
- Brokers can review plan details and identify overlooked deductions, helping businesses unlock maximum tax savings.
- TPAs manage administrative tasks such as claims fund reporting, employee statements, and surplus fund tracking, which reduces the risk of errors and penalties.
- Both brokers and TPAs stay updated on the latest compliance rules, offering peace of mind by managing tax-related responsibilities on your behalf.
In addition to relying on these experts, employers should maintain thorough documentation of expenses, premium payments, and claims reserve activity. Clear and accurate records not only support compliance but also make audits more manageable, should they occur.
With the right partnerships and proper documentation, businesses can confidently navigate the tax landscape of level-funded plans while focusing on providing valuable employee benefits.
Is a Level-Funded Plan Right for Your Business?
Level-funded health plans are a game-changer for businesses seeking cost savings, tax benefits, and financial predictability. By understanding how these plans work and staying compliant with IRS and ACA requirements, you can create a win-win for your company and employees.
Don’t leave potential savings on the table—start exploring level-funded plans and take control of your health coverage strategy today.
