PHCC Educational Foundation

Personnel e.bulletinfor March 2010

Human Resources’ Impact on Taxes

Prepared for the PHCC Educational Foundation by TPO, Inc.

As you prepare your tax filing, now is an excellent time to look at ways to reduce your small business’s taxes for next year. As we all know, budgeting, saving and investing are fundamental elements of sound financial planning. Taxes can profoundly affect your bottom line, and there may be ways to avoid some of the tax implications by looking more closely at employer-provided benefits. Various retirement plans, Section 125 plans, flexible spending accounts, education deductions and the Work Opportunity Tax Credit are areas worth investigating.

Flexible Spending Accounts

A Flexible Spending Account (FSA), also known as a flex plan or reimbursement account, is an employer-sponsored benefit that allows employees to pay eligible unreimbursed healthcare and/or dependent care expenses on a pre-tax basis.

For most employees,a FSA saves employees money by allowing them to reduce their income tax liability. A fixed amount of money is set aside from each paycheck into the Flex Spending Account. These contributions made by the employee are deducted from the employee’s pay BEFORE any Federal, State, or Social Security Taxes are calculated. The employee can then use these funds to pay for eligible healthcare and dependent care expenses. The end result is that the employee can pay for eligible expenses with pre-tax dollars, which decreases his/her taxable income and increases the employee’s spendable income.

For employers, an FSA plan can significantly enhance an employer’s overall benefits program or reduce some of the pain of other benefit cutbacks. If you have to increase plan deductibles or co-pays participants in your health plan, an FSA helps reduce the out of pocket impact. In addition, there is a significant tax advantage for employers who provide Healthcare Flexible Spending Account programs. Employer matching FICA, also known as payroll taxes, are reduced proportionally for every dollar employees contribute to their FSA. FSA plans often have administrative fees but if planned carefully, an FSA creates the opportunity to offer a benefit to employees for little or no real cost to the employer.

There are however some stipulations on who can participate in these plans. Partnerships, sole proprietors and Sub-chapter S Corporations may sponsor these plans, but there are restrictions on their individual participation in the plan. Sole proprietors, partners and greater than 2% shareholders in Sub-chapter S corporations may have plans for their companies to benefit their employees, but they are not allowed to participate. Also, partners of LLPs or LLCs are not permitted to participate in a FSA. Despite these constraints, overall the FSA plan is one of the only employee benefits programs available that can provide significant employee and employer tax savings at such a low cost. If you are interested in installing an FSA, speak with your insurance broker who can direct you to a qualified FSA plan administrator. Remember, it is not uncommon that setting up an FSA will cover the cost of the plan administration in the employer tax savings that it produces.

Section 125 Plans

Internal Revenue Service (IRS) Section 125 employee benefit plans, also known by their various types as cafeteria plans or Premium Only Plans, allow employees to pay their portion of the premiums for employer-sponsored health insurance on a pretax basis. When these plans are used only to shelter employee health premium dollars, they are called premium-only plans. Section 125 premium-only plans are simple to implement, have minimal tax filing obligations, lower the cost of health insurance for employees, and can even save employers tax costs as well.

Like FSA plans, Section 125 plans work by lowering an employee’s taxable income and resulting tax liability and by increasing their take-home income. As well as adding tax-free dollars to an employee’s income, a Section 125 plan also makes a difference to employer payroll taxes, a consideration that employers should find well worth considering. Employers save money on payroll taxes by reducing federal and state unemployment taxes, as well as reducing Social Security and Medicare taxes paid. In some states, employers may also be entitled to reductions in workers compensation payroll calculations that can result in a significant savings in insurance fees. You can get specific Section 125 tax related information relevant to your state at

Employees who already have an employer offered health insurance plan can readily benefit from a Section 125 plan. As Table 1 illustrates, there aresignificant benefits to both employees and employers.

Table 1: Sample Section 125 Tax Savings Plan

Monthly / Annual
Employee premium for a family policy (before tax savings) / $250 / $3,000
Tax Savings, if in a Section 125 plan:
Federal income tax @25% / $62.50 / $750
FICA tax @7.65%* / $19 / $229
State income tax @11% / $27 / $330
Total employee tax savings / $108.50 / $1,309
Net cost of coverage after tax savings / $141.50 / $1,691
Percentage savings / 43% / 43%
Employer savings (from reduction in FICA) / $11 / $129

*Also known as payroll taxes

Once again, there are special considerations to keep in mind when talking about sole proprietorships, partnerships and S-Corporations. Similar participation constraints to those that applied to FSAs also apply here.

For all employees, paying premiums with pre-tax dollars imposes restrictions on the ability to voluntarily drop coverage during the plan year. Your insurance representative and/or tax accountant can help you evaluate the pros and cons of introducing a Section 125 plan if you fall into the business categories above.

Retirement Plans

Another area where employers can see tax savings is with retirement plans. Before considering implementing a retirement plan, employers need to ask themselves several questions:

  • What are the goals for your business?
  • Will a retirement plan help you to attract and retain key employees?
  • What are your legacy goals, both personally and for your business?

The Internal Revenue Code (IRC) and the Employee Retirement Income Security Act of 1974 (ERISA) established strict requirements, which if met by an employer-offered retirement plan, allow for significant tax benefits for the employer. First, if the plan includes matching contributions by the employer to employees participating in the retirement plan, these contributions qualify as an allowable tax deduction. The other tax benefit to employers has to do with the trust holding the funds, in which the earnings are not taxed to that trust. These tax benefits can have a considerable impact on the finances of the employer offering the retirement plan and those employees who take advantage of participating in the plan. Both parties receive tax savings while saving for retirement and the employer is more likely to attract and retain valuable employees.

A tax-qualified retirement plan needs to try to avoid being a “top heavy” plan. This occurs when certain company executives called “key employees” account for more than 60% of the plan’s assets. If this happens, the company must make a minimum contribution to the accounts of “non-key” employees equal to 3% of their pay. Employers can avoid discrimination and top heavy testing of contributions by making certain mandatory contributions in what is known as a safe harbor 401(k) plan. The employer must provide for 100% immediate vesting of safe harbor employer contributions and nondiscretionary safe harbor employee contributions. For additional information on testing requirements,visit

There are techniques to increase your employees’ participation, including a stepped matching program that encourages a greater percent of employee contributions and even automatic 401(k) enrollment. The IRS offers a Saver’s Credit to assists low- and moderate-income taxpayers who may need help saving for retirement by allowing workers to take a tax credit for up to half of what they contribute to their employer-sponsored defined contribution retirement plan. The maximum total credit is $1,000 and eligibility depends on filing status and modified adjusted gross income. For more information, see

The Economic Growth and Tax Relief Reconciliation Act of 2001(EGTRRA) was a piece of tax legislation that made significant changes affecting retirement and pension plans. Generally, the act lowered tax rates and simplified retirement and qualified plan rules. Many of the tax reductions in EGTRRA were designed to be phased in over a period of up to 9 years. All the 2001 tax cuts are set to expire at the end of 2010 unless Congress acts to extend them, which many feel they will do. Small employers are granted tax incentives to offer retirement plans to their employees, and sole proprietors, partners and S corporation shareholders gain the right to take loans from their company pension plans.

A non-refundable credit of 50% for the administrative and retirement education expenses may be available for certain small businesses that adopt a new tax-qualified defined benefit, defined contribution, SIMPLE or SEP retirement plan. The credit applies to the first $1,000 of qualifying expenses of the plan in each of its first three plan years. The maximum credit allowed is $500 a year for three years. A plan is considered “new” if the employer sponsored no other qualified retirement plan(s) in the three years prior to the first year the credit is available.

Information regarding the number of employees that are eligible to participate in your retirement plan, as well as your overall profitability, will determine the type of plan that bests suits your company. There are many types of qualified plans and they can be tailored to your business needs. A qualified tax attorney or a pension benefits consultant can help you review your options and determine the most appropriate plan for your business and personal needs.

Education Deductions

Employers can deduct employee educational expenses if the courses preserve or improve job-related skills, or if employees need the education to continue in their current jobs. In addition, transportation to and from these classes may be deducted. Any educational expenses incurred to gain new skills cannot be deducted. The IRS has strict guidelines for deducting educational expenses, so be sure to read Publication 970, "Business Deductions for Work-Related Education," at

The Work Opportunity Tax Credit

The Work Opportunity Tax Credit (WOTC) promotes the hiring of individuals who qualify as members of certain target groups, by providing federal tax credit incentives of up to $9,000 for employers who hire these individuals. This program reduces an employer's cost of doing business and requires little paperwork.

Employers qualifying for the Work Opportunity Tax Credit can expect tax savings that are dependent on which target group they hire. Employers can hire from 9 different targeted groups:

  • Qualified Temporary Assistance for Needy Families (TANF) Recipients
  • Qualified Veterans
  • Qualified Ex-Felons
  • Qualified Designated Community Residents (DCR)
  • Qualified Vocational Rehabilitation Referrals
  • Qualified Summer Youth
  • Qualified Food Stamp Recipients
  • Qualified Supplemental Security Income (SSI) Recipients
  • Qualified Long-Term Family Assistance Recipients

The tax credit applies to the first year of employment only. Wage calculations are capped at the first $6,000 of qualified wages. The maximum tax credit is $2,400 per new hire. Full credit is calculated at 40 percent, up to $2,400. New hires are required to work a minimum of 400 hours or more. A partial credit of 25 percent, up to $1,500, is available if a new employee works at least 120 hours but less than 400 hours. You can gain additional information on this program at

Other fringe benefits have tax implications and benefits for employers and employees. For a full list, visit

Summary

We often wish that we planned ahead to take advantage of opportunities to save on our taxes. With a new year started, now is the time to plan for tax savings, particularly as profits begin to return to many businesses. There are many choices that small businesses can consider to save on their taxes and provide valuable benefits to their employees. However, companies must take into consideration the different types of organizations (partnerships, sole proprietor, S-Corporation, etc.) and the requisites needed to implement any of the above options. Therefore, it is highly recommended that you discuss the tax advantages and implications with a tax advisor before pursing any of these tax saving vehicles.

This content was developed for the PHCC Educational Foundation by TPO, Inc. (). Please consult your HR professional or attorney for further advice, as laws differ in each state. Employment laws continue to evolve; the informationpresented isas of March 2010.

The PHCC Educational Foundation, a partnership of contractors, manufacturers and wholesalers was founded in 1987 to serve the plumbing-heating-cooling industry by preparing contractors and their employees to meet the challenges of a constantly changing marketplace.

If you found this article helpful, please consider supporting the Foundation bymaking a contribution at

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