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Tuesday, February 1, 2011

Tax Benefits for Health Insurance and Expenses: Overview of Current Law

Janemarie Mulvey
Specialist in Aging and Income Security

How tax policy affects health insurance and health care spending is a perennial subject of discussion in Washington. The issue is prompted by the size of the tax benefits, by their effect on the cost and allocation of health care resources, and by interest in comprehensive tax reform.

Current law contains significant tax benefits for health insurance and expenses. By far the largest is the exclusion for employer-paid coverage, which employees may omit from their individual income taxes. The exclusion also applies to employment taxes and to health benefits in cafeteria plans. (The exclusion should be distinguished from the deduction employers may take for the payments they make and other costs they incur.) Other important tax benefits include the following: 
  • ·         Self-employed taxpayers may deduct 100% of their health insurance, even if they do not itemize deductions and taxpayers who itemize may deduct insurance payments and other unreimbursed medical expenses to the extent they exceed 7.5% of adjusted gross income; 
  • Some workers eligible for Trade Adjustment Assistance or receiving a pension paid by the Pension Benefit Guarantee Corporation can receive the Health Coverage Tax Credit (HCTC) to purchase certain types of insurance; 
  • Four tax-advantaged accounts are available to help taxpayers pay their health care expenses: Flexible Spending Accounts, Health Reimbursement Accounts, Health Savings Accounts, and Medical Savings Accounts; 
  • Voluntary Employees’ Beneficiary Association plans (VEBAs) are vehicles for prefunding retiree health benefits on a tax-advantaged basis for certain groups of workers, particularly unionized workers; and 
  • Coverage under Medicare, Medicaid, CHIP, and military and veterans health care programs is not considered taxable income. 
By lowering the after-tax cost of insurance, these tax benefits generally help extend coverage to more people; they also lead some people to obtain more coverage than they otherwise would. The incentives influence how coverage is acquired: the uncapped exclusion for employer-paid insurance is partly responsible for the predominance of employment-based insurance in the United States. In addition, the tax benefits increase the demand for health care by enabling insured people to obtain services at discounted prices; this in turn contributes to rising health care costs. When insurance is viewed as a form of personal consumption, most tax benefits appear to be inequitable because taxpayers’ savings depend on marginal tax rates. When viewed as spreading catastrophic economic risk over multiple years, however, basing those savings on marginal rates might be justified as the proper treatment for losses under a progressive tax system.

This report details the current law for various tax benefits for health insurance coverage and identifies changes in certain provisions affected by the Patient Protection and Affordable Care Act (PPACA; P.L. 111-148).

Date of Report: January 11, 2011
Number of Pages: 20
Order Number: RL33505
Price: $29.95

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