FLEX PLAN CONTRIBUTIONS GET A BREAK FROM TAX BITE

HARRISBURG, Pa.-Employees in Pennsylvania no longer are being taxed on contributions made to flexible benefit plans to cover their health care expenses and premiums.

Legislation, H.B. 134, that was signed into law last month by Gov. Tom Ridge exempts contributions to flexible benefit plans from Pennsylvania's 2.8% state income tax. The law is retroactive to Jan. 1.

The new law will exempt from state taxes several major types of flexible plans. Those programs include:

Premium conversion plans, in which employees pay a portion of a health insurance premium. The change in law means those contributions can be made with pre-tax dollars. For example, if an employee made $50,000 in salary and paid $1,000 toward a group health insurance premium through a premium conversion plan, his or her state taxable income would be $49,000, the same amount it would be for federal tax purposes.

Flexible spending accounts. In these plans, employees make contributions to pay for expenses not covered by a health care plan, such as those that fall under a deductible or expenses such as dental services that a health care plan might not cover.

With the change in law, a $500 employee contribution, for example, to a health care FSA would reduce his or her taxable income by $500.

Flexible benefit plans that give employees a choice of applying credits that can be used to "purchase" benefits that are given certain values by employers or cashed out.

Under the change in law, flexible credits used to buy health care coverage would not be taxed even if the employee had the option to take those credits as cash. Credits taken as cash, though, would be taxed.

The flexible benefit plan provisions are part of a broader tax bill generally aimed at reducing corporate taxes in the state.

"The focus is to make Pennsylvania more friendly to do business and invest in," said Peter McCormick, a benefit consultant in the Pittsburgh office of Buck Consultants Inc.

The change in law is especially important for multi-state employers, because Pennsylvania now joins 48 other states that do not tax flexible benefit plan contributions. In New Jersey, flexible benefit plan participants still are taxed on contributions to premium conversion plans as well as FSA contributions, according to A. Foster Higgins & Co. Inc.

"For multistate employers, it eases administration of the programs," said Mr. McCormick of Buck Consultants.

However, the Pennsylvania law only provides favorable tax treatment to health care-related flexible benefit programs. Contributions for dependent care, which typically are funded through employees' contributions to a FSA, still will be considered aftertax dollars for Pennsylvania state tax purposes.

Because of the law's Jan. 1 retroactive effective date, Mr. McCormick suggests that benefit managers contact their corporate payroll departments so that adjustments in withholding for state taxes can be made as quickly as possible.

Under Section 125 of the Internal Revenue Code, contributions to flexible benefit plans are considered pretax for federal tax purposes.