Broker Check

What is a Payroll Tax Reduction Plan and How Does It Work?

| April 25, 2019

If you would prefer to watch a 13 minute video explaining this strategy, you can do so here.

If I told you there is a way that to reduce the amount of FICA and payroll taxes your business pays, increase employee benefits, and doing so would have no effect on any employees’ net pay; you might say I’m crazy. Well, my sanity may still be questionable, but the above stated is true.

A Payroll Tax Reduction Plan (PTRP) is just taking full advantage of the tax code, particularly IRC Section 125. Before anyone gets into the mindset of “well we have a cafeteria plan, or Section 125 Plan, so this doesn’t apply to us.” Chances are it still does, less than 1 percent of the business we come across have this plan in place, and this is a proprietary strategy. Furthermore, to take advantage of this plan, a business either must already have a Section 125 Plan (Cafeteria Plan), or one must be put in place. At a minimum the business needs to already have a healthcare plan in place to consider this.

The high-level highlights of the plan are below:

Benefits of the plan:

  • The employer receives an annual tax savings of up to $1,400 per participating employee 
  • Through the limited medical benefit provider, employee receives tax credits to fund additional healthcare and insurance benefits
  • The tax credits reduce overall taxable income, decreasing the businesses FICA and payroll taxes
  • On average employee benefits quadruple and their net pay DOES NOT change

Employer Eligibility Requirements:

  • 25 or more full time W2 employees making at least $25,000 a year.
  • Employer must currently offer a healthcare plan

Employee Eligibility Requirements:

  • Must currently have healthcare (it does not have to be with the employer, it can be through a spouse, parent the exchange ect)
  • Must be full-time with the employer
  • Must be a W2 Employee
  • Must be 18 years or older
  • Must have an annual income of $25,000 or more with the same employer


While most Section 125 Plans have tax benefits for both the business and the employee, we do not see them structured in a manner that takes full advantage of the tax code.

If you use this proprietary strategy, you can reduce the business’s payroll (FICA) taxes by up to $1,400 a year per participating employee and increase employee benefits. All while having no effect on the employees’ net pay. This may sound too good to be true, but I will walk you through exactly how we do it.

To obtain these benefits we must utilize a limited medical benefit provider (LMBP). The LMBP is required to provide a limited medical benefit plan. The LMBP must provide real benefits, they cannot be used as a shell just to create pre and post-tax deductions. The participating employees will be required to enroll in the Limited Medical Benefit Plan, and they will be required to use any and all tax credits on additional benefits, they cannot take the tax credits as cash.

By enrolling the employee will gain access to additional limited medical benefits such as self administered programs to; quit smoking, track their health, assist in weight loss, and a range of many other benefits that can pertain to lifestyle issues. The LMBP generally provides other benefits such as; Teladoc services, vision discounts, dental discounts, pharmacy discounts etc. which are of substantial value as well.

The employee’s participation allows the employer to take a pre-tax premium of up to $1,200 a month for the limited medical benefit plan, which can then be reimbursed post tax via a Medical Expense Reimbursement Plan (MERP). So, what’s really happening here? We are reducing the employee’s taxable income by $1,200 a month, or $14,400 a year. The result is; the business is matching less in FICA and payroll taxes, and the employee’s net pay will increase (average increase in net pay is $200-300 a month).

The caveat is, the employee does not get to keep the increase in their net pay, they must use the increase in their net pay on additional benefits. Those benefits can be but are not limited to; disability income insurance, long term care insurance, accident/gap insurance, life insurance, health savings account contributions etc.

The below example gives a before and after of an employee pay check:

The above illustration shows an example of a "before" and "after" paycheck for an employee that participates in the program. This example shows the employee used their tax credits to purchase additional life insurance and an accident plan. Actual insurance benefits offered are determined by the employer and the employee.

In the above example you see that the entire increase in net pay is used for additional benefits and the employees net pay did not change.

A common question we get from employees is “can I just keep the increase in my net pay?”

The answer is; absolutely not. There are several sections, and subsections of the IRS code that clearly prohibit an employer from giving a “cash” incentive to their employees to create a tax benefit for the business. If the employee were to keep the increase in their pay, it may be interpreted as a cash incentive. However, by using the net increase to purchase additional healthcare and insurance benefits, we are in complete compliance with the tax code, and the benefits are clearly not a CASH incentive.

It’s important when we are doing advanced tax planning work and implementing plans like this, that we take full advantage of the tax code. What’s equally as important is that we do not abuse the tax code. I want to reiterate that just one more time, we do not abuse the tax code.

By ensuring that we are compliant and not abusing the tax code we are doing several things. The most important being; protecting our clients from any tax consequences, back taxes, penalties or fees. We are also ensuring that tax planning strategies like this stick around. Generally, legislators are not going to put new regulation in place that eliminate tax plans like this, if the tax code is not being corrupted. When the tax code is being blatantly abused, it’s no surprise that the IRS and legislators will then put in legislation to prevent it.

A common question I get from business owners is “Why isn’t every business doing this?”

There are a couple reasons; not all businesses are eligible for a plan like this. For a business to be eligible, the business must currently have a health care plan in place along with a Cafeteria Plan. You cannot have a limited medical benefit plan, without first having a health care plan and Cafeteria Plan. The business also must have 25 or more W2 employees making more than $25,000 a year. Also, while it does not eliminate eligibility, this strategy is much easier to implement if the employees’ pay is consistent or they have a base salary. Remember, we are taking out a premium pre-tax, and reimbursing that same premium post tax to create the tax savings for both the business and the employee. It’s much easier to determine how to do so with salaried employees. This tends to eliminate many businesses that have a lot of hourly and/commissionable employees.

Another factor that limits our ability to implement these plans is; there are not many limited medical benefit providers. The health care industry is very highly regulated, which limits the amount of LMBPs there are. This is a large barrier to entry, and it is much more profitable to just be a health care company than to be a LMBP. Most companies that manage to navigate through the regulation, are going to pick the more profitable route.

So how can a plan like this benefit you? If you’re an employee, it will benefit you by decreasing your taxable income, increase your healthcare and insurance benefits, and create a supplemental retirement plan through those insurance benefits. If you’re an employer, it will benefit your business by decreasing the businesses payroll and FICA taxes, increasing employee morale, employee retention, and be an additional benefit to new employee recruitment.

On average the business will see a tax savings of $1,100 - $1,400 a year per participating employee. There have also been many studies and surveys over the years that have shown that increasing and customizing employee benefits drastically increases employee retention. Two recent studies by the Society for Human Resource Management shows that 76% of Millennials said benefits customization was important for increasing their loyalty to their employers, and 95% of employees consider health care to be their most important benefit.

To reiterate or give a brief synopsis of the plan. We use a limited medical benefit plan and medical expense reimbursement plan to offer the tax savings. We are not replacing any current health benefits we are adding benefits to create the tax savings. This type of structure reduces the employer's payroll taxes and has no effect on the employees' net pay. The tax credits are used to fund additional employee benefits, and the employer is able to offer additional benefits and reduce their overall costs.

We are transparent with the IRS, so we do have a complete Legal Tax Opinion Letter for this plan, if you would like to retain a copy, we are happy to provide it upon request.

If you’ve made it this far in this article/newsletter, then your attention span is greater than most, but I’m also sure I may have raised a couple questions. If you do have questions you can reach out to our office on our website here or email me at my email address listed below. If you’d like to see if your business may be eligible for a plan like this, please feel free to contact us, we are always happy to help other businesses and their employees.


Dan Nuwash, MBA

Founder, Managing Partner

Finance For Thought



TAX- To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purposes of avoiding penalties that may be imposed by law. Each tax payer should seek tax, legal or accounting advice from a tax professional based on his/her individual circumstances.


TAXES- This material is for informational purposes only. Neither APFS nor its Representatives provide tax, legal or accounting advice. Please consult your own tax, legal or accounting professional before making any decisions.