The Pre-Tax PlaybookThe employer's briefing on Section 125 benefits
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Guide

FICA and payroll tax mechanics

Where the payroll tax savings come from, the formulas, and the one step that decides whether they hold.

Reviewed November 12, 2026 · Pre-Tax Playbook editorial team · Not tax or legal advice

Required federal noticeFixed indemnity insurance

IMPORTANT: This is a fixed indemnity policy, NOT health insurance

This fixed indemnity policy may pay you a limited dollar amount if you're sick or hospitalized. You're still responsible for paying the cost of your care.

  • The payment you get isn't based on the size of your medical bill.
  • There might be a limit on how much this policy will pay each year.
  • This policy isn't a substitute for comprehensive health insurance.
  • Since this policy isn't health insurance, it doesn't have to include most Federal consumer protections that apply to health insurance.

Looking for comprehensive health insurance?

  • Visit HealthCare.gov or call 1-800-318-2596 (TTY: 1-855-889-4325) to find health coverage options.
  • To find out if you can get health insurance through your job, or a family member's job, contact the employer.

Questions about this policy?

  • For questions or complaints about this policy, contact your State Department of Insurance. Find their number on the National Association of Insurance Commissioners' website (naic.org) under "Insurance Departments."
  • If you have this policy through your job, or a family member's job, contact the employer.

The payroll taxes involved

TaxEmployer rateWage base (2026)
Social Security (OASDI)6.2%First $184,500 of wages
Medicare (HI)1.45%All wages
Total employer FICA, most hourly workers7.65%See above
FUTA6.0% (usually 0.6% after state credit)First $7,000

Employees pay the same 7.65% FICA on their side.[1]

Step 1: the pre-tax premium lowers taxable wages

When an employee pays a premium through a Section 125 plan, that amount comes out before taxes, so neither side pays income tax withholding or FICA on it.[2, 3] This step is standard, and the IRS agrees with it.[2]

Employer FICA reduction per enrolled employee, per year = monthly pre-tax premium × 12 × 7.65%
Before program fees, for employees under the Social Security wage base, and only if benefit payments aren't treated as wages.[4]

Step 2: how benefit payments are taxed decides the outcome

In this design the carrier funds each claim payment and payroll passes it to the employee (Elysian-stated).[5] Elysian's tax counsel concluded that the payments are not wages.[6] The IRS Chief Counsel has taken a different written position: when an employee has no unreimbursed medical expense related to the payment, wellness-style indemnity payments under a pre-tax policy are taxable wages for FICA, FUTA and income tax withholding.[7, 8] This is a direct disagreement, and the employer carries the withholding and FICA risk.[8, 9]

Step 3: the employee's take-home formula

Change in monthly take-home pay = claim payments received − premium deducted + (premium × employee's combined tax rate)[10]

The employee comes out ahead only if the plan pays a claim close to the premium nearly every month. That monthly pattern is exactly what the IRS has questioned, which is why we show the formula instead of a promise.[10, 11] See the worked examples.

Other effects to know

  • California workers' comp: qualifying Section 125 benefit deductions are excluded from workers' comp payroll if the employer keeps per-employee records, so premiums may drop. Outside California, don't assume a workers' comp saving.[12]
  • Future Social Security: lower Social Security wages can mean slightly lower future benefits.[13]
  • Fees: program fees are disclosed in the Financial Impact Statement. Compare them with the FICA reduction.[14]
  • Downside: if the IRS disagrees, the employer can owe under-withheld income tax, both halves of FICA, FUTA, penalties and interest.[9]

Sources & footnotes

  1. Verified Employer FICA is 7.65% for most hourly workers. Social Security Administration — maximum taxable earnings; IRS Tax Topic 751 — Social Security and Medicare withholding rates. Proof library P-40
  2. Verified Step 1 — pre-tax premium through a Section 125 cafeteria plan. IRS Chief Counsel Advice 202323006; Elysian enrollment authorization (JobsRUs). Proof library P-30
  3. Verified Section 106: pre-tax health premiums are excluded from income. Treasury/DOL/HHS final rule, 89 FR 23338. Proof library P-47
  4. Analysis Employer FICA savings — how to estimate. Elysian benefits proposal (redacted client, provided by Elysian). Proof library P-41
  5. Elysian-stated Step 4 — the carrier funds the claim; payroll passes it through. Holland & Knight memorandum to Elysian Healthcare (confidential; available on request, subject to Elysian's permission). Proof library P-32
  6. Elysian-stated Step 5 — Elysian's counsel: claim payments are not wages. Holland & Knight memorandum to Elysian Healthcare (confidential; available on request, subject to Elysian's permission). Proof library P-33
  7. Verified CCA 202323006 — the key IRS memo. IRS CCA 202323006. Proof library P-58
  8. Verified FICA: the point where Elysian's counsel and the IRS disagree. IRS CCA 202323006; Holland & Knight memorandum to Elysian Healthcare (confidential; available on request, subject to Elysian's permission). Proof library P-51
  9. Verified What's at stake if the IRS disagrees. Morgan Lewis — ML BeneBits; Bloomberg Tax — HR Solutions That Become Tax Problems. Proof library P-63
  10. Analysis The take-home formula. Our analysis of P-30 and P-37. Proof library P-38
  11. Verified April 2024 final rule — IRS concern “recently escalated”. Treasury/DOL/HHS final rule, 89 FR 23338. Proof library P-60
  12. Verified California workers' comp may also drop. WCIRB California — Uniform Statistical Reporting Plan. Proof library P-42
  13. Analysis What employees should know. Elysian enrollment authorization (JobsRUs). Proof library P-39
  14. Pending NDA doc Program fees. Elysian Dealer FAQ. Proof library P-34