Why a Raise for Health Insurance Is a Tax Trap for Both of You

If you've ever given an employee a raise to help them pay for health insurance, you may have meant well — but you both lost money in the process. It's one of the most common and costly mistakes small business owners make. The good news? There's a smarter way to handle it in 2026.

The Problem With Raising Pay for Health Insurance

When you add money to an employee's paycheck to cover health insurance, that extra money is treated as regular taxable income. The IRS doesn't care what it's for. Your employee gets taxed on it just like any other pay.

Here's what that looks like in real numbers:

• You give a $500 raise to help cover health insurance premiums.
• After federal and state taxes — roughly 30% — your employee takes home about $350.
• That $150 disappears to taxes. It never buys a single day of coverage.

And it's not just bad for your employee. You also pay payroll taxes on that extra $500. So you're spending more than $500, and your employee is getting less than $500 in real value. That's a lose-lose situation.

How ICHRA Fixes the Tax Problem

An Individual Coverage Health Reimbursement Arrangement (ICHRA) works completely differently. Instead of adding taxable pay, you reimburse employees directly for their health insurance premiums. That reimbursement is 100% tax-free — for both of you.

Here's the same example with ICHRA:

• You set a defined contribution of $500 per month.
• Your employee uses that $500 to pay for a qualifying individual health insurance plan.
• They get the full $500 in coverage value — not $350.
• You pay no payroll taxes on the contribution.

Same $500. Completely different result. Every dollar goes toward actual health coverage instead of the IRS.

Why ICHRA Works So Well for Small Businesses

ICHRA gives small business owners flexibility that traditional group health plans simply can't match. You decide how much to contribute. There's no annual maximum — unlike other reimbursement arrangements. You can offer different contribution amounts to different classes of employees. And you're not locked into a one-size-fits-all group plan that may not fit your team's needs.

Each employee shops for their own individual health insurance plan — one that fits their doctors, their family, and their budget. As long as the plan has Minimum Essential Coverage (MEC), it qualifies for ICHRA reimbursement.

Stop Leaving Money on the Table

A raise for health insurance sounds generous. But when taxes eat up 30% of it, you're not helping your employees as much as you think — and you're paying more than you need to. ICHRA turns that same money into a real, tax-free benefit that works for everyone.

If you're a small business owner looking for a smarter way to offer health benefits in 2026, ICHRA is worth a serious look.

Ready to see how ICHRA can work for your business? Visit benefitx.com to learn more and get started today.