Wellness Plan Nontaxable Cash Payments: Too Good To Be True
On May 12, 2017, the IRS released a Chief Counsel Advice memorandum (CCA) rejecting the claimed favorable tax treatment of cash payments under self-funded health plans currently being promoted to employers in the market. These plans are promoted as a way to provide nontaxable cash payments to employees and employment tax savings to employers/employees. The promoters claim the benefits under these plans do not constitute income or wages and therefore reduce the employer and employee share of employment taxes. The CCA uses two scenarios to illustrate how these arrangements are structured:
Scenario 1: Self-Funded Health Plan with Fixed Cash Payment to Employees
- Employer provides all employees (regardless of their enrollment in other group health plan coverage) with the ability to enroll in a self-funded plan.
- Employees who elect to participate, pay a small after-tax contribution.
- The self-funded health plan pays the employee a fixed cash payment benefit for participating in certain no-cost, wellness activities (e.g., biometric screenings and attending educational courses).
- The fixed cash payment is much greater than the employee’s after-tax contribution to participate in the self-funded health plan.
Scenario 2: Self-Funded Health Plan and Wellness Plan with Fixed Cash Payment to Employees
- Same facts as above in Scenario 1, except that the employer also provides employees with the ability to enroll in a wellness plan which qualifies as an accident and health plan under Internal Revenue Code (“IRC”) Section 106.
- Employees who elect to participate, pay a substantial pre-tax contribution through the employer’s Section 125 Cafeteria Plan (e.g., $1,500 per month) in addition to the to the small after-tax contribution for participation in the self-funded health plan.
- The wellness program provides no-cost, health-related wellness activities to employees that result in fixed cash payments.
- If the employee’s net-take home pay after receiving the fixed cash payment from the self-funded health plan is greater than the employee’s net-take home pay prior to the implementation of these plans, then the excess is paid in the form of flex credits that can be used to purchase benefits under the employer’s Section 125 Cafeteria Plan.
- Therefore, the net-take home pay of employees who participate in the plans generally remains unchanged.
Are the Benefit Payments Excludable From Income?
To answer this question, the CCA focuses on the income exclusion found in IRC Section 104(a)(3). IRC Section 104(a)(3) provides that gross income does not include amounts received through accident or health insurance for personal injuries or sickness. This exclusion does not apply if the amounts are either (1) attributable to employer contributions that were not included in the employee’s gross income, or (2) paid by the employer. Additionally, the CCA explains that in order for the IRC Section 104(a)(3) income exclusion to apply, the arrangement must be insurance, which requires adequate risk-shifting.
- The Fixed Cash Payment. The CCA concludes that in both Scenarios 1 and 2, the fixed cash payments do not qualify for the IRC Section 104(a)(3) exclusion since (1) the fixed cash payment plan does not involve insurance risk (i.e., there is no risk of economic loss or a fortuitous event) and is therefore not insurance for federal income tax purpose, and (2) the average fixed cash payments received by employees for participating in wellness activities markedly exceeds the employees’ after-tax contribution and thus the amounts received are either (1) paid by the employer, or (2) attributable to employer contributions that were not included in the gross income of the employee. Therefore, fixed cash payments received by employees in excess of the employee contribution must be treated as gross income and wages, subject to income tax withholding as well as FICA and FUTA taxes.
- The Cafeteria Plan Flex Credits. The flex credits awarded under Scenario 2 are excluded from the income and wages of participating employees unless the credits are used to purchase taxable benefits under the Section 125 Cafeteria Plan. To the extent that the flex credits are used to purchase taxable benefits, the credits are included in the gross income and wages of the participating employee, subject to income tax withholding as well as FICA and FUTA taxes.
Conclusion and Clarification on Fixed Indemnity Payments
As promoters continue to design and promote programs that claim favorable tax treatment, employers should keep the following adage in mind—if it seems too good to be true, it probably is. Such programs should be carefully reviewed prior to implementation to ensure they comply with the IRC and other applicable laws.
Not only does this CCA refute the tax claims associated with the programs described above, but it also provides clarification on the IRS’s position on the tax treatment of payments from fixed indemnity plans following the release of a recent CCA suggesting that where premiums for fixed indemnity plans are paid pre-tax, the benefits are taxable regardless of the amount/type of the medical expenses triggering the payment. Specifically, this CCA acknowledges prior guidance stating that fixed indemnity plan payments attributable to pre-tax contributions are taxable only to the extent that they exceed otherwise unreimbursed medical expenses.
The content herein is provided for educational and informational purposes only and does not contain legal advice. Please contact our office if you have any questions about the Chief Counsel Advice memorandum.
Dated: June 27, 2017