The IRS has issued a Chief Counsel Advice addressing whether a benefit paid from an employer’s self-funded, fixed-indemnity health plan is taxable when the average amount received by employees for participating in health-related activities, including rewards for participating in so-called “wellness programs”, exceeds the employees’ after-tax contributions.
Background. A fixed-indemnity health plan pays covered individuals a specified amount of cash with the occurrence of certain health-related events. Insurance promoters are marketing certain fixed-indemnity health plans intended to reduce an employer’s FICA obligation, at little or no cost, by significantly increasing employees’ pre-tax salary reductions. These plans operate as follows:
- Employees make pre-tax contributions and relatively small after-tax contributions to the program. A large portion of the pre-tax contributions are returned to the employees as cash payments from the program, either as overpayments of the employee’s actual medical expenses or as rewards for participating in what the promoter calls “wellness programs.”
- The pre-tax contributions to the program decrease the employer’s and employees’ FICA taxes, and the cash payments are treated as not includible in income. This results in the employees’ net take-home pay generally remaining unchanged.
- The employer pays a fee to the promoter for administering the plans, the amount of which is less than the FICA tax that would have been paid had the employer not adopted the program.
Law. In general, the Internal Revenue Code provides that gross income of an employee does not include amounts received through accident or health insurance. However, in order for this exclusion to apply, the arrangement must meet the definition of “insurance.” The Supreme Court has explained that in order for an arrangement to constitute insurance for federal tax purposes, both risk shifting and risk distribution must be involved. This would include self-funded plans that have the same effect as insurance.
Example: A fixed-indemnity plan has premiums paid on a pre-tax basis through a cafeteria plan. A covered individual’s expenses for a doctor’s office visit are $30. However, the plan pays $200 per office visit. The excess amount of $170 is included in the individual’s income.
Analysis. The IRS concludes that because these plans do not involve a risk of economic loss as a result of overpayments or rewards for wellness plan participation, this is not insurance for federal tax purposes. Therefore, since the plans are neither insurance nor have the effect of insurance, amounts received by employees are not excluded from the employees’ income and are subject to FICA payments from both the employer and employees.
The Memorandum is available at: https://www.irs.gov/pub/irs-wd/201719025.pdf