IRS has released guidance, in the form of Chief Counsel Memorandum Number: 202323006 (the “Memorandum”), denying favorable tax treatment to wellness incentive program payments provided through cafeteria plans when the payments are not related to health care expenses.
Background. The term “wellness program” generally refers to a health promotion and disease prevention program or activity offered by an employer to employees, and sometimes their spouses, either as part of the employer’s group health plan, or separately as a benefit of employment. Examples of wellness programs include diabetes management programs, weight loss plans, and preventative health screenings. Employers may give certain incentives for participation in wellness programs, including a reduction in employee costs for group health care coverage and certain other program.
Some employers have paired their wellness programs with an Internal Revenue Code (“Code”) Section 125 cafeteria plan in an attempt to reduce income, FICA and unemployment taxes by reducing employees’ taxable income through salary reduction contributions that result in supposedly tax exempt “incentive payments” to the employee.
Facts. The Memorandum includes the following example:
In addition to its regular group health coverage, the employer allows all employees, regardless of enrollment in other health coverage, to enroll in coverage under what is called a “fixed-indemnity health insurance policy.” The employees pay monthly $1,200 premiums by salary reduction through a cafeteria plan. The cafeteria plan pays a wellness benefit incentive of $1,000 per month if an employee participates in certain health or wellness activities. The wellness benefit incentives are paid by an insurance company to the employer, which then pays out the incentive to employees on a tax-free basis via the employer’s payroll system.
Guidance. The Memorandum notes that the Code defines the term “wages” as all remuneration for services performed by an employee for his or her employer, including the cash value of all remuneration (including benefits) paid in any medium other than cash, with certain specified exceptions. Among the specific exceptions are several exceptions related to the provision of medical insurance and benefits under Code Section 105.
The Memorandum confirms that wellness benefit incentive payments are includible in the gross income of the employee if the employee has no unreimbursed medical expenses related to the payment. The exclusion under Code Section 105 is limited to amounts paid solely to reimburse expenses incurred for medical care and does not apply to amounts that the taxpayer is entitled to receive irrespective of whether expenses for medical care are incurred. Thus, the exclusion from income in Code Section 105 does not apply to wellness incentive payments when the employee has no unreimbursed medical expense because either the activity that triggers the payment does not cost the employee anything, or the cost of the activity is reimbursed by other coverage.
Under the facts described above, when the cafeteria plan pays $1,000 merely because the employee has participated in a wellness benefit program, the payment is included in the employee’s income and constitutes wages for purposes of FICA, FUTA, and Federal income tax withholding.
Takeaway for Employers. IRS may seek to collect taxes, penalties, and interest from employers based on their failure to properly withhold income and employment taxes from wellness program incentive payments that are impermissibly made on a tax-free basis. Therefore, employers should avoid sponsoring the type of wellness incentive program discussed in the Memorandum. Employers currently sponsoring wellness incentive programs that do not comply with the guidance offered in the Memorandum are advised to work with qualified legal counsel to determine the action steps needed to correct the issue.
The IRS Chief Counsel Memorandum 202323006 is available at: https://www.irs.gov/pub/irs-wd/202323006.pdf