The IRS has recently issued an internal memorandum confirming its position on certain wellness plan arrangements that are being marketed by promoters as being able to save employers money by reducing their liability for FICA and FUTA taxes.
The memorandum supplements earlier memoranda that addressed these types of arrangements.
In the scenario discussed by the IRS, an employer offers its employees a standard major medical health plan. In addition, the employer offers all its employees the opportunity to enroll in a fixed-indemnity health insurance policy that includes a wellness component. It works like this:
- Employees pay a premium for coverage of $1200 per month through a Section 125 cafeteria plan. The only payments received by the insurance company are these premiums.
- The policy pays $1000 per month for each employee who participates in certain easily achievable health or wellness-related activities. The benefit is limited to one payment per month. The insurance policy provides wellness and nutrition counseling and telehealth benefits at no additional cost. The employees are responsible for the cost of participating in the activities although often the activities are provided at no cost to the employee. The policy also pays a fixed amount for each day the employee is hospitalized. The policy pays the wellness benefit to the employer which then pays the employees through its payroll system.
The IRS reiterated its long-held position that welfare indemnity payments under an employer-funded fixed-indemnity policy are included as wages in an employee’s taxable gross income if the employee has no unreimbursed medical expenses (or no medical expenses at all) related to the payment. A policy whose premiums are paid for through a Section 125 cafeteria plan is considered employer-funded coverage.
Because the payments are considered wages, employers are subject to FICA, FUTA and income tax withholding on the plan’s $1,000 per month wellness payments.
This recent memorandum, viewed along with the earlier IRS memorandum, should send a cautionary signal to employers with respect to programs that claim to pay tax-free benefits under fixed-indemnity policy to employees without regard to whether they incur medical expenses and to relieve employers from FICA, FUTA taxes and income tax withholding with respect to those benefits.
If you have adopted such a program (or are contemplating doing so), consider reviewing the arrangement with your tax counsel.