Wellness program benefits: Tax free or not?
As health care costs have increased, employers have scrambled to find creative ways to help employees pay for benefits without decreasing their net paychecks or paying an employer contribution to benefits. Insurance promoters have responded by providing a variety of wellness benefit programs. Some offer plans that purport to increase tax-free benefits to the employee at little cost to the employer. The IRS has issued several memoranda to clarify which wellness benefits may be excluded from employee wages and which will trigger employment tax reporting and payment requirements (see, e.g., Cumings, "IRS Continues to Play Whack-a-Mole With Wellness Plans," 155 Tax Notes 1394 (June 5, 2017)).
A wellness program is a workplace program intended to improve and promote health and fitness, in which an employer typically offers premium discounts, cash rewards, gym memberships, or other incentives to participate. Wellness programs can be tax-free to an employee. They might be offered under employer-provided accident or health plan benefits or reimbursements excluded from employees' income under Sec. 106(a), Sec. 105(b), or Sec. 104(a)(3). In all of these cases, when an employer makes any contribution toward health coverage or the coverage is paid for on a pretax basis, the plan (group or individual) is considered to be an employer-provided benefit.
A wellness program can be offered separately from an employer's comprehensive health coverage, and that program's benefits can be excluded from an employee's income as an accident and health plan. To be excludable from income, the benefit must qualify as medical care as defined under Sec. 213. Also excludable are de minimis fringe benefits under Sec. 132(e).
In Chief Counsel Advice (CCA) 201622031, issued in April 2016, the IRS clarified that not all incentives paid to an employee as part of a wellness program are excluded from wages. Using three examples, the IRS clarified that the following items are always included as taxable income, even when paid under a wellness program:
- Cash payments of any amount for participating in a wellness program.
- Noncash rewards or other benefits that are not medical care as defined by Sec. 213 (e.g., gift cards or gym memberships that are not medically necessary).
- Reimbursements of all or a part of health insurance premiums paid through an employee's salary reduction, including through a cafeteria plan under Sec. 125.
The last point addresses some promoted wellness program arrangements, whose promoters suggest that an employee can participate in a salary-reducing Sec. 125 plan that offers both an integrated health plan and a wellness benefit option. As part of this scenario, the employee elects to make a substantial pretax premium payment to participate in the wellness benefit plan. The wellness plan provides typical wellness program benefits; however, the plan also provides substantial incentives that, in essence, reimburse the employee's pretax contributions for the wellness plan. The CCA determined that the payment to employees of reimbursements for all or a portion of the premiums paid by salary reduction made through a wellness plan does not distinguish such a program from the double-dipping arrangement addressed in Rev. Rul. 2002-3, and a reimbursement of all or a portion of the premium for the wellness benefit plan that was paid for via pretax salary reductions is included in the employee's gross income.
WELLNESS PLUS FIXED-INDEMNITY PLANS
CCA 201703013, issued in December 2016, addresses wellness benefit plans that combine with fixed-indemnity health plans. A fixed-indemnity health plan pays a specific amount of cash for certain health-related events (e.g., $40 per office visit or $100 per hospital day). Fixed-indemnity plans are generally voluntary benefits offered to complement or supplement group health insurance. The amount paid is neither related to the medical expense incurred nor coordinated with other health coverage. However, under Sec. 104(a)(3) these payments qualify as received through accident or health insurance and are excluded from gross income if the premiums are paid with after-tax dollars. For instance, a fixed-indemnity health plan may pay $100 for each visit to a doctor, even though the cost to the employee is only $30. If the plan was purchased with the employee's after-tax dollars, the $70 difference is not taxable to the employee.
CCA 201703013 describes five situations in which fixed-indemnity health plans combined with wellness benefits would result in taxable income to the employee. The IRS takes the position that the exclusions under Sec. 105(b) and Sec. 104(a)(3) do not apply to amounts that are attributable to contributions not included in the employee's income. In brief:
- Fixed-indemnity health plan payments are included in wages if the employee premiums for the plan were paid by the employer; and
- Payments from a wellness plan are taxable to the employee if the payments for that coverage were made by a salary reduction under a Sec. 125 cafeteria plan.
WELLNESS PLUS SELF-FUNDED PLANS
CCA 201719025, issued in April 2017, addresses wellness benefit plans that combine with self-funded health plans. In a self-funded plan, the employer assumes the financial risk for providing health care benefits to its employees. In practical terms, self-insured employers pay for each out-of-pocket claim as it is incurred instead of paying a fixed premium to an insurance carrier.
Using two examples, the CCA discusses a plan in which an employer offers all employees enrollment in a self-funded health plan, for which the employees pay a small, after-tax contribution to participate. In the first example the plan is a stand-alone plan; in the second it is combined with a wellness benefit plan and "flex credits" that can be used for benefits under a Sec. 125 plan. The self-funded plan pays employees a fixed cash payment for participating in health-related activities (such as attending a seminar). The fixed amount that the employees receive for each activity (e.g., $1,425 per activity) is much greater than the after-tax premium that they paid (e.g., $60 per month).
The CCA clarifies that employers' self-funded health plans are taxable to the employee if:
- The health plan does not involve insurance risk to the employer or employee; or
- The amounts received by the employees for wellness program participation are greatly in excess of their post-tax contributions to the program.
The IRS concludes that in the first example, the self-funded health plan does not have the "effect of insurance" and there is very little risk of economic loss to either the employer or the employee, so payments from the plan are not excluded from an employee's income under Sec. 104(a)(3). Since the majority of the payments are funded either by contributions by the employer that are not includible in the employee's gross income or paid by the employer, the excess of payments over the post-tax employee contributions would be considered taxable wages to the employee. In the second example, the benefits under the self-funded plan would be treated the same. However, the flex credits awarded under the wellness plan would be excluded from a participating employee's wages and income unless the credits were used to purchase taxable benefits under the Sec. 125 cafeteria plan, such as whole life insurance (in contrast to group term life insurance) or a gym membership.
A WELLNESS PROGRAM CHECKUP
The overall message of these CCAs is that when employees are reimbursed their contributions of pretax earnings, or when an employer is directly funding benefits that are not Sec. 213(d) medical expenses, the benefit is likely to be taxable to the employee. The IRS is likely to ignore the distinctions between combinations of two or more plans and analyze the overall result to make this assessment.
CPAs and their clients that provide wellness program benefits would do well to review the details of their program's funding arrangements and the administration of benefit payments to ensure that benefits are correctly excluded or reported in employee's wages.
Dayna E. Roane (email@example.com) is a shareholder with Perry & Roane PC, Niwot, Colo.