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A Better Partnership


Feb 2017
February 06, 2017

Should Your Health and Welfare Plan Offer Supplemental Benefits on a Pre-Tax or After-Tax Basis?

If your company’s health and welfare plan offers its employees supplemental benefits — such as accident insurance, hospital insurance, cancer insurance or critical disease insurance — on a tax-free basis, it may be time for a change.

Supplemental insurance policies often pay a fixed dollar amount if a covered individual suffers a certain medical condition or needs certain types of medical treatment. These policies also often pay without regard to the actual medical expenses that the individual incurs and without coordinating with medical plans. The IRS views these kinds of programs as indemnity insurance agreements.

In Chief Counsel Memorandum 201703013, the IRS clarifies the tax treatment of indemnity insurance coverage when premiums are paid tax free. If premiums for indemnity insurance coverage are paid tax free — whether by the employer or by an employee through a cafeteria plan — the benefit payments made by these policies in the event of a claim are taxable income and considered part of the employee’s wages. The implications are that the employer is required to withhold and pay federal income, FICA and FUTA taxes on those benefit payments. This may be difficult to achieve, as the insurer may not have any way to withhold and submit the required taxes, leaving the employer potentially liable for underpayment penalties.

In light of this guidance, employers who offer supplemental benefits on a tax-free basis should re-evaluate the program. Employers might start by discussing with the insurer whether the insurer will withhold and submit required taxes on any benefits paid under an indemnity insurance agreement. If the insurer is unable to commit to withholding and paying taxes, then employers should consider whether premium payments should be made with taxable income. Even though paying the premiums with taxable income effectively increases the cost of the program, an advantage for employees is that the benefits paid on a claim will be tax free.

If you have questions about indemnity insurance arrangements or need assistance amending a health and welfare benefits plan, please contact Norbert Kugele (, 616.752.2186), Stephanie Grant (, 248.784.5068), Kent Sparks (, 616.752.2295) or any other member of our Warner Norcross Employee Benefits Practice Group.

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