Fall is a common time for employers to consider new benefits for the upcoming year. During discussions with benefit providers and consultants, employers may be pitched a “wellness indemnity program” for employees. These wellness indemnity programs promise significant tax savings that often sound too good to resist. Unfortunately, these programs usually do not provide the tax treatment that promoters promise, and the IRS has repeatedly made its position clear.
This eAlert provides a brief overview of how these programs are commonly structured and why their promised tax savings are usually too good to be true.
Features of Wellness Indemnity Programs
At their core, wellness indemnity programs generally involve fixed-indemnity insurance policies at little or no cost to the employer with the following common features:
- Employees pay a monthly premium for the indemnity insurance coverage through pre-tax payroll deductions. The deductions reduce employees’ taxable wages, which also reduces the employment taxes paid by employees and employers.
- Employees receive fixed payments from the indemnity insurance policy when certain “payment events” occur, such as:
- Completing health or wellness activities;
- Receiving preventive care, such as vaccines or annual wellness checks;
- Being hospitalized; or
- Receiving certain medical diagnoses.
At first glance, these programs seem like a win-win for both employers and employees. Employees reduce their taxable income by paying premiums on a pre-tax basis, and payments under the insurance are provided tax-free to employees. Meanwhile, employers pay less in employment taxes, and the benefit is provided at little to no cost to the employer.
So what’s the problem? Enter the IRS...
IRS Position on Wellness Indemnity Programs
The IRS has addressed the tax treatment of these wellness indemnity programs. A full analysis of the IRS’s position is beyond the scope of this eAlert, but the IRS takes issue with both the employee and employer components of a wellness indemnity program:
- Payments to Employees May Be Taxable Income
The Internal Revenue Code generally excludes from gross income amounts paid to an individual solely to reimburse expenses actually incurred for medical care. This exclusion does not apply, however, to amounts that an individual is entitled to receive regardless of whether medical care expenses are actually incurred. It also does not apply to the extent a payment exceeds the individual’s actual, unreimbursed medical expenses.
This is a problem for wellness indemnity programs because they often provide fixed payments that are unrelated to the amount of any medical expenses. For example, a program may pay an employee a flat amount solely because the employee received a particular diagnosis, completed a wellness activity, or received preventive care that was provided at no cost to the employee. Because these payments do not fall within the medical care exclusion, employees must treat the payments from a wellness indemnity program as taxable income.
2. Payments from Wellness Indemnity Program May Also Be Taxable Wages for Employment Tax Purposes
Unless an exception applies, the Internal Revenue Code defines wages broadly as all compensation for employment, including the taxable value of non-cash benefits. The IRS has clarified that payments made to an employee because of sickness, accident or disability may constitute taxable wages when the payments are included in the employee’s gross income. In other words, if the payments are taxable to employees, they generally cannot be excluded from wages for purposes of FICA, FUTA, and income tax withholding simply because they were paid under an insurance policy or triggered by a health-related event.
Conclusion
Although wellness indemnity programs make many promises to employers and employees, the IRS has made it clear that providers of some of these programs cannot make good on those promises, potentially leaving you and your employees with an unpaid tax bill.
This does not mean that every wellness indemnity program is automatically taxable. The tax treatment may differ, for example, when an employee pays the entire premium on an after-tax basis. The concern here is with programs that combine pre-tax funding with a promise that employees can receive tax-free cash payments regardless of their actual medical expenses.
Wellness indemnity programs can take many different forms, some more complex than others. If you have questions about an arrangement you are considering (or already participating in), please contact Stephanie Grant, Brandon Cross or one of the attorneys in our Employee Benefits Practice Group.
