Be Wary of Designs to Avoid Employment Taxes through Wellness Plan Benefits
We are aware that employers are being marketed various types of benefit arrangements designed to reduce the employer’s tax obligations by using a combination of wellness programs, voluntary benefits, and cafeteria plans. Not surprisingly, the Internal Revenue Service (IRS) has taken interest in these designs and has provided guidance which may dampen the enthusiasm for such arrangements.
In the IRS Chief Council Advice Memorandum 201622031, the IRS addresses the tax treatment of three different situations in which wellness benefits result in taxable income to employees.
Situation 1: The employer provides health coverage, with a separate no-cost wellness program that provides health screenings and other services that generally qualify as a tax-favored accident and health plan under Internal Revenue Code (Code) section 106. Employees that participate in the wellness program may also earn cash rewards and other benefits that do not qualify as Code section 213(d) medical expenses, such as gym memberships. Those cash rewards are taxable income to the employee and subject to income tax withholding and employment taxes. Similarly, benefits not otherwise excludible from income, such as the payment of gym membership fees, are included in employee’s gross income at fair market value and are also subject to income tax withholding and employment taxes.
Situation 2: The same as situation 1 except that to participate in the wellness program, employees pay pre-tax premiums through a Code section 125 cafeteria plan. The use of the cafeteria plan makes no difference as to the tax treatment of cash rewards and other benefits not excludible from income. They are taxable income subject to income tax withholding and employment taxes.
Situation 3: The same as above with the added wrinkle that the wellness program benefits include reimbursement of the wellness program premiums made by the employee. The IRS found the reimbursements should be included in the employee’s gross income and be subject to income tax withholding and employment taxes.
The IRS reviewed similar wellness plan arrangements in IRS Chief Council Advice Memorandum 201703013. In that memo, the IRS addressed the tax treatment of fixed indemnity cash payments paid by a wellness plan without regard to the amount of medical expenses incurred by the employee, where the employee is paying premiums to participate in the wellness program. If the premiums are paid on a pre-tax basis through a Code section 125 cafeteria plan, any amounts paid by the plan are included in the employee’s gross income and subject to income tax withholding and employment taxes. Of course, this raises the administrative issue of how the employer is to account for the taxes if the payments are from the third-party insurance carrier.
Key Employer Takeaway
Note, though the Chief Counsel Advice Memoranda cannot be used or cited as precedent, they do provide useful insight into the IRS’s interpretation of the law. Accordingly, employers being marketed these or similar arrangements should take care that the offered program comports with this IRS guidance.