October 09, 2024

Certain pre-tax wellness arrangements that promise large tax savings for employers and employees with little employer investment (sometimes referred to as “wellness indemnity plans” or “FICA savings programs”) frequently lack a legitimate basis in tax law (the Internal Revenue Code (IRC)) and consequently are typically too good to be true. Unfortunately, marketing and other promotional materials regarding these cafeteria plan wellness arrangements can be vague and misleading, making it difficult to recognize an illegitimate program. Employers should always seek guidance from their tax advisor and/or legal counsel for any concerns about the legitimacy of a program, especially if it implicates the tax laws.

The Rules

The IRC establishes boundaries within which all employee benefit tax exclusions must operate. While wellness programs can be beneficial to employers and employees in many ways, they generally do not offer additional tax savings beyond those that would otherwise be available for a qualified benefit provided through a typical cafeteria plan. If an arrangement promotes “innovative design,” “huge tax savings,” or “essential benefits at no cost,” and/or is associated with a wellness program designed to supplement existing comprehensive coverage, it deserves careful examination.

The relevant IRC guidelines are as follows:

• Amounts that an employer pays for an employee’s health insurance premiums are generally excluded from taxation. This includes pre-tax salary reduction amounts paid through a cafeteria plan.
• Amounts paid or received for qualified medical expenses incurred by an employee (or spouse or dependent) are also generally excluded from taxation. Such amounts are excluded, however, only to the extent that they relate to an unreimbursed qualified medical expense. If there is no charge for the expense (e.g., completing a health risk assessment) or the expense is otherwise covered by a group health plan (e.g., preventive care services such as annual physicals and FDA-approved vaccinations), then the amounts received by program participants are not excluded from income and are considered taxable wages.
• Under a traditional wellness program, incentives or rewards are provided to employees for participating in “healthy activities” like filling out a health risk assessment, getting an annual physical, or engaging in a health-contingent program. Typically, a premium is not charged for participation. Incentives like cash awards and gift certificates are taxable and included in an employee’s income. Other incentives linked to a nontaxable benefit, such as a payment for an unreimbursed qualified medical expense, reduction in healthcare premiums, deductibles, or copays, or a contribution to an HSA, health FSA, or HRA, may be tax-free.

Purported Tax Savings — When It Sounds Too Good to Be True…

Many of these purported tax-saving designs appear to provide a wellness program that is in and of itself a medical reimbursement program (e.g., a group health plan) akin to an HRA or health FSA, where a pre-tax premium is paid to participate and a maximum tax-free reimbursement is provided, often equivalent to the tax-free premium paid.

However, payments or reimbursements from these programs may not be tied to legitimate qualified expenses. For example, the tax-free reimbursement might be for an expense already covered under the comprehensive medical plan (like a vaccination or physical) or an event for which no actual expense has been incurred (e.g., filling out a health questionnaire). In other words, a participant can’t have the same qualified medical expense reimbursed twice (i.e., “double-dipping”). There must be an actual unreimbursed qualified medical expense. Other potential issues with these programs include the lack of any insurance risk and overpayment of qualified medical expenses (i.e., the reimbursement is much larger than the expense).

In recent years, the IRS has issued several legal memoranda addressing these types of wellness indemnity arrangements that appear to exploit the nontaxable nature of wellness, group health, and cafeteria plans. The IRS is actively enforcing noncompliance with the tax law. There are significant taxes and penalties associated with improper income tax withholding and/or payment of employment taxes.

Takeaways

The IRC rules on permissible employee benefit tax exclusions are well-established. Programs promoting innovative designs with substantial tax savings may instead set up improper withholdings and underpayment of employment taxes. Accordingly, employers should review the details and legal risks of any similarly promoted tax savings vehicles with their tax advisor and/or legal counsel before adding these to their employee benefits plans.