Taxable Income Includes Cash Rewards and Premium Reimbursements under Wellness Programs

(Parker Tax Publishing June 2016)

Employers may not exclude from an employee's income cash rewards for participating in a wellness program, nor may they exclude reimbursements of premiums for participating in such programs made by salary reduction through a cafeteria plan. CCA 201622031.

Background

In CCA 201622031, the IRS Office of Chief Counsel (IRS) was asked to address whether an employer may, under Code Sec. 105 or Code Sec. 106, exclude from an employee's income cash rewards paid to an employee for participating in a wellness program, or exclude reimbursements of premiums for participating in a wellness program if the premiums for the wellness program were originally made by salary reduction through a Code Sec. 125 cafeteria plan.

In general, Code Sec. 106(a) provides that gross income of an employee does not include employer-provided coverage under an accident or health plan. Under Code Sec. 106(a), an employee may exclude from income premiums for accident or health insurance coverage that are paid by an employer. Also, under Code Sec. 105(b), an employee may exclude amounts received through employer-provided accident or health insurance if those amounts are paid to reimburse expenses incurred by the employee for medical care (of the employee, the employee's spouse, or the employee's dependents, as well as children of the employee who are not dependents but have not attained age 27 by the end of the taxable year) for personal injuries and sickness.

To the extent amounts are excluded from gross income under Code Secs. 105(b) or 106(a), they are also excluded from wages subject to income tax withholding under Code Sec. 3401(a). In addition, amounts paid to reimburse expenses incurred by the employee for medical care for personal injuries or sickness are excepted from wages for FICA and FUTA tax purposes under Code Secs. 3121(a) and 3306(b), respectively.

Code Sec. 125 provides that an employer may establish a cafeteria plan that permits an employee to choose among two or more benefits, consisting of cash (generally, salary) and qualified benefits, including accident or health coverage. Pursuant to Code Sec. 125, the amount of an employee's salary reduction applied to purchase such coverage is not included in gross income, even though it was available to the employee and the employee could have chosen to receive cash instead.

Analysis

The IRS advised that an employer may not exclude from an employee's gross income payments of cash rewards for participating in a wellness program.

Similarly, an employer may not exclude from an employee's gross income reimbursements of premiums for participating in a wellness program if the premiums for the wellness program were originally made by salary reduction through a Code Sec. 125 cafeteria plan.

The IRS illustrated its conclusions through three hypothetical situations.

In the first situation, an employer provides all employees, regardless of enrollment in other comprehensive health coverage, with certain benefits under a wellness program at no cost to the employees. In particular, the wellness program provides health screening and other health benefits such that the program generally qualifies as an accident and health plan under Code Sec. 106. In addition to those benefits, employees who participate in the program may earn cash rewards of varying amounts or benefits that do not qualify as Code Sec. 213(d) medical expenses, such as gym membership fees.

In the second situation, an employer provides all employees, regardless of enrollment in other comprehensive health coverage, with certain benefits under a wellness program. Employees electing to participate in the wellness program pay a required employee contribution by salary reduction through a Code Sec. 125 cafeteria plan. The wellness program provides health screening and other health benefits such that the program generally qualifies as an accident and health plan under section 106. In addition to those benefits, employees who participate in the program may earn cash rewards of varying amounts or benefits that do not qualify as Code Sec. 213(d) medical expenses, such as gym membership fees.

The third situation is the same as the second, except that one of the benefits available under the wellness program includes a reimbursement of all or a portion of the required employee contribution for the wellness plan that the employee made through salary reduction.

The IRS advised that in all three situations, the coverage provided by the wellness program is excluded from an employee's income under Code Sec. 106(a) as coverage under an accident and health program. The health screenings and other medical care as defined under Code Sec. 213(d) provided to employees by the program are excluded from the employees' income under Code Sec. 105(b). If an employee earns a cash reward under the program, the amount of the cash reward is included in the employee's gross income under Code Sec. 61 and is a payment of wages subject to employment taxes under Code Secs. 3121(a), 3306(b), and 3401(a). Similarly, if the employee earns a reward of a benefit not otherwise excludible from the employee's income, such as the payment of gym membership fees, the fair market value of the reward is included in the employee's gross income under Code Sec. 61 and is a payment of wages subject to employment taxes under Code Secs. 3121(a), 3306(b), and 3401(a).

In addition, the IRS advised that in the third situation, the fact that the payment to employees of reimbursements for all or a portion of the premiums paid by salary reduction is made through a wellness plan does not distinguish the arrangement from the arrangement addressed in Rev. Rul. 2002-3 (holding that Code Secs. 106(a) and 105(b) do not apply where an employer has an arrangement under which employees may reduce their salaries and have the salary reduction amounts used to pay health insurance premiums for the employees). Accordingly, the exclusions under Code Secs. 106(a) and 105(b) do not apply to amounts paid to employees as reimbursements of a portion of the premium for the wellness program that is excluded from gross income under Code Sec. 106(a) (including salary reduction amounts pursuant to a cafeteria plan under Code Sec. 125 that are applied to pay for such coverage). Thus, the reimbursement amounts are included in the employee's gross income under Code Sec. 61 and are payments of wages subject to employment taxes under Code Secs. 3121(a), 3306(b), and 3401(a).

For a discussion of the taxation of employer-provided accident and health benefits, see Parker Tax ¶120,101.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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