Chief Counsel's Office: Wellness Indemnity Payments Are Taxable Income and Wages

(Parker Tax Publishing July 2023)

The Office of Chief Counsel advised that wellness indemnity payments under an employer-funded, fixed-indemnity insurance policy (including where the premium for the coverage is paid by employee salary reduction through a Code Sec. 125 cafeteria plan) are includible in the gross income of the employee if the employee has no unreimbursed medical expenses related to the payment. The Chief Counsel's Office further advised that because such payments are provided in connection with the employee's employment, they are treated as wages for employment tax purposes. CCA 202323006.

Background

The Office of Chief Counsel was asked to advise whether wellness indemnity payments under an employer-funded, fixed-indemnity insurance policy (including where the premium for the coverage is paid by employee salary reduction through a Code Sec. 125 cafeteria plan are includible in the gross income of the employee if the employee has no unreimbursed medical expenses related to the payment. The Chief Counsel's Office was also asked whether the wellness indemnity benefits that are includible in gross income (taxable wellness indemnity benefits) are wages for purposes of Federal Insurance Contributions Act (FICA) taxes, Federal Unemployment Tax Act (FUTA) taxes, and federal income tax withholding (FITW) (collectively, employment taxes).

Under the facts presented, an employer provides comprehensive health coverage for its employees through a group health insurance policy. The comprehensive health coverage provides preventive care benefits, such as reimbursements for the cost of flu shots and other vaccinations, without any cost sharing for covered individuals. The coverage constitutes accident or health coverage for purposes of the exclusion for employer-provided accident or health coverage under Code Sec. 106(a).

In addition to the health coverage, the employer provides all employees, regardless of enrollment in other comprehensive health coverage, with the ability to enroll in coverage under a fixed-indemnity health insurance policy that would qualify as an accident and health plan under Code Sec. 106. Employees pay monthly $1,200 premiums for the fixed-indemnity health insurance policy by salary reduction through a Code Sec. 125 cafeteria plan. The only payments that the insurance company receives with respect to the insurance provided to the employees are the premium payments. In other words, the employer has no liability for any costs incurred by the insurance company that may exceed the premiums paid by its employees.

The employer's fixed-indemnity health insurance policy is a voluntary program primarily intended to supplement its employees' other health coverage through the provision of wellness benefits. The first type of wellness benefit provided by the fixed-indemnity health insurance policy is a payment of $1,000 if an employee participates in certain health or wellness activities. This benefit is limited to one payment per month. Use of preventive care, such as vaccinations, under a comprehensive health plan in which an employee is enrolled, qualifies the employee for the payment for the month. The fixed-indemnity health insurance policy provides wellness counseling, nutrition counseling, and telehealth benefits at no additional cost. The employee is responsible for any costs associated with receiving any health-related activity, although in many cases all or part of the cost of the health-related activity will be provided at no cost or is covered by other insurance. The fixed-indemnity health insurance policy also provides a benefit for each day that the employee is hospitalized. Under the fixed-indemnity health insurance policy, the wellness benefits are paid from the insurance company to the employer, which then pays out the wellness benefit to employees via the employer's payroll system.

Under Code Sec. 106(a), the gross income of an employee generally does not include employer-provided coverage under an accident or health plan. Code Sec. 106(a) provides an employee may exclude from gross income premiums for accident or health insurance coverage that are paid by an employer.

Code Sec. 105(a) generally provides that amounts received by an employee through accident and health insurance for personal injuries or sickness are included in gross income to the extent the amounts (1) are attributable to contributions by the employer which are not includable in the gross income of the employee or (2) are paid by the employer. However, Code Sec, 105(b) provides that gross income does not include amounts paid by an employer to reimburse an employee for expenses incurred by the employee for medical care. Under Reg. Sec. 1.105-2, the exclusion under Code Sec. 105(b) is limited to amounts paid solely to reimburse expenses incurred for medical care and does not apply to amounts which the taxpayer would be entitled to receive irrespective of whether expenses for medical care are incurred. Reg. Sec. 1.105-2 also provides that if the amounts are paid to the taxpayer solely to reimburse expenses which were incurred for the prescribed medical care, Code Sec. 105(b) applies even though such amounts are paid without proof of the amount of the actual expenses incurred by the taxpayer, but Code Sec. 105(b) does not apply to the extent that such amounts exceed the amount of the actual expenses for such medical care.

In general, Code Sec. 3121(a) defines "wages" that are subject to Federal Insurance Contributions Act (FICA) and Federal Unemployment Tax Act (FUTA) taxes as all remuneration from employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash. Code Sec. 3121(a)(5)(G) provides an exception from FICA wages for any payment to or on behalf of an employee under a Code Sec. 125 cafeteria plan if such payment would not be treated as wages without regard to such plan and it is reasonable to believe that (if Code Sec. 125 applied for purposes of Code Sec. 3121) Code Sec. 125 would not treat any wages as constructively received. Code Sec. 3306(b)(5)(G) contains a similar exception from wages for purposes of FUTA tax.

Code Sec. 3121(a)(2) provides an exception from FICA wages for payments (including any amount paid by an employer for insurance) made to, or on behalf of, an employee under an employer plan which makes provision for its employees generally on account of (1) sickness or accident disability, but only if the payments are received under a workers' compensation law; and (2) medical or hospitalization expenses in connection with sickness or accident disability.

Analysis

The Office of Chief Counsel advised that wellness indemnity payments under an employer-funded, fixed-indemnity insurance policy (including where the premium for the coverage is paid by employee salary reduction through a Code Sec. 125 cafeteria plan are includible in the gross income of the employee if the employee has no unreimbursed medical expenses related to the payment. The Chief Counsel's Office also advised that, because the payment is provided in connection with the employee's employment, it is included in remuneration and treated as "wages" for employment tax purposes.

The Chief Counsel's Office noted that the exclusion from gross income under Code Sec. 105(b) is limited to amounts paid solely to reimburse expenses incurred for medical care; it does not apply to amounts which the taxpayer would be entitled to receive irrespective of whether expenses for medical care are incurred. The Chief Counsel's Office explained further that the exclusion under Code Sec. 105(b) also does not apply to payments when the employee has no unreimbursed medical expense, because the activity that triggers the payment does not cost the employee anything or because the cost of the activity is reimbursed by other coverage. The Chief Counsel's Officed noted that in the facts stated above, the fixed indemnity health insurance policy pays $1,000 per month without regard to whether the employee has any unreimbursed health insurance expenses. Thus, the payment is included in the employee's gross income.

The Chief Counsel's Office further advised that taxable wellness indemnity benefits are provided by employers to employees as remuneration for employment under benefit plans funded by employers and, thus, fit within the basic definition of wages under Code Sec. 3121(a). The Chief Counsel's Office found that to the extent the taxable wellness indemnity benefits are not paid under a worker's compensation law, they do not qualify for the exception from wages provided by Code Sec. 3121(a)(2)(A). Moreover, the taxable wellness indemnity benefits cannot qualify for the exception under Code Sec. 3121(a)(2)(B), according to the Chief Counsel's Office, because the payments are not made on account of medical or hospitalization expenses in connection with sickness or accident disability.

Thus, under the facts described above, the Chief Counsel's Office concluded that when the insured plan pays $1,000 because the employee used a wellness benefit, the $1,000 is included in the employee's income and wages. Accordingly, taxable wellness indemnity benefits are wages for purposes of FICA, FUTA, and FITW with respect to the payments of benefits in the situation described above.

For a discussion of the exclusion from income for employer medical care expense reimbursements, see Parker Tax ¶120,110.

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.

Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com

We hope you find our professional tax research articles comprehensive and informative. Parker Tax Pro Library gives you unlimited online access all of our past Biweekly Tax Bulletins, 22 volumes of expert analysis, 250 Client Letters, Bob Jennings Practice Aids, time saving election statements and our comprehensive, fully updated primary source library.

Try Our Easy, Powerful Search Engine

A Professional Tax Research Solution that gives you instant access to 22 volumes of expert analysis and 185,000 authoritative source documents. But having access won’t help if you can’t quickly and easily find the materials that answer your questions. That’s where Parker’s search engine – and it’s uncanny knack for finding the right documents – comes into play

Things that take half a dozen steps in other products take two steps in ours. Search results come up instantly and browsing them is a cinch. So is linking from Parker’s analysis to practice aids and cited primary source documents. Parker’s powerful, user-friendly search engine ensures that you quickly find what you need every time you visit Our Tax Research Library.

Dear Tax Professional,

My name is James Levey, and a few years back I founded a company named Kleinrock Publishing. I started Kleinrock out of frustration with the prohibitively high prices and difficult search engines of BNA, CCH, and RIA tax research products ... kind of reminiscent of the situation practitioners face today.

Now that Kleinrock has disappeared into CCH, prices are soaring again and ease-of-use has fallen by the wayside. The needs of smaller firms and sole practitioners are simply not being met.

To address the problem, I’ve partnered with a group of highly talented tax writers to create Parker Tax Publishing ... a company dedicated to the idea that comprehensive, authoritative tax information service can be both easy-to-use and highly affordable.

Our product, the Parker Tax Pro Library, is breathtaking in its scope. Check out the contents listing to the left to get a sense of all the valuable material you'll have access to when you subscribe.

Or better yet, take a minute to sign yourself up for a free trial, so you can experience first-hand just how easy it is to get results with the Pro Library!

Sincerely,

James Levey

Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com