Edward A. Lenz, Esq., senior counsel, American Staffing Association
Alden J. Bianchi, Esq., counsel, McDermott Will & Emery LLP
In a memorandum dated May 9, 2023, and publicly released on June 9, the Office of Chief Counsel of the U.S. Internal Revenue Service addresses the tax status of certain fixed-indemnity health plans that promise employers major payroll tax savings. A fixed-indemnity health policy is an insurance policy that pays covered individuals a specified amount of cash for the occurrence of certain health-related events, such as physician office visits or days in the hospital.
The tax issues relating to these plans were the subject of a May 19 ASA Staffing Law Conference session, and the related ASA issue paper “Buyer Beware: The Newest Wave of Hospital/Fixed Indemnity Programs Promising Payroll Tax Savings.” The IRS’s publication supports all aspects of the ASA view of the issues as presented in the conference session and in the paper on the subject.
In the memorandum, the chief counsel’s office considered whether payments under an employer-funded, fixed-indemnity insurance policy, where premiums are paid by employee salary reductions through a cafeteria plan offered pursuant to Section 125 of the Internal Revenue Code, must be included in the employee’s gross income and treated as wages subject to federal income and payroll tax withholding. The IRS concluded that such payments are includible in income and subject to tax if the employee has no unreimbursed medical expenses related to the payments.
Under the type of plan discussed in the IRS memorandum, employees pay $1,200 in monthly premiums for the fixed-indemnity insurance policy by salary reduction through a Section 125 cafeteria plan. The policy pays a benefit of $1,000 per month if an employee participates in certain health or wellness activities. Use of preventive care, such as vaccinations, qualifies the employee for the monthly payment. So does participating in wellness counseling, nutrition counseling, and telehealth benefits at no additional cost.
On the facts described, the IRS concluded that the payments made under the fixed-indemnity policies are includible in the gross income of the employee as wages subject to income and payroll tax withholding. According to the memorandum, section Section 105(b) of the Internal Revenue Code limits the tax exclusion to amounts paid solely to reimburse expenses incurred for medical care. Payments which the employee would be entitled to receive irrespective of whether medical expenses are incurred cannot be excluded. Because the $1,000 payments made under the fixed indemnity policies in question are triggered without regard to whether the employee has any unreimbursed medical expenses or are triggered by activities that do not cost the employee anything, they will be viewed as payments provided in connection with the employee’s employment and therefore considered “wages” for employment tax purposes.
The IRS memorandum represents the opinion of the Office of Chief Counsel. While technically not binding on taxpayers, it confirms, and heightens, the concern expressed in the ASA issue paper that, upon audit, the IRS would view these plans as noncompliant, subjecting participating employers to back taxes and potential penalties. Therefore, the association continues to urge staffing firms that may be considering participating in plans of the type described in the memorandum to exercise caution and consult with expert tax and benefits counsel before doing so.
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