By: HUB’s EB Compliance Team

Although employee benefits represent a form of compensation, such programs don’t usually result in increased “take-home” pay to the employee, particularly for not doing very much. So if an arrangement is pitched to use benefits in such a suspiciously “efficient” manner, employers should carefully assess whether a nefarious double-dip scheme has entered their midst.

What is the Double-Dip?

Designs vary, but the general approach usually starts with a pre-tax employee contribution at least nominally funding some kind of employee benefit. The dollar amount of that employee contribution is later repaid to the employee, sometimes in exchange for doing a very simple task, like completing a health risk assessment, watching a health-promoting video, or talking to a wellness coach. Note that both the employee’s funding and the employer’s reimbursement will hinge on a pair of tax-favored transactions that each are supposed to generate payroll tax savings.

It’s worth noting that traditionally engaging a wellness coach or similar activity results in a cost to the employer or employee, not a payment made to the employee. Imagine ordering a meal from a restaurant and instead of paying for the meal, the restaurant pays you to eat their food. The same logic applies to these plans.

An indemnity plan supposedly serves as the engine driving this tax dodge, although one would struggle to find any well-known carrier offering such a product. The payment for this very minimal activity is, at least according to these scheme promoters, not taxed. The end result is that the employee has the same (or almost the same) gross pay, but artificially reduced payroll taxes sometimes result in an actual increase in take-home pay. The twin tax win by employer and employee spawns the name “double-dip” schemes.

To put it another way:

  • The employer and employee pay less in payroll taxes;
  • The employee gets some kind of nominal benefit (sometimes);
  • The employee’s take-home pay is essentially unchanged;
  • The “provider” collects an administrative fee; and
  • The only loser is the IRS.

It should probably go without saying that the IRS does not appreciate being the only loser. The IRS has made clear that these arrangements are impermissible and likely will subject an employer to significant IRS penalties for failure to withhold and pay income and employment taxes, plus interest. Penalties are also possible on the state level.

Hiding the Double-Dip

Some promoters try to conceal the double-dip behind other benefits, like a health plan that provides minimal reimbursements or payments for services. In other cases, the arrangement may offer benefits alongside the double-dip, like stand-alone dental or vision plans. However, all of this does as much to insulate the double-dip as mixing a cup of sugar does to reduce the effect of a gallon of poison. It may taste better, but it’ll still kill you.

In some cases, con artists trying to sell these schemes will waive a legal opinion in front of you, claiming that such an opinion conclusively proves that the pitched-product complies with both state and federal law. In the past, these opinions were often rendered by attorneys with little to no meaningful ERISA or tax experience.

Lately, some opinions even seem to be drafted by ERISA attorneys. However, a careful review of such opinions will often include disclaiming language such as “memorandum solely written for ABC Company.” Alternatively, the legal opinion may caveat that they’re relying on representations provided by the promoter or some other materials that the reader has not been provided in reaching their tax or legal conclusions. They also rarely cite to any IRS guidance that expressly allows whatever type of plan they’re offering (and the citations they do offer do not support their structure to the extent they say it does). A closer read also usually reveals that the lawyer stops well short of saying the scheme is free and clear of any issues. “May be” permissible is a long way from “is”.

Any mix of such flaws in a memo being presented to validate a double-dip scheme should raise a red flag.  It is also worth asking why a legal opinion is even necessary if this benefit is supposedly as compliant as its promoters usually claim. Similarly, why aren’t all US employers already profiting from use of such a supposedly vetted and compliant maneuver?

The IRS Position Has Not Changed

Because these schemes have a zombie-like quality of never quite dying, the IRS has repeatedly denounced various versions as tax evasion. Dating back to the early 2000s, the IRS issued Revenue Ruling 2002-3 stating reimbursements of pre-tax premium amounts employees paid were not tax free. Later, in Revenue Ruling 2002-80, the IRS concluded that "advance reimbursements" or "loans" for medical expenses (that were really repayments of employee health premiums) should be included in the employee's gross income and are subject to employment taxes. This is a far cry from the claims of promoters who want to have their pre-tax deduction cake and eat their tax-free reimbursement too.

In more recent years, the IRS has issued Chief Counsel Memorandum 201622031 and Chief Counsel Memorandum 201719025 to alert employers that schemes labeled as wellness programs or self-funded health plans that reimburse in excess of actual medical claims are not what they appear to be.  The IRS also issued Chief Counsel Memorandum 201703013 saying fixed indemnity plans cannot have premiums paid on a pre-tax basis and benefit payments that are also tax-free. If premiums for fixed indemnity insurance are made pre-tax, then the benefits are generally taxable, to the extent they exceed the individual’s actual medical expenses.

As is perhaps obvious, a wellness coaching visit, filling out a health risk assessment, or similar activities provided at essentially no cost to the employee cannot possibly be a medical expense for which the employee can be reimbursed. As a result, under IRS guidance detailed above, any payment for it would be taxable if premiums were paid pre-tax.  While the above Chief Counsel Memos are not law, they are informative of the IRS’s views. Courts also sometimes rely on them for authority.

Informally, IRS officials have also stated that schemes involving “fixed indemnity wellness” types of products descried above are not actually insurance. This makes sense because there is no meaningful risk of actual loss. Such officials also that say neither a decision by a state Department of Insurance to treat a fixed indemnity product as insurance, nor a legal opinion, will change the federal tax analysis. Although such statements are unofficial, they remain consistent with and further reinforce the positions taken in official IRS guidance. On a more practical note, inside a conference room during any Uncle Sam versus employer confrontation, such comments likely reflect the identical position the IRS would express on audit.

Takeaways

Employers should carefully evaluate proposed products that marketers’ purport will activate pre-tax payment of premiums and tax-free payments to employees with little or no reduction in take home pay (or even an increase in take home pay). Any legitimate arrangement where employees can put pre-tax money aside and receive it back tax-free will require the employee to have an actual expense (such as medical or dependent care) that the plan reimburses and involve a real risk that the employee might not get all his or her money back. A mere payment that has the effect of giving the employee supposedly tax-free income, without having incurred a permitted type of expense, is almost certainly just an illegal tax avoidance scheme.

If you have any questions, please contact your HUB Advisor. View more compliance articles in our Compliance Directory.

NOTICE OF DISCLAIMER

Neither Hub International Limited nor any of its affiliated companies is a law or accounting firm, and therefore they cannot provide legal or tax advice. The information herein is provided for general information only and is not intended to constitute legal or tax advice as to an organization’s or individual's specific circumstances. It is based on Hub International's understanding of the law as it exists on the date of this publication. Subsequent developments may result in this information becoming outdated or incorrect and Hub International does not have an obligation to update this information. You should consult an attorney, accountant, or other legal or tax professional regarding the application of the general information provided here to your organization’s specific situation in light of your or your organization’s particular needs.