Lifestyle Accounts: Employee Benefits, Champagne Wishes, and Caviar Dreams

By: HUB’s EB Compliance Team

The Great Resignation is upon us and more employers are looking to enhance their benefits packages to support their recruiting and retention efforts. Enter the lifestyle account (“LSA”), a not so new benefit that is gaining popularity and seeing growth in adoption by employers. LSAs can be valuable tools to help employers attract and retain talent. However, LSAs have limitations.

Account Format

Though LSAs come in many different varieties, they are all employer funded accounts which employees can use on certain lifestyle expenses. The allowable expenses vary by plan, but common allowable expenses include gym memberships, fitness equipment, financial planning, and backup childcare. Employers can fund these accounts either annually or monthly. Expenses can be processed either by the employer directly or by an outside vendor.

Beware of Medical Expenses

LSAs can run into compliance issues if they cover medical expenses under Section 213(d) of the Internal Revenue Code. By covering medical expenses, LSAs open themselves up to a myriad of rules that impose compliance obligations they will not meet. Specifically, an LSA reimbursing medical expenses would be considered a group health plan under ERISA, which would then require it to comply with COBRA, HIPAA and the ACA market reforms. 

If the LSA were subject to COBRA, the plan sponsor would need to ensure initial COBRA notices were sent to enrollees, as well as COBRA election notices for those who experience COBRA qualifying events.

Since LSAs are 100% employer funded, and LSA that covers medical expenses would be subject to HIPAA just as any other self-insured group health plan. Among other obligations, the LSA would then need to establish privacy practices as well as comply with the Privacy and Security rules. If the LSA was administered by a vendor, that vendor would then become the Business Associate of the LSA, necessitating a Business Associate Agreement.

The ACA market reforms require plans to remove annual and lifetime maximums. Since LSAs by nature have annual limits, they fail the ACA market reforms. This means LSA enrollment would need to be integrated with other group health coverage and tied to enrollment in the medical plan to satisfy the ACA market forms. At a minimum, this would restrict enrollment to a smaller group than most employers want since LSAs are most often offered to all full-time employees, whether or not they are enrolled in the medical plan.

Taxation of LSAs

Amounts paid by LSAs need to be taxable to employees. This is because under general income tax principles, amounts received must be included in gross income unless there is a basis to exclude it. LSAs cover a wide range of expenses, but there simply is no basis to exclude the amounts paid from the employee’s income.

Normally, payment of medical expenses by an employer sponsored plan can be excluded from gross income. However, in addition to the issues already raised by LSAs covering medical expenses, such payments also raise tax issues. An employer funded account that pays medical expenses is considered a health reimbursement arrangement (“HRA”). The HRA rules generally stipulate that if an HRA pays any taxable amount, all amounts paid by the HRA are taxable. Since we already know LSAs pay taxable amounts, any medical expense reimbursements from an LSA would be taxable.

Choices Between Taxable and non-Taxable Funds

LSAs by nature are flexible in that they allow employees to choose from allowable categories how the funds are used. Flexibility has its limits however since the tax doctrine of constructive receipt does not allow employees to have the choice between allocating LSA funds to taxable and non-taxable uses. Benefits offered through a cafeteria plan are an exception to the constructive receipt doctrine, but the LSA would not qualify as a permitted cafeteria plan benefit.

For example, if an employer offered an LSA with an annual value of $1,000, the employer could not allow employees to choose to put some amount (like $500) in an HRA (which would cover medical expenses and thus not be taxable to the employee) and the remaining amount in a regular LSA that would be taxable to the employee. The doctrine of constructive receipt would treat the entire $1,000 as taxable. A potential workaround would be for the employer to divide the funds into these buckets rather than give employees the choice of how to allocate the funds. The HRA, however, would still have to comply with the rules applicable to group health plans described above. In the end, it may be best to keep any medical expenses out of an LSA to avoid potential compliance pitfalls and complications.

Conclusion

LSAs offer employers yet another opportunity to enhance their benefit packages. They offer tremendous flexibility; however, the flexibility isn’t unlimited. Employers considering an LSA should understand the restrictions on how funds can be used to avoid conflicting with the appropriate rules.

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.