October 9, 2017 

In what is the tax equivalent of Whack-a-Mole, the IRS is combating new versions of the so-called “double-dip” tax evasion scheme. While the designs vary, the general approach typically involves a pre-tax employee contribution, usually toward a benefit account or bank. Then, the employee contribution is later paid back to the employee in some form and this payment is supposedly not taxed. Usually, the end result is that the employee has basically the same take home pay, but pays less in taxes.

Among other structures, marketers of these schemes have offered products that involve:

  • pre-tax employee salary reductions used to pay for health coverage premiums where some or all of the premiums are paid back to the employee by the employer;
  • a promise to lower employment tax liability by using flex benefits to purchase whole-life insurance policies (whole life insurance policies cannot be purchased on a pre-tax basis);
  • medical reimbursement plans (flexible spending accounts (FSA)) funded by salary reduction amounts that exceed the ACA limit ($2,600/year, as adjusted).

Newer tax evasion schemes involve marketers that have convinced a state Department of Insurance to approve a fixed indemnity product as an insurance plan that provides for payment of a fixed amount to an employee who completes a certain wellness activity. The employees pay for this “insurance” with pre-tax dollars and are paid an amount for each time they engage in the wellness activity, like calling a wellness coach. In some cases, a legal opinion will be presented by the marketer stating that the product complies with both state and federal law. 

The IRS authorities denounce such tax evasion schemes or “double-dipping” because they allegedly allow an employee to maintain the same level of pay, but reduce the employee’s taxes. Any arrangement that is marketed in that fashion should be viewed with great suspicion. The IRS has made clear that these arrangements are impermissible and could subject an employer to significant IRS penalties for failure to withhold and pay income and employment taxes.

Specifically, the IRS issued Chief Counsel Memorandum 201622031 and Chief Counsel Memorandum 201719025 to alert employers about these tax evasion schemes. The IRS also issued Chief Counsel Memorandum 201703013 to alert employers that marketers are also offering fixed indemnity health plan products that say that the premiums can be paid on a pre-tax basis and benefit payments are also tax-free. This is incorrect. The IRS’s view is that if premiums for fixed indemnity insurance are made pre-tax, then the payments are generally taxable if they exceed the individual’s actual medical expenses. While these Chief Counsel Memos do not have the force of law of regulations or Revenue Rulings, they are informative of the IRS’s views in an area and courts do sometimes rely on them for authority.

Informally, IRS officials have also stated that newer schemes involving “fixed indemnity wellness” types of products descried above are not actually insurance. They 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 tax analysis at the federal level. While the statements are unofficial, they are consistent with the positions taken in other IRS guidance and therefore are likely the same positions the IRS would take on audit.

This is not the first time in the last 15 years that the IRS addressed abusive “double-dipping” schemes marketed to employers that misapply tax rules. The IRS previously issued guidance intended to end similar arrangements. In Revenue Ruling. 2002-3, the IRS said reimbursements to employees for pre-tax premiums they paid toward the cost of insurance were not tax free. Additionally, in Revenue Ruling 2002-80, supposed "advance reimbursements" or "loans" for medical expenses (that were really repayments of employee health premiums) were included in the employee's gross income and are subject to employment taxes.

Takeaways:

Carefully evaluate proposed products that marketers’ products (accident and health, fixed indemnity or whole life) that purport to allow pre-tax payment of premiums and tax-free payments to employees. While there are some legitimate arrangements where employees can put pre-tax money aside and receive it back tax-free, they usually require the employee to have an actual expense (such as medical or dependent care) that the plan reimburses. A mere payment that has the effect of giving the employee supposedly tax-free income, without having incurred a permitted type of expense, is probably just an impermissible tax avoidance scheme.

Contact your HUB International consultant for additional assistance.

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NOTICE OF DISCLAIMER
The information herein is intended to be educational only and is based on information that is generally available. HUB International makes no representation or warranty as to its accuracy and is not obligated to update the information should it change in the future. The information is not intended to be legal or tax advice. Consult your attorney and/or professional advisor as to your organization’s specific circumstances and legal, tax or other requirements.