By: HUB’s EB Compliance Team

Emergency situations (like the COVID-19 pandemic) often create opportunities for a resurgence in various schemes. At any time, however, employers should be wary of anyone who purports to have an essentially “free” solution to lower tax liabilities while also providing benefits. 

What is the Double-Dip?

Designs vary, but the general approach typically involves a pre-tax employee contribution, usually toward a benefit account (sometimes called a “wellness bank” or more simply, a “bank”). Occasionally, the deduction is, at least nominally, for some kind of benefit. The employee contribution is later paid back to the employee and this payment is supposedly not taxed. The end result is that the employee has basically the same take home pay, but pays less in taxes (hence the term “double-dip” – the employee gets both his/her pay and tax savings).  To put it another way:

  • The employer and employee pay less in payroll taxes;
  • The employee gets some kind of benefit (sometimes);
  • The employee’s take home pay is not reduced;
  • The provider gets an administrative fee; and
  • The only loser is the IRS.

You don’t have to be a professional accountant to realize that the IRS doesn’t like to lose. 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. Penalties are also possible on the state level.

Double-Dip Flavors

Among other structures, these products may 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); or
  • medical reimbursement plans (flexible spending accounts (FSA)) funded by salary reduction amounts that exceed the ACA limit ($2,750/year, as adjusted).

In some cases, marketers say a state Department of Insurance has 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 (nominal) wellness activity, like calling a wellness coach. It’s also worth noting that traditionally engaging a wellness coach or similar activity results in a cost to the 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.

More current versions may layer apparently legitimate voluntary benefits on top of the double-dip, such as vision or dental insurance or even a minimum essential coverage health plan. Those benefits may, independently, be legitimate, but the underlying concerns with the double-dip remain. This appears to be a “smoke and mirrors” gambit where the legitimate benefits appear to provide “cover” for the underlying double-dip scheme. 

In some cases, a legal opinion will be presented by the marketer stating that the 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 seem to be drafted by ERISA attorneys. However, read those opinions closely. Often times, what they are saying is that there is an argument or a basis for claiming that the scheme is permissible, but they stop well short of saying the scheme is free and clear of any issues.

The IRS Has Doubled Down

Over time, the IRS has denounced various versions of these schemes as tax evasion. The IRS issued guidance intended to end these arrangements in the early 2000s. In Revenue Ruling. 2002-3, the IRS said reimbursements of pre-tax premium amounts employees paid 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.

More recently, the IRS has issued Chief Counsel Memorandum 201622031 and Chief Counsel Memorandum 201719025 to alert employers. 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. While these 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 described 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 federal tax analysis. While the statements are unofficial, they are consistent with the positions taken in official IRS guidance. Therefore, they are likely the same positions the IRS would take on audit.

Takeaways

Carefully evaluate proposed products that marketers’ products that purport to allow pre-tax payment of premiums and tax-free payments to employees with no reduction in take home pay. 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 or 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 most likely just an impermissible tax avoidance scheme.

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

 

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.