Wellness Fixed-Indemnity: You Can’t Have Your Preventive Care and Tax-Free Indemnity Too

By: HUB’s EB Compliance Team

From time-to-time vendors reach out to employers and pitch what they usually characterize as “innovative” new program designs. Problematically, these programs are often structured for plan sponsors to save tax dollars without providing much in the way of meaningful benefits. These vendors argue that “special IRS rules” allow for this. HUB has addressed various such concepts over the years (most recently here), but as these vendors persist, the IRS is forced to renew their opposition. Most recently, a new IRS Chief Counsel Memo has been published that puts the kibosh on another one of these schemes: the wellness fixed indemnity plan.

How it Works…

The program involves tandem use of the employer’s group health plan and a fixed indemnity plan. Premiums for both are funded on a pre-tax basis through the cafeteria plan. 

The fixed indemnity plan (in addition to other benefits) provides a fixed payment of up to a certain amount per month for certain “wellness activities” like the use of preventive care under the group health plan. This could include such “plain vanilla” activities as getting a vaccine or a physical exam. There may be other activities that also warrant a payment.

Note that the fixed-indemnity plan does have another, more traditional fixed indemnity component, like a per day benefit for hospitalization. However, in all cases (whether for the wellness activity or hospitalization benefit), the amount is paid regardless of whether the employee incurs any expenses. 

Program promoter claims for a successful tax outcome hinge on the idea that benefits paid from the fixed indemnity plan are not taxable. In other words, the employee gets to deduct premiums pre-tax plus receive tax-free payments. An almost too good to be true taxpayer win-win, right? 

…Or Rather, Doesn’t Work

Not so fast. In the Chief Counsel Memo, the IRS made it clear that fixed indemnity plan payments remain taxable to the individuals, and subject to employment taxes like FICA and FUTA, if the employee has no unreimbursed medical expenses related to the payment. Since many of the wellness activities (like vaccinations and physicals) are covered 100% under the group health plan, the employee will have no unreimbursed expenses. Therefore, the entire fixed indemnity payment will be taxable.

Because the payments are taxable and made from an employer-sponsored plan, the IRS concludes that the payments are subject to federal income tax withholding as well was withholding of the FICA and FUTA employment taxes. This immediately poses a troubling employer burden. From a practical standpoint, it’s difficult, if not impossible for the employer to correctly address tax liability for these reimbursements since a third party (the insurer) directly pays participants. Therefore, in most cases the employer will not know the extent of the employee’s unreimbursed medical expenses. This effectively nullifies the tax benefits these promoters often espouse.

Conclusion

The IRS is intentionally trying to tamp down on these schemes (often called double-dip programs, and often prominently highlighted on the IRS’ annual “tax scam” listing). These programs are marketed as benefits programs but are really tax avoidance schemes. This is just another nail in the coffin of such arrangements. While it is worth noting that Chief Counsel Memos are not binding guidance, they are reflective of the IRS’s position on a particular matter. As a result, employers approached by promoters of these wellness/fixed indemnity kind of programs should view them with skepticism. 

As a practical matter, it also makes sense for fixed indemnity policies to be paid for on an after-tax basis anyway to avoid some of these reimbursement tax issues. Regardless of whether a fixed indemnity policy includes the wellness component, the principle the IRS articulates in its newest guidance still applies: if premiums are paid on a pre-tax basis, reimbursements are taxable (and subject to withholding) to the extent they exceed unreimbursed medical expenses. The simpler approach is to collect the premiums after-tax so that payments can be non-taxable.

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.