This Chief Counsel Advice memorandum (CCA) addresses arrangements that combine self-insured health plans with wellness plans in an attempt to provide nontaxable cash payments to employees and employment tax savings for the employer and employees. The CCA uses two scenarios to illustrate these arrangements and explain why they don’t work. In the first scenario, employees pay a small after-tax contribution to enroll in a self-insured health plan (the fixed-payment plan). Enrolled employees who participate in specified no-cost wellness activities receive cash payments from the fixed-payment plan that greatly exceed their after-tax contributions. Under an actuarial analysis, all employees are expected to receive—and, in practice, do receive—payments that markedly exceed their contributions. In the second scenario, employees also have the opportunity to enroll, by making substantial pre-tax contributions through a cafeteria plan, in a wellness plan that independently qualifies as an accident and health plan under Code § 106 and offers no-cost wellness activities. Employees participating in the wellness plan also qualify for payments from the fixed-payment plan. If an employee’s take-home pay—after taking into account the employee’s contributions to both plans and payments from the fixed-payment plan—exceeds the employee’s take-home pay without the plans, the excess is treated as flex credits under the cafeteria plan.
The CCA focuses on Code § 104(a)(3), which provides that gross income does not include amounts received through accident or health insurance for personal injuries or sickness, unless the amounts are either (1) attributable to employer contributions not includible in the employee’s gross income; or (2) paid by the employer. The CCA emphasizes that the reference to “insurance” requires risk-shifting and risk-distribution. Those characteristics are lacking in the fixed payment plan—which does not involve a risk (to employees) of economic loss or a fortuitous event. Moreover, because the average benefits under the fixed-payment plan markedly exceed employees’ total contributions to that plan, the excess benefits are either paid by the employer or attributable to employer contributions not includible in employees’ gross income. Either way, the benefit payments will not qualify for the Code § 104(a)(3) exclusion, and the benefits in excess of the employee contributions must be treated as gross income and subject to income tax withholding. The excess benefits are also subject to FICA and FUTA taxes because they are treated as wages and are not exempt—the CCA notes they are not paid for medical or hospitalization expenses in connection with sickness or accident disability. However, any flex credits granted under the second scenario would be excluded from employees’ income and wages in accordance with Code § 125 unless used to purchase taxable benefits.
Comment: In addition to refuting the “too good to be true” tax claims, this CCA clarifies the IRS’s position on tax treatment of payments from fixed indemnity plans (plans that pay covered individuals a fixed cash amount upon the occurrence of certain health-related events, such as hospitalization). A recent CCA had suggested that, where premiums for fixed indemnity insurance are paid pre-tax, the benefits are taxable, regardless of the amount or type of medical expenses that triggered the payment. This CCA acknowledges prior guidance stating that fixed indemnity payments attributable to pre-tax contributions will be taxable only to the extent that they exceed otherwise unreimbursed medical expenses.