IRS Discusses Tax Treatment of Wellness Program Benefits
Author: Rena Pirsos, XpertHR Legal Editor
June 10, 2016
The IRS has released a Chief Counsel Advice Memorandum discussing the tax treatment of wellness program benefits and employer reimbursement of premiums provided on a pretax basis under a § 125 cafeteria plan (under the Internal Revenue Code - IRC). Chief Counsel Advice Memorandums represent the IRS's response to a particular taxpayer's request for the IRS's assistance and may not be relied on as precedent. However, for an employer interested in offering similar benefits, they provide a good indication of the IRS's position.
The Memorandum answers two questions:
- May an employer exclude from an employee's taxable income, under IRC § 105 or § 106, cash rewards paid to an employee for participating in a wellness program?
- May an employer exclude from an employee's taxable income, under § 105 or § 106, reimbursement of premiums for participating in a wellness program, if the premiums were originally paid by salary reduction through a § 125 cafeteria plan?
The IRS answered no to both questions based on three specific situations proposed by the employer.
- Situation 1. The employer's wellness program provides all employees (even if enrolled in other health coverage) with free health screenings and accident and health plan benefits under § 106. Participants may also earn cash rewards of varying amounts or benefits that do not qualify under the IRC as medical expenses, such as gym membership fees.
- Situation 2. The same facts as Situation 1, except that employees must pay a contribution, by salary reduction, through a § 125 cafeteria plan to participate in the wellness program.
- Situation 3. The same facts as Situation 2, except that one of the benefits available under the wellness program includes the employer's reimbursement of all, or a portion of, the required employee contributions to the plan.
The IRS concluded that, in Situation 1, 2 and 3, the employer must exclude the coverage provided by the wellness program from the taxable income of the employees under § 106(a) as coverage under an accident and health program. The employer must also exclude the health screenings and other medical care under § 105(b).
However, if an employee earns a cash reward under the program, the employer must include the amount of the cash reward in the employee's taxable income (under IRC § 61). The cash reward would also be considered a payment of wages subject to employment taxes (e.g., FICA - Social Security and Medicare tax; and FUTA - federal unemployment insurance tax) (under IRC §§ 3121(a), 3306(b) and 3401(a)).
Similarly, if an employee earns a reward of a benefit not otherwise excluded from income, such as the payment of gym membership fees, the employer must include the fair market value of the reward in the employee's taxable income, and it would be considered a payment of wages subject to FICA and FUTA taxes.
In addition, in Situation 3, despite the fact that the payment to employees of reimbursements for all, or a portion of, the premiums paid by salary reduction is made through a wellness plan, the exclusions under §§ 106(a) and 105(b) would not apply (including salary reductions under a § 125 cafeteria plan that are applied to pay for such coverage). Accordingly, the employer would have to include the reimbursements in the taxable income of the employees as payments of wages subject to FICA and FUTA taxes.