The Internal Revenue Service (IRS) has begun to audit fixed indemnity health/wellness benefit plans that have been marketed by promising significant payroll tax savings to employers and employees. The IRS has long disagreed with the claimed tax treatment, issuing a steady stream of guidance since 2016 disagreeing with various iterations of such plans. However, the law and guidance in this area is complicated, and promoters offer opinions supporting the legality of these programs that can lead employers to potentially misinterpret the rules on benefits that can be excluded from employee income.
These arrangements are marketed as supplemental health or wellness benefits that will result in significant FICA tax savings and increased employee take-home pay. The savings are purportedly achieved in various ways, most commonly by double-dipping: employees are paid or reimbursed a portion of the premiums that the employees paid on a pre-tax basis, and promoters claim that some or all of these amounts can be excluded from employee taxable income. Under a common design, payments are promised even if employees never incur or pay medical expenses as defined in the Internal Revenue Code.
Despite the promised savings, the IRS may view these arrangements skeptically on audit. In the preamble to final regulations on short-term, limited-duration insurance issued in 2024, 89 Fed. Reg. 23338 (April 3, 2024), the IRS commented that its concerns with fixed indemnity plans and policies had escalated after identifying an increasing number of arrangements that distributed cash benefit payments, purportedly for medical expenses, even though expenses incurred already had been reimbursed through other coverage, or participants did not incur medical expenses within the meaning of Section 213(d) of the Code. Employers whose fixed indemnity health/wellness benefit plans are audited may be found liable for under-withheld tax as well as penalties and interest.
We can assist employers who have adopted or purchased this type of plan by helping evaluate whether the arrangement is legally defensible and how to approach an audit to minimize potential liability. For further information, contact any of the authors of this blog post.