Wellness coaching, personal health dashboard, higher take-home pay, no out-of-pocket costs – all of this sounds like a great employee benefits experience, doesn’t it? From an employer perspective, what if you could offer all of this to your team while saving hundreds of dollars in payroll taxes per employee each year? That sounds like something most organizations would definitely be interested in, especially in a competitive labor market.
In recent years, there has been an uptick in preventative or wellness-related health plans funded in a way that promises to deliver tax benefits and savings for both employer and employee. However, a closer look at these plans reveals that the promised tax benefits really come in the form of tax avoidance and underpayment. Read on for an overview of these dubious plans, an explanation of the tax issues they create and how to properly structure a wellness benefits offering.
Here’s how it works
Generally speaking, these types of wellness plans are funded by pre-tax premiums taken from employee paychecks, resulting in higher take-home pay. Because they are intended to fund a health plan, the employer is exempt from paying federal payroll tax on these dollars. Then, participating employees are reimbursed with tax-free payments when they take a “triggering” action defined by the wellness plan, which usually includes a wellness activity, a health coach check-in, attending a seminar or visiting a website.
Here’s why this runs afoul of tax law
This really comes down to pre-tax versus after-tax payments. Any after-tax premiums or health benefit payments are not subject to tax. For pre-tax payments made through a Section 125 cafeteria plan, which does not offer health insurance but rather allows the employee to select from a menu of benefit options, the taxability depends on the amount of unreimbursed medical expenses. The excess amount is taxable to the employee, according to IRS Revenue Ruling 69-154.
The IRS specifically addressed the tax treatment of wellness programs in a series of memos released in April 2016, December 2016 and April 2017, in which it concluded that “an employer may not exclude from an employee’s gross income payments of cash rewards for participating in a wellness program” and “an employer may not exclude from an employee’s gross income payments under an employer-provided fixed indemnity health plan if the value of the coverage was excluded from the employee’s gross income and wages.” While this advice may not be used or cited as a precedent, it clearly demonstrates the IRS’s thought process and approach to these types of marketed wellness programs.
Bottom line: From the employee perspective, these wellness programs (potentially) violate the IRS’s excess benefit rule and do not inherently provide the promised tax-free benefits they promote. As for employers, they risk substantial underpayment of federal payroll taxes should they exclude these benefit payments from employees’ gross income.
What employers should do
Employers approached by a wellness provider should first contact their tax advisor before signing on to any program. Be wary of promises like salary reduction, take-home pay increase and tax-free, which are generally indicators of future tax liabilities or avoidance. Properly administered Section 125 plans continue to offer an opportunity for legitimate and appropriately taxed premium payments via salary reduction. This method will spare employers and employees from inadvertently underreporting income, avoiding taxes and generating future liabilities.
Want to discuss the tax implications of such plans within your organization’s specific context? Contact your RKL advisor or use the form below to reach out.