Health Care Reform, Wellness Programs

Taxability of Wellness Program Incentives – IRS Memo 201622031

Wellness Program Taxible Man Running

Employer wellness programs are on the rise, and both the IRS and EEOC have released recent guidance on various aspects of wellness programs. Although the EEOC final regulations on Wellness programs and the ADA and GINA have garnered most of the attention, the IRS also issued guidance (IRS Memorandum 201622031) on the taxation of certain payments and rewards under wellness programs.   IRS memos may not be used or cited as precedent (because they are Office of Chief Counsel responses to individual requests for advice on specific fact situations); however, they are useful as an indication of the IRS’s position, so other taxpayers with the same or similar fact situation will know the IRS position and rationale.

(For information on the EEOC final regulations on how the ADA and GINA affect employer wellness programs, see Leavitt article at https://news.leavitt.com/health-care-reform/wellness-programs-ada-gina-eeoc-final-rule/ .)

What is the gist of IRS Memo 201622031?

Cash and non-cash incentives, payments and rewards paid to an employee are not excludable from an employee’s taxable income merely because they are paid under an employer wellness program.

What wellness rewards are included in taxable income?

For purposes of income and employment taxes (e.g., FICA and FUTA), the following items are included as taxable income/wages even if paid under an employer wellness program:

  • Cash payments (even small amounts such as $10 or $25) for participating in a wellness program.
  • Non-cash rewards, incentives or other benefits that are not medical care as defined under Code section 213. E.g., payment of gym membership, unless, based on the facts and circumstances, it would be a medical expense under 213(d).
  • Payment or “reimbursements” through a wellness program to reimburse employees for all or a portion of the premiums the employees paid by salary reduction.

What wellness rewards are excluded from taxable income?

The following items are excluded from taxable income, whether paid under a wellness program or not:

  • Benefits, services and non-cash rewards or incentives that are medical care as defined under Code section 213. E.g., biometric screenings, smoking cessation programs, health risk assessments.
  • Rewards or incentives that qualify as “de minimis” fringe benefits under Code section 132(e). These are defined as property or services whose value is so small that accounting for them would be unreasonable or administratively impracticable. An example would be tee shirts provided under a wellness program.

Two other types of employer payments that were not addressed under Tax Memo 201622031 are:

  • “Premium differentials.”  These are group health plan premium reduction amounts paid as rewards for employees who participate in or complete specified activities under the employer wellness program that is connected to the group health plan.  These are included in taxable income of employees.  For example, if an employee qualifies for a $30/month premium reduction, the employee receives that $30 as taxable income.
  • Employers’ H.S.A. contributions for employees who complete specified activities under the employer wellness program.  Employers cannot do this if comparability rules apply, only if cafeteria plan nondiscrimination rules apply.  This will be the case if employees can make H.S.A. contributions via salary reduction through an employer cafeteria plan.  Employer H.S.A. contributions are not taxable, so long as they meet the nondiscrimination rules.  (However, if the employee later takes a distribution from the H.S.A. for non-medical expenses, amounts will be taxable at that time.)

Practical effects for employers with wellness programs

  • Employers that provide cash rewards under their wellness programs should include amounts received in taxable income of recipient employees.
  • Employers should review their non-cash wellness program rewards and incentives to determine whether or not they should be imputing income to employees for the value of benefits or services received (i.e., if they are not medical care under 213(d) and are not “de minimis” in value as defined under 132(e)).

Employers should beware of advisors who tout complicated “defined benefit” wellness programs for which employees pay “premiums” pre-tax via salary reduction (often $800-$1100/month).  The premiums are paid to participate in the wellness program, not to purchase other insurance.  These premiums are excluded from employees’ wages, thus reducing employment taxes for both employers and employees, and reducing income taxes for employees.  Generally these wellness plans then pay employees a cash reward for participating in specified “wellness activities” each month or quarter, such as biometric screenings, health risk assessments, healthy eating programs, smoking cessation programs and meeting with a health coach.  Some programs call it “reimbursement” but in fact employees are not paying for the wellness services (except that they pay a premium to participate in the wellness program), so the only reimbursement they are receiving is for the pre-tax premiums they paid, and this is taxable under Rev. Ruling 2002-3 (see below) and under this IRS Memo 2016-22031.

Additionally, under these complicated wellness programs, the maximum monthly cash reward amount is the amount the employee paid pre-tax for the wellness program “premiums,” minus a hefty “administrative fee” which is paid to the advisor. Under some variations of these wellness plans, employees and employers are also offered insurance products they can buy with the money they are purportedly saving by not having to pay taxes on the “premiums” for the wellness program.

Note that there is nothing illegal about these complicated wellness programs themselves; the issue is that the wellness rewards paid to employees are taxable. Thus, employers and employees will likely end up paying the employment and income taxes they thought they were saving (plus possibly also late payment penalties), and they will have paid hefty administrative fees and exorbitant premiums to participate in the wellness program, and they may have purchased insurance products they would not otherwise have purchased if they were not getting the supposed tax breaks.

Additional Details on IRS Memo 2016-22031

The IRS Memo lists three fact scenarios (Situations 1, 2 and 3) under which participants in wellness programs receive varying types of cash and non-cash rewards or incentives. There is no cost to employees under Situation 1, but under Situations 2 and 3 employees who elect to participate must pay an employee contribution by salary reduction through a section 125 cafeteria plan. The IRS then explains the tax sections and prior guidance that support its conclusion that cash rewards and certain non-cash rewards for participating in a wellness program are NOT excludable from wages for purposes of income or employment taxes.

Amounts NOT Included as taxable income

The following amounts generally are NOT included as taxable income for purposes of income taxes (Code section 61) and are not included as taxable wages for purposes of employment tax withholding (FICA and FUTA, under Code sections 3121(a), 3306(b) and 3401(a):

  • Employer-provided coverage under an accident or health plan – Code section 106(a)
  • Amounts received through employer-provided accident or health insurance if those amounts are paid to reimburse employees for expenses they incurred for medical care for themselves or for tax code dependents (or for children under age 27 who are not dependents). Code section 105(b)

However, this exclusion from income does not apply to amounts the taxpayer would be entitled to receive whether or not the taxpayer incurs expenses for medical care.  (IRS regs. Section 1.105-2).

Amounts Included as taxable income

The following amounts ARE included as taxable income:

  • Rewards, incentives or other benefits received by a medical program that are not medical care as defined in Code section 213(d), unless it qualifies as an employee fringe benefit under Code section 132.
    • A “de minimis” fringe is defined under Code section 132(e) as any property or service the value of which is so small as to make accounting for it unreasonable or administratively impracticable.
      • Practical tip: An example of a de minimis fringe benefit is a tee shirt provided by a wellness program.
      • Practical tip: A cash fringe benefit is never excludable as a de minimis fringe benefit, unless it is for overtime meal money or local transportation fare. IRS regs. Section 1.132-6(c).
    • Practical tip: An employer or wellness plan payment of a gym membership generally does NOT qualify as medical care as defined in Code section 213(d) so would not be excludible from the employee’s income, even if paid through a wellness plan.

Prior IRS Guidance: Rev. Ruling 2002-3

The IRS memo also reviews IRS Rev. Ruling 2002-3, 2002-3 I.R.B. 316, which provides that employer payments to employees are NOT excludable from income or wages where the employer paid the amount to employees to partially reimburse them for amounts they paid by salary reduction toward health premiums.  Such amounts are includable in employees’ gross incomes under Code section 61 and are wages subject to employment taxes under Code sections 3121(a), 3306(b) and 3401(a).

IRS Conclusions in Memo 201622031

The IRS memo concludes that any payments through the wellness program to reimburse employees for all or a portion of the premiums the employees paid by salary reduction are no different than the arrangement addressed in Rev. Ruling 2002-3.  Accordingly, such reimbursements from the wellness program are included in the employee’s gross income and subject to income taxes and are considered “wages” subject to employment taxes under sections 3121(a), 3306(b) and 3401(a).

The IRS memo also concludes that health screenings and other medical care provided under the Wellness program are excluded from income of the recipient employee. However, if the employee earns a cash reward under the program, the cash amount is included as income and is subject to income and employment taxes.  The same applies regarding the fair market value of non-cash rewards provided under the wellness program, if they are NOT fringe benefits under Code section 132 and not medical care under Code section 213.

2 Comments

  1. Hi – was reading this and think I disagree with your analysis on this point..

    “Two other types of employer payments that were not addressed under Tax Memo 201622031 are:

    “Premium differentials.” These are group health plan premium reduction amounts paid as rewards for employees who participate in or complete specified activities under the employer wellness program that is connected to the group health plan. These are included in taxable income of employees. For example, if an employee qualifies for a $30/month premium reduction, the employee receives that $30 as taxable income.”

    Through a Section 125 plan, I don’t see how a premium reduction (or penalty) would ever qualify as taxable income… I have NEVER heard that said before….

    I think this memo was trying to address those crazy wellness programs which would save employers thousands of dollars in FICA/FUTA by reimbursing employees tens of thousands, ostensibly through the wellness plan…. But offering an employee a lower premium if they go through the wellness program is completely different..

    Thanks.

    1. You are correct on one point: The memo was trying to address those crazy employee-paid “wellness” programs where employers try to avoid paying FICA & FUTA taxes and then return money to employees as wellness “incentives”.
      I added the other two points b/c I had several questions from people about them.
      Premium differentials are a common type of wellness incentive. The reason they are included in taxable income is that the employee no longer has to pay part of the amount the employee WOULD HAVE paid on a pre-tax basis toward group health plan premiums. E.g., the $30 in my example. Instead of paying $30 pre-tax toward premium, the employee receives that $30 as taxable income.
      -Lisa

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