By memorandum dated April 24, 2017, the Office of the Chief Counsel of the IRS warned IRS agents who audit employer health plans about “scams” sold to employers as a way for the employer to provide tax-free compensation to employees by classifying that compensation as a medical insurance payout, even when there is no legal basis to do so. The promoters improperly claim that a certain structure will avoid the application of income and employment taxes on amounts paid to employees, saving employers and employees money. The promoters’ fees might be expressed as a portion of the employment taxes saved. A copy of this letter is available at https://www.irs.gov/pub/irs-wd/201719025.pdf.
In these situations, cash payments are made to employees upon the occurrence of a stated event that is easy to trigger and completely within the employee’s control, such as participation in a phone call on wellness. The promoters claim this payment is not taxable. Unfortunately, while benefits received from a proper medical plan may be tax-free (under IRC ss. 104-106) and certain wellness program rewards such as reduced premiums can be tax-free under IRC s. 105, when an arrangement is structured so that there is no risk of premiums exceeding the value of benefits, then the arrangement is not the type of “insurance” that can provide tax free benefits.
Similar promotions involve convoluted processes to allow employees to “borrow” funds from a health flexible spending or similar account to avoid the “use it or lose it” rule that generally applies to insurance arrangements under IRC s. 125. In such instances, the promoter may even provide “legal opinions” that are no more than marketing pieces. Employers should know that if an idea is pitched as an arrangement in which the employer and employee absolutely cannot lose money, the promoter is either unaware of the risk, or ignoring it.
Although the April 24 IRS memorandum did not focus on when proper wellness program rewards are nontaxable, it is worth noting that such rewards must be treated as taxable payments unless a specific exemption applies. Reduced premiums satisfy this requirement because the benefit is an additional portion of the premium paid by employers, and employer payments for medical insurance are tax-free under IRC s. 105. Coffee mugs, t-shirts, gift cards, and similar rewards are generally taxable.
Employers that engage in arrangements like the above risk failing to properly pay employment taxes, and failing to properly collect and remit income and the employee portion of employment taxes.
If you have questions about the above or would like additional information, please contact the author of this alert or the Carlton Fields attorney with whom you usually communicate.