In a recent Chief Counsel Advice, the IRS discussed whether payments received by an employee from an employer-provided fixed indemnity health and wellness plan are excludible from the employee’s income either (i) outright under Code Sec. 105, or (ii) under Code Sec. 105 if the employee’s coverage is attributable to salary reduction payments made pursuant to a Code Sec. 125 cafeteria plan. A fixed indemnity health and wellness plan is a plan that provides covered individuals with specified cash payments for the occurrence of certain health-related events, such as a visit to the doctor’s office.
Using five examples for analysis, the IRS determined that an employee may not exclude from gross income both the value of the coverage provided and the amount of benefits received. Rather, if the value of coverage under the fixed indemnity plan is excluded from the employee’s gross income and wages, then any amount received by the employee is not excludible from the employee’s gross income. In other words, the IRS determined that taxpayers cannot have their cake and eat it too.
The IRS determined that the value of such coverage and any reimbursements for actual medical expenses incurred will generally be excluded from an employee’s gross income. However, the amount of any reward, incentive, or other benefit that is not a payment or reimbursement for medical care is not excluded from the employee’s income because the exception under Code Sec. 105(b) does not apply to amounts a taxpayer is entitled to receive without regard to whether the taxpayer actually incurred medical care expenses.
With respect to benefits provided under coverage attributable to an employee’s salary reduction payments under Code Sec. 125 cafeteria plans, since the salary reductions are considered an employer-contribution that is excluded from an employee’s gross income, any payments received under a plan attributable to such contributions will be included in the employee’s gross income.
What’s better – taxing an employee on the value of the coverage or the benefits provided? You have to choose one or the other, and now may be a good time to review your current arrangements to confirm that you are comfortable with the taxation.