My company’s HR representatives have been approached by various vendors claiming that we can save substantially on payroll taxes by using our cafeteria plan in combination with another plan (e.g., a wellness plan or an indemnity plan) that will reimburse certain medical expenses. These programs are being sold as a way for employers to save significant money, but they also seem “too good to be true.” Is there anything we should be aware of when evaluating these programs?
Employers should proceed with extreme caution when considering whether to adopt these programs. The specific design and tax implications of each program will need to be discussed with the employer’s legal counsel or tax advisor before implementation. This is because certain pre-tax arrangements that promise large tax savings for employers and employees with little employer investment (sometimes referred to as “wellness indemnity plans” or “FICA tax savings programs”) frequently do not meet legal requirements under the Internal Revenue Code (IRC).
Unfortunately, vendor marketing and other promotional materials regarding these programs can be vague or ambiguous, making it difficult to recognize whether the program is legitimate in the eyes of the IRS. The IRS has released various guidance condemning any program that allows taxpayers to “double dip.” Employers should always seek guidance from their tax advisor or legal counsel when reviewing the legitimacy of a tax savings program, especially if it relies on the vendor’s interpretation of tax laws and not on the IRS’s interpretation.
For decades, vendors have created “innovative” payment arrangements aimed at boosting an employee’s take-home pay while reducing the employer’s employment tax obligations. A variety of reimbursement arrangements are marketed to employers that purportedly allow them to reimburse employees, on a supposed tax-free basis, for health insurance contributions paid by the employees on a pre-tax basis. The IRS, however, has long taken the position that double dipping is not permissible under the IRC.
Double dipping refers to a plan in which both premiums and benefit payments are purportedly exempt from taxation — a proposition that is enticing to both employers and employees. To support its position against the double dip, the IRS has released various rulings and memoranda aimed at certain wellness programs that charge employees a premium to participate in a wellness plan that is separate from the health plan and then reimburse those premiums on a tax-favored basis. These programs typically have names like “FICA-savings plan,” or “wellness-tax advantage,” and they are marketed by vendors that claim they can save the employer large sums of money.
According to the IRS, benefits that essentially reimburse employees for contributions made on a pre-tax salary reduction basis are considered double dipping and will be taxed — along with potential penalties being assessed by the IRS.
The IRS strongly cautions employers from adopting these types of programs. In fact, the IRS has issued revenue ruling guidance and multiple advice memoranda clearly indicating that it believes that these double-dipping programs are tax evasion schemes.
In July 2023, as one part of a broader set of proposed rules, the Department of Treasury and the IRS proposed regulatory amendments to clarify that payments from employer-provided fixed indemnity health insurance plans and other similar plans are not excluded from a taxpayer’s gross income if the amounts are paid without regard to the actual amount of medical expenses incurred. Additionally, the proposed regulation would have clarified that the taxpayer must meet substantiation requirements for reimbursements for qualified medical expenses from any employer-provided accident and health plan to be excluded from the taxpayer’s gross income.
In April 2024, the IRS issued a final regulation that finalized some, but not all, of the proposed rules. The IRS chose not to finalize the proposed rule regarding the tax treatment of payments from employer-provided fixed indemnity health insurance and other similar plans because it needed more time to study the matter.
However, the IRS reiterated its concern regarding fixed indemnity policies and other arrangements where premiums for the coverage are paid pre-tax and cash payments are made even though no medical expenses are incurred (including when participants simply complete certain health-related activities) or the medical expenses are reimbursed through other coverage. It explained that these payments generally are taxable wages subject to payroll taxes. The IRS intends to issue future guidance on the final regulations.[1]
An employer sponsoring a FICA-savings program that is found to be violating the IRC may incur:
Employers may also be responsible for paying any employee FICA taxes the IRS cannot collect.
The IRC’s rules on permissible tax exclusions and employee benefits are well established. Programs promoting innovative designs with substantial tax savings may instead result in improper withholdings and underpayment of employment taxes. The IRS’s decision to withdraw the proposed regulation on the tax treatment of payments from employer-provided fixed indemnity health insurance is likely to increase the number of vendors promoting these double-dip plans. Accordingly, employers should review the details and legal risks of any similarly promoted tax savings programs with their legal counsel or tax advisor before implementation.
We recommend that employers being solicited by a vendor offering a tax-savings program suggest that the vendor seek a private letter ruling or formal guidance directly from the IRS affirming the proposed program is valid for tax purposes. In our experience, this request typically ends the discussion, as vendors of these programs are rarely willing to take this step. Legal counsel may want to go even further and request an IRS ruling on the program before the employer would consider adopting it.
