How to Know When Payments from Indemnity and Wellness Plans Are Taxable
When individuals receive payments from fixed-indemnity health insurance plans (sometimes better known as supplemental insurance plans, which are the kinds of plans that pay participants a set amount of money for a hospital stay, each doctor’s visit or a certain medical diagnosis) or a wellness program, does that money count as taxable income? Is it subject to income and employment tax withholding?
It can be, if specific criteria are met, such as the insurance premiums were paid from pre-tax dollars and a set amount is paid regardless of how much a person incurs in medical expenses.
Chief Counsel Advice (“CCA”) 201703013 clearly outlines the scenarios where payments from these types of supplemental insurance programs and employer wellness programs should be included in taxable income totals. The CCA even provides five different examples with guidance on how each scenario should be treated for income and employment tax purposes.
This CCA states that payments from indemnity health plans are treated as taxable income when the plan pays a fixed amount regardless of the cost of the medical expenses incurred and:
- The premiums for the indemnity plan are paid by the employer and not included in an employee’s gross income and wages for income and employment tax withholding; or
- The employee pays for the coverage through a Section 125 cafeteria plan (e.g., flexible spending account or “FSA”), meaning the premiums have been excluded from his or her gross income and wages.
The same criteria apply to wellness programs, where employees are incentivized to engage in and maintain healthy behaviors. If an employee enrolls in a wellness program and contributions are either paid by the employer and not included in the employee’s taxable income or paid through a Section 125 cafeteria plan with salary reduction, any benefits the program pays out are taxable. Those cash benefits are subject to income and employment tax withholding and need to be reported.
The IRS has not provided any guidance on the treatment of claims payments if wellness program coverage costs are paid on an after-tax basis. However, we believe that those amounts would only be excluded from income if the payment is in the nature of insurance. If a nominal payment is made to participate in a wellness program and payment is made for activities that are within the control of the individual, payments don’t appear to have the characteristics of an insurance claim. What the IRS has said so far is that when the plan pays a fixed amount regardless of any actual medical expense (i.e., $100 for every doctor’s visit and $200 for every day during a hospital stay) and the cost of the coverage has been excluded from income, those benefits are taxable and subject to income and employment tax withholding.
What Are Your Next Steps?
With the clear guidance from this CCA, you now know when certain payments you receive from indemnity and wellness plans will be taxable. If you are an employer, now is a great time to review your processes and procedures for determining income inclusion for these and other employee benefits. That way, no one will be hit with any unexpected taxes or penalties, and you can be sure everything is documented correctly for your Forms W-2.
Should you find any errors and need help figuring out your next steps, or if you’re looking at switching plans and would like some guidance on how they fit into your big benefits picture, reach out to Deborah Walker, CPA, National Director of Compensation and Benefits at Cherry Bekaert to start the conversation. If you come away with even one new idea or new nugget of information, it will be worth your time.