More and more employers are providing wellness programs to their employees in an effort to encourage them to develop healthy lifestyles. Studies show that employers can reap benefits from these programs including lower health-related costs, increased productivity, and higher employee morale, which increase their bottom line. The programs also are likely to be popular with employees. Before employees get too excited about these extra benefits, however, they need to know the IRS's position on their taxability.
The IRS released Chief Counsel Advice (CCA) 201622031 on May 27, 2016, responding to two questions related to employer-provided wellness programs, about the tax treatment of benefits received and reimbursement of premiums paid through a pretax salary reduction under a Sec. 125 cafeteria plan.
Question 1: May an employer exclude from an employee's income under Sec. 105 or Sec. 106 a cash reward paid to an employee for participating in a wellness program?
In general, the CCA noted, Sec. 61(a)(1) provides that, except as otherwise provided in the Code, gross income includes compensation for services, including fees, commissions, fringe benefits, and similar items. In other words, any awards or benefits provided by employers are taxable to employees, need to be included on Form W-2, Wage and Tax Statement, and are subject to federal tax withholding, as well as Social Security and Medicare taxes.
Does that mean that employees need to include in gross income medical care costs covered by employer-provided wellness programs? Sec. 106(a) provides that an employee's gross income does not include employer-provided coverage under an accident or health plan, which means employees are not subject to taxes on any premiums for accident or health insurance coverage that are paid by their employers. Also, under Sec. 105(b), employees can exclude from gross income amounts received through employer-provided accident or health insurance for personal injuries or sickness if:
such amounts are paid, directly or indirectly, to the taxpayer to reimburse the taxpayer for expenses incurred by him for the medical care (as defined in [Sec.] 213(d)) of the taxpayer, his spouse, his dependents . . . and any child . . . of the taxpayer who as of the end of the taxable year has not attained age 27.
How about other cash rewards paid to employees as part of a wellness program, such as payment for gym membership fees, and other fringe benefits? Regs. Sec. 1.132-6 includes a de minimis fringe exception. Gross income does not include the value of a de minimis fringe provided to an employee. A de minimis fringe is any property or service the value of which (after taking into account the frequency with which similar fringes are provided by the employer to the employer's employees) is so small as to make accounting for it unreasonable or administratively impracticable. Therefore, for example, the value of T-shirts or mugs provided under employer-sponsored wellness programs can be excluded from gross income under the de minimis rule, since it is impracticable to trace and allocate a value to each item and report it on the employee's Form W-2.
However, any cash rewards and benefits received cannot be excluded under the de minimis rule and need to be included in the employee's gross income. The rationale is that a cash reward already has a known value, so the de minimis exception does not apply. An employee must include gym membership payments in gross income since those are essentially cash rewards and are not for qualified medical care as defined under Sec. 213(d).
Question 2: May an employer exclude from an employee's income under Sec. 105 or Sec. 106 reimbursements of premiums for participating in a wellness program if the premiums for the wellness program were originally made by salary reduction through a Sec. 125 cafeteria plan?
A cafeteria plan is an employee benefit plan provided by employers under Sec. 125 that offers employees choices of two or more benefits. The most common choices are either cash benefits (usually through salary reductions) that employees can contribute to the plan and apply to qualified coverage or noncash benefits, such as participation in an employer-provided qualified benefit plan. Under Sec. 106, the amounts employees pay through salary reduction for qualified coverage under Sec. 125 are excluded from their gross income even though they are essentially cash benefits.
How about the scenario when the employer reimburses employees with a salary reduction amount that was applied to purchase a qualified accident and health plan? Are these reimbursements taxable, or are they excluded from gross income as well?
The question discussed here involves reimbursements of premiums that were originally made by salary reduction through a Sec. 125 cafeteria plan but were paid to a third party by the employer, not by the employees themselves. The Chief Counsel's Office states that this arrangement is not distinguishable from the arrangement addressed in Rev. Rul. 2002-3. Thus, Sec. 106 does not apply in this situation, and employees need to include those reimbursements in gross income.
Conclusion
For employees to evaluate the true tax benefits received, they must understand the wellness programs and qualified accident and health plans that the employer is offering. To determine whether participating in a program is beneficial, they must consider their personal needs and whether the benefits they will receive from the program or plan will lower their taxable income.
EditorNotes
Mark Cook is the lead tax partner with SingerLewak LLP in Irvine, Calif.
For additional information about these items, contact Mr. Cook at 949-261-8600 or mcook@singerlewak.com.
Unless otherwise noted, contributors are members of or associated with SingerLewak LLP.
