New IRS Enforcement Interpretation Takes Aim at Tax Status of Certain Wellness Program Payments
New EEOC regulations and new court decisions will keep employers on their toes in evaluating their current wellness plan designs and in making changes for 2017 open enrollment later this year.
Seemingly out of the blue, however, the Internal Revenue Service (“IRS”) has inserted a new issue into the mix for employers to consider. But, for most employers, this new IRS position statement (not official rules or regulations) should largely pass as a non-event.
This E-Alert summarizes the issues that the IRS addressed in the recently released Chief Counsel Advice 201622031 (the “CCA”), which can be read at this link. The CCA is dated April 14, 2016 but was released to the public on May 27, 2016.
The CCA addresses the income tax treatment of payments that an employer made to employees in connection with the employer’s wellness program. The CCA takes the unsurprising position that cash rewards and reimbursement payments that are connected to an employer’s wellness program are taxable income payments from the employer to the employee. The IRS held that these payments were subject to income tax withholding and payroll taxes, like all other wage payments.
Although not addressed at all in the CCA, presumably a regional office of the IRS encountered on audit a wellness program design in which an employer believed that it was making nontaxable wellness program cash payments. The CCA is the instrument by which the IRS National Office provides input to the IRS field office on questions of interpretation, enforcement and IRS policy. Especially notable is that the CCA was written by Stephen Tackney, a long time veteran of IRS benefits tax administration. Mr. Tackney has been closely involved with the administration of important benefits tax projects ranging from Section 409A through the Obamacare employer mandate.
In the CCA, the IRS laid out three slightly different wellness program designs and used those fact patterns as a framework within which to address the taxability questions.
In the first fact pattern, the employer provided its employees with a no-cost wellness program which was completely separate and apart from the employer’s comprehensive health coverage. The wellness program provided health screenings and other services such that it qualified as an accident and health plan. Employees who participated in the wellness program earned cash rewards or benefits that did not qualify as Section 213(d) medical expenses, such as gym membership fees.
The second fact pattern is similar with the exception that employees paid premiums to participate in the wellness program through salary reduction in a Section 125 cafeteria plan. Cash rewards and non-medical benefits were provided as in the first scenario.
And, the third fact pattern builds on the first two by including a provision for the employer’s reimbursement of the wellness program premiums paid by the employee through the Section 125 cafeteria plan.
Against this backdrop, the CCA asked and answered these two questions:
- May an employer exclude from an employee’s income under section 105 or section 106 cash rewards paid to an employee for participating in a wellness program?
- May an employer exclude from an employee’s income under section 105 or section 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 section 125 cafeteria plan?
In a very thorough and precise legal analysis, the IRS held that the cash payment and premium reimbursements could not be excluded from the taxable income of the employees who received those amounts. The cash payments and reimbursements would be considered wage income and would be subject to income tax withholding and payroll taxes, as with any other payment of income to employees.
It is possible, perhaps even likely, that the wellness program designs in the CCA are not typical and therefore the CCA will not be a source of concern for many or most employers. On the other hand, employers
who believe that their wellness programs include features similar to any of those that are described in the three fact patterns outlined by the IRS should consider whether the CCA hits too close to home and whether plan design changes and corrective actions may be necessary. Corrective actions may include adjustments to withholding and payroll tax adjustments and amended employment tax returns and W-2s. This could be a very time consuming exercise but, as the CCA shows, it is now an issue that the IRS has on its radar screen and proper attention to compliance is important.
If you have questions on this new CCA, please contact Jim Griffin at email@example.com or 214.953.5827. For more information on wellness programs, including the new EEOC regulations, please contact Virginia Mimmack at firstname.lastname@example.org or 214.953.5875. For any other questions involving employee benefit plans, please contact any member of Jackson Walker’s Employee Benefits and Executive Compensation group.