IRS says certain wellness programs do not save taxes
Benefits provided are subject to FICA and income taxes
TAX ALERT |
The Affordable Care Act (ACA) permits employers to provide incentives to employees for participating in wellness programs in the workplace. However, certain benefit consultants have been promoting wellness programs, combined with either a section 125 cafeteria plan or health reimbursement plan, as a means for employers and employees to save on FICA taxes by reducing employees’ taxable income while their net pay remains substantially the same. If that seems too good to be true, the IRS thought so as well.
The most aggressive plan design that the IRS describes in its guidance works as follows:
- Wellness plan. The employer establishes a section 125 cafeteria plan and employees elect to participate in the group health, dental, vision and other benefits that a typical cafeteria plan offers. However, in addition to the standard benefits, the employee elects to make a substantial pretax premium contribution (e.g., $1,000 per month) to participate in the plan’s wellness benefit option.
- Tax savings. The employer purportedly saves FICA taxes of 7.65 percent of the employee’s wellness premium so $76.50 per month in this example ($1,000 × 7.65%). If the employer has 100 participating employees, that is $91,800 in annual savings ($76.50 × 12 × 100). Supposedly, the employee also saves $76.50 each month in FICA taxes plus saving federal and state (when applicable) income taxes.
- Wellness benefit. The wellness program provides health screenings, telephone counseling and other health benefits in a manner typical of any other wellness program. However, the plan also provides employees with certain cash or cash-equivalent incentives, as well as reimbursement of a substantial portion of the employees’ pretax contributions for the wellness premium.
The promoters claim that, by employees reducing their pay, the employer saves on employment taxes and the employees save on both employment and income taxes; yet, because of the ACA, the plan can provide a tax-free reimbursement of a significant portion of the employees’ wellness premiums so that the employees do not see a reduction in their net take-home pay.
In a Chief Counsel Advice memorandum, the IRS determined that the coverage provided by the wellness program plus the health screenings and other medical care provided are excludable from the employees’ incomes. However, the IRS stated that any cash or cash-equivalent rewards, as well as the wellness premium reimbursement, are includable in the employees’ gross incomes and subject to the FICA and income tax withholding rules.
The idea of turning taxable wages into non-taxable cash is somewhat akin to the medieval alchemists’ claim of turning lead into gold. It did not work in medieval times and nothing in the ACA (intended or unintended) makes it work now.
Employers that have adopted such plans are now faced with decisions about terminating the arrangements and the possible impact of an IRS payroll examination. It is expected that, upon examination, the IRS would seek to collect taxes, penalties and interest related to the failure to withhold taxes when due. In addition, the IRS would most likely assert penalties based on the employer’s incorrect filing and issuing of its Forms W-2. See our July 13, 2015, article, IRS penalties for information returns have doubled, regarding those penalties.