Fixed wellness payments are taxable wages when no medical expense remains

Plain-English summary

An employer offered employees a fixed-indemnity health policy funded through $1,200 monthly salary reductions under a Section 125 cafeteria plan. The policy paid $1,000 when an employee completed a qualifying wellness activity, even if the activity cost nothing or another health plan covered the cost. Chief Counsel advised that the payment is taxable income when the employee has no unreimbursed medical expense because Section 105(b) excludes only amounts that reimburse medical care actually incurred. Paying the premium through a cafeteria plan counts as an employer contribution, so the employee-funded-insurance exclusion does not shelter the benefit. The payment is also compensation tied to employment and is not excluded as medical-expense reimbursement or sick pay. It therefore constitutes wages subject to FICA, FUTA, and federal income tax withholding.

Ruling snapshot

• Question: Are fixed wellness payments taxable income and employment-tax wages when employees have no unreimbursed medical expense?
• Outcome: Advice given: the payments are included in income and are wages subject to FICA, FUTA, and federal income tax withholding
• Key authorities: IRC §§ 104(a)(3), 105(a)-(b), 106(a), 125, 3121(a), 3306(b), 3401(a), and 3402(a); Treas. Reg. §§ 1.104-1(d), 1.105-2, 31.3121(a)-1, 31.3306(b)-1, and 32.1

Full text (IRS public release)

           Office of Chief Counsel
           Internal Revenue Service
           memorandum
           Number: 202323006
           Release Date: 6/9/2023
           CC:EEE:EB:HW
           PRESP-100769-23

 UILC:     105.00-00, 125.00-00

  date:    May 09, 2023

     to:   Jay Jensen
           SB/SE Employment Tax Policy

  from:    Laura Warshawsky
           Deputy Associate Chief Counsel
           (Employee Benefits)
           (CC:EEE:EB)

           Lynne Camillo
           Deputy Associate Chief Counsel
           (Exempt Organizations and Employment Taxes)
           (CC:EEE:EOET)


subject:   Tax Treatment of Employer-Funded, Insured, Fixed-Indemnity Wellness Policy

           This Chief Counsel Advice responds to your request for assistance. This advice may not
           be used or cited as precedent.

           ISSUES

                 Whether wellness indemnity payments under an employer-funded, fixed-

           indemnity insurance policy (including where the premium for the coverage is paid by

           employee salary reduction through a cafeteria plan under section 125 of the Internal
PRESP-100769-23                             2

Revenue Code (Code)) are includible in the gross income of the employee if the

employee has no unreimbursed medical expenses related to the payment.


      Whether the wellness indemnity benefits that are includible in gross income

(taxable wellness indemnity benefits) are wages for purposes of Federal Insurance

Contributions Act (FICA) taxes, Federal Unemployment Tax Act (FUTA) taxes, and

federal income tax withholding (FITW) (collectively, “employment taxes”) with respect to

the payments of benefits in the situation described below.


FACTS

      An Employer provides comprehensive health coverage for its employees through

a group health insurance policy. The comprehensive health coverage provides

preventive care benefits, such as reimbursements for the cost of flu shots and other

vaccinations, without any cost sharing for covered individuals. The coverage constitutes

accident or health coverage for purposes of the exclusion for employer-provided

accident or health coverage under § 106(a).

      In addition to the health coverage, the Employer provides all employees,

regardless of enrollment in other comprehensive health coverage, with the ability to

enroll in coverage under a fixed-indemnity health insurance policy that would qualify as

an accident and health plan under § 106. Employees pay monthly $1,200 premiums for

the fixed-indemnity health insurance policy by salary reduction through a § 125 cafeteria

plan. The only payments that the insurance company receives with respect to the

insurance provided to the employees are the premium payments. In other words, the
PRESP-100769-23                                3

Employer has no liability for any costs incurred by the insurance company that may

exceed the premiums paid by its employees.

       The Employer’s fixed-indemnity health insurance policy is a voluntary program

primarily intended to supplement its employees’ other health coverage through the

provision of wellness benefits. The first type of wellness benefit provided by the fixed-

indemnity health insurance policy is a payment of $1,000 if an employee participates in

certain health or wellness activities. This benefit is limited to one payment per month.

Use of preventive care, such as vaccinations, under a comprehensive health plan in

which an employee is enrolled, qualifies the employee for the payment for the month.

The fixed-indemnity health insurance policy provides wellness counseling, nutrition

counseling, and telehealth benefits at no additional cost. The employee is responsible

for any costs associated with receiving any health-related activity, although in many

cases all or part of the cost of the health-related activity will be provided at no cost or is

covered by other insurance. The fixed-indemnity health insurance policy also provides a

benefit for each day that the employee is hospitalized. Under the fixed-indemnity health

insurance policy, the wellness benefits are paid from the insurance company to the

Employer, which then pays out the wellness benefit to employees via the Employer’s

payroll system.

LAW AND ANALYSIS

       In general, § 106(a) provides that gross income of an employee does not include

employer-provided coverage under an accident or health plan. Under § 106(a), an

employee may exclude from gross income premiums for accident or health insurance

coverage that are paid by an employer.
PRESP-100769-23                              4

      Section 105(a) provides that generally amounts received by an employee

through accident and health insurance for personal injuries or sickness are included in

gross income to the extent the amounts (1) are attributable to contributions by the

employer which are not includable in the gross income of the employee or (2) are paid

by the employer.

      Section 105(b) provides that gross income does not include amounts paid by an

employer to reimburse an employee for expenses incurred by the employee for medical

care as defined in § 213(d). The exclusion under § 105(b) is limited to amounts paid

solely to reimburse expenses incurred for medical care and does not apply to amounts

which the taxpayer would be entitled to receive irrespective of whether expenses for

medical care are incurred.

      Treasury Regulation § 1.105-2 provides that section 105(b) does not apply to

amounts which the taxpayer would be entitled to receive irrespective of whether the

expenses are incurred for medical care. Section 1.105-2 also provides that if the

amounts are paid to the taxpayer solely to reimburse expenses which were incurred for

the prescribed medical care, section 105(b) is applicable even though such amounts are

paid without proof of the amount of the actual expenses incurred by the taxpayer, but

section 105(b) is not applicable to the extent that such amounts exceed the amount of

the actual expenses for such medical care.

      Generally, an employee choice between two or more benefits consisting of

taxable benefits, such as cash, and nontaxable benefits, such as employer-provided

health coverage, results in a cafeteria plan, the taxable benefits under which are

included in income unless the choice is provided in accordance with the rules under
PRESP-100769-23                               5

§ 125 of the Code. Under § 125, an employer may establish a cafeteria plan that

permits an employee to choose among two or more benefits, consisting of cash

(generally, salary) and qualified benefits, including accident or health coverage.

Pursuant to § 125, the amount of an employee’s salary reduction through a cafeteria

plan applied to purchase health coverage is not included in gross income, even though

it was available to the employee and the employee could have chosen to receive cash

instead. If an employee elects salary reduction pursuant to § 125 to pay for health

coverage, the coverage is excludable from gross income under § 106 as employer-

provided accident or health coverage.

       Section 104(a)(3) provides that gross income does not include amounts received

through accident or health insurance (or through an arrangement having the effect of

accident or health insurance) for personal injuries or sickness. This exclusion does not

apply, however, if the amounts are either (1) attributable to contributions by the

employer that were not includable in the gross income of the employee, or (2) paid by

the employer. See Treas. Reg. § 1.104-1(d). For this purpose, salary reduction under a

§ 125 cafeteria plan is treated as an employer contribution, and not an employee

contribution.

       A fixed-indemnity health insurance policy is an insurance policy that pays

covered individuals a specified amount of cash for the occurrence of certain health-

related events, such as office visits or days in the hospital. Similarly, a critical disease or

specific disease policy pays a specific amount for the diagnosis of a particular disease.

The amount paid is not related to the amount of any medical expense incurred or

coordinated with other health coverage. The amount of the payment is not based on the
PRESP-100769-23                             6

employee’s actual absence from work on account of the health-related event. The

exclusion from gross income under § 104(a)(3) applies to amounts received through

accident or health insurance, or through an arrangement having the effect of accident or

health insurance, for personal injuries or sickness. The exclusion under § 104(a)(3),

however, does not apply to the extent that amounts paid are attributable to contributions

by the employer which were not includable in the gross income of the employee, or paid

by the employer.

EMPLOYMENT TAXES

      Sections 3101 and 3111 impose FICA taxes (comprised of social security tax and

Medicare tax) on “wages” as that term is defined in section 3121(a). Section 3121(a)

defines wages as all remuneration for employment, including the cash value of all

remuneration (including benefits) paid in any medium other than cash, with certain

specific exceptions.

      Section 3301 imposes federal unemployment (FUTA) tax on “wages” as that term

is defined in § 3306(b). Section 3306(b) defines wages as all remuneration for

employment, including the cash value of all remuneration (including benefits) paid in

any medium other than cash, with certain specific exceptions.

      Treasury Regulation § 31.3121(a)-1(b), relating to FICA tax, provides that the

term “wages” means all remuneration for employment, unless specifically excepted

under § 3121(a) of the Code or the regulations thereunder. Treasury Regulation

§ 31.3306(b)-1(b) contains a similar provision for purposes of FUTA.
PRESP-100769-23                             7

      Section 3121(a)-1(c) of the Code and Treasury Regulation § 31.3306(b)-1(c)

provide that the name by which the remuneration is designated is immaterial. Salaries,

fees, and bonuses, for example, are all wages if paid as compensation for employment.

      Sections 31.3121(a)-1(d) and 31.3306(b)-1(d) provide that, generally, the basis

upon which the remuneration is paid is immaterial in determining whether the

remuneration constitutes wages.

      Section 3121(a)(5)(G) of the Code provides an exception from FICA wages for

any payment to or on behalf of an employee under a cafeteria plan (within the meaning

of § 125) if such payment would not be treated as wages without regard to such plan

and it is reasonable to believe that (if § 125 applied for purposes of § 3121) § 125 would

not treat any wages as constructively received. Section 3306(b)(5)(G) contains a similar

exception from wages for purposes of FUTA tax.

      Section 3121(a)(2) provides an exception from FICA wages for:

        the amount of any payment (including any amount paid by an employer
        for insurance or annuities, or into a fund, to provide for any such
        payment) made to, or on behalf of, an employee or any of … [the
        employee’s] dependents under a plan or system established by an
        employer which makes provision for … [its] employees generally (or for
        … [its] employees generally and their dependents) or for a class or
        classes of … [its] employees (or for a class or classes of … [its]
        employees and their dependents) on account of
              (A) sickness or accident disability (but, in the case of payments
        made to an employee or any of … [the employee’s] dependents, this
        subparagraph shall exclude from the term “wages” only payments which
        are received under a [workers’] … compensation law);
              (B) medical or hospitalization expenses in connection with sickness
        or accident disability….

      Section 3306(b)(2) contains an exception similar to § 3121(a)(2) that applies for

purposes of FUTA wages.
PRESP-100769-23                                      8

        Temporary Treasury Regulation § 32.1(a), in effect, provides that

payments to or on behalf of an employee on account of sickness or accident

disability are not excluded from the term wages unless they are received under a

workers’ compensation law or qualify for the exception from wages provided

under § 3121(a)(4) of the Code, which provides an exception for any payment on

account of sickness or accident disability made after the expiration of 6 calendar

months following the last calendar month in which the employee worked.1

        Temporary Treasury Regulation § 32.1(d) provides that for purposes of

determining the payments subject to FICA taxation under Temporary Treasury

Regulation § 32.1(a):

          a payment made on account of sickness or accident disability includes
          any payment for personal injuries or sickness includible in gross income
          under section 105(a) and the regulations thereunder and thus does not
          include—
               (1) any amount which is expended for medical care as described
          in section 105(b) and section 1.105-2,
               (2) any payment which is unrelated to absence from work as
          described in section 105(c) and section 1.105-3, or
               (3) any payment or portion thereof which is attributable to a
          contribution by the employee as determined in paragraphs (d) and (e) of
          section 1.105-1.
          A payment made on account of sickness or accident disability does not
          include any payment which is excludable from gross income under
          section 104(a)(2), (4), or (5).




1
  Although § 7805(e)(2) provides that any temporary regulation shall expire within 3 years after the date of
issuance of such regulation, that paragraph is effective only for temporary regulations issued after
November 20, 1988, and thus does not apply to this temporary regulation issued in 1982. Temporary
Treasury Regulation § 32.1 was amended in 2005 by TD 9233, 70 FR 74198 (December 15, 2005)
confirming its continuing authority.
PRESP-100769-23                             9

APPLICATION OF EMPLOYMENT TAXES

FICA

        The taxable wellness indemnity benefits are provided by employers to employees

as remuneration for employment under benefit plans funded by employers and, thus, fit

within the basic definition of wages under § 3121(a). To the extent the taxable wellness

indemnity benefits are not paid under a worker’s compensation law, they do not qualify

for the exception from wages provided by § 3121(a)(2)(A). Although the payments are

made on account of sickness or accident disability, the parenthetical in § 3121(a)(2)(A)

removes the payments from the exclusion because they are not received under a

workers’ compensation law. Moreover, the taxable wellness indemnity benefits cannot

qualify for the § 3121(a)(2)(B) exception because the payments are not made on

account of medical or hospitalization expenses in connection with sickness or accident

disability.

        Temporary Treasury Regulation § 32.1(d) specifically bases inclusion in the

definition of “payments on account of sickness or accident disability” subject to FICA tax

on the payment being “includible in gross income under § 105(a).” All the exceptions

from treatment as payments on account of sickness or accident disability that are

specifically mentioned in § 32.1(d) support the conclusion that the payments subject to

FICA taxes under the regulations are only those payments that are includible in gross

income under § 105(a) of the Code. The specifically listed numbered exceptions in

Temporary Treasury Regulation § 32.1(d) and the amounts excludable under

§ 104(a)(2), (4), and (5) of the Code are all amounts that are excludable from gross

income. It is, therefore, clear that Temporary Treasury Regulation § 32.1(d) was not
PRESP-100769-23                            10

intended to provide an exception from FICA wages for payments that are includible in

gross income. The taxable wellness indemnity benefits would be excludable under

§ 32.1(d)(1) to the extent that they are expended for medical care as described in

§ 105(b) of the Code and Treasury Regulation § 1.105-2. However, because the taxable

wellness indemnity benefits do not qualify for the Temporary Treasury Regulation

§ 32.1(d)(1) exception, and no other exception applies, they are subject to FICA.

      A similar analysis applies for purposes of the similar exception under

§ 3306(b)(2)(A) of the Code with respect to FUTA taxes. Thus, the taxable wellness

indemnity benefits are also subject to FUTA taxation.

Federal Income Tax Withholding

      Section 3402(a) of the Code, relating to U.S. Federal Income Tax Withholding

(FITW), generally requires every employer making a payment of wages to deduct and

withhold upon those wages a tax determined in accordance with prescribed tables or

computational procedures. The term “wages” is defined in § 3401(a) for FITW purposes

as all remuneration for services performed by an employee for his employer, including

the cash value of all remuneration (including benefits) paid in any medium other than

cash with certain specific exceptions. Among the specific exceptions are several

exceptions related to the provision of medical insurance and benefits. See

§ 3401(a)(20), 3401(a)(21), and 3401(a)(22). No statutory exception applies to the

taxable wellness indemnity benefits.

      The taxable wellness indemnity benefits are not sick pay (because they are not

dependent upon an absence from work), and there is no exception from the definition of

wages under § 3401(a) that applies to the payments. Thus, as wages under § 3401(a),
PRESP-100769-23                              11

the taxable wellness indemnity benefits are subject to FITW under the general FITW

rules rather than the rules applicable to sick pay.

CONCLUSIONS


       Wellness indemnity payments under an employer-funded, fixed-indemnity

insurance policy (including where the premium for the coverage is paid by employee

salary reduction through a cafeteria plan under section 125 of the Internal Revenue

Code (Code)) are includible in the gross income of the employee if the employee has no

unreimbursed medical expenses related to the payment.


       The exclusion under § 105(b) is limited to amounts paid solely to reimburse

expenses incurred for medical care and does not apply to amounts which the taxpayer

would be entitled to receive irrespective of whether expenses for medical care are

incurred. The exclusion from income in § 105(b) does not apply to payments when the

employee has no unreimbursed medical expense either because the activity that

triggers the payment does not cost the employee anything or because the cost of the

activity is reimbursed by other coverage.

       The fixed indemnity health insurance policy pays $1,000 per month without

regard to whether the employee has any unreimbursed health insurance expenses.

Thus, the payment is included in the employee’s gross income. Because the payment is

provided in connection with the employee’s employment, it is included in remuneration

and treated as “wages” for employment tax purposes. The exclusions from “wages” for

medical expenses would not apply because the payments are not for medical expenses.
PRESP-100769-23                           12

      Thus, under the facts described above, when the insured plan pays $1,000

because the employee used a wellness benefit, the $1,000 is included in the

employee’s income and wages. Accordingly, taxable wellness indemnity benefits are

wages for purposes of FICA, FUTA, and FITW with respect to the payments of benefits

in the situation described above.


      Please call (202) 317-5500 if you have any further questions.