IRS Opines on the Tax Treatment of Employer Wellness Policies

IRS Opines on the Tax Treatment of Employer-Funded, Insured, Fixed-Indemnity Wellness Policies


In light of recent Internal Revenue Service (IRS) guidance, employers should carefully examine any supplemental health plan, program or arrangement (which may or may not claim to leverage fixed indemnity insurance) that promises substantial payroll tax savings.

A legal advice memorandum recently issued by the IRS’s Office of Chief Counsel (available here) addresses and rejects the claimed tax treatment and purported advantages of certain “wellness indemnity” payments under an employer-funded hospital indemnity or other fixed indemnity insurance policy. The arrangement described in the memo is similar to other so-called “double dipping” arrangements that the IRS has previously rejected. While varying in their design features and terminology, the latest iterations of these programs share certain features: reduction of employee salary or wages coupled with a restoration of the salary or wages and a claim of outsized payroll tax savings.

In Depth


Health benefits-based programs promising tax savings are not new. In a 2002 revenue ruling, the IRS considered and rejected a “double dipping” arrangement under which employers were encouraged to reimburse employees, purportedly tax-free, for health insurance premiums paid by the employees on a pre-tax basis. The arrangement first reduced an employee’s pay on a pre-tax basis for health insurance premiums, thus reducing the employee’s taxable income and the employer’s payroll tax liability. The employer then reimbursed the employee for part of the premium expenses deducted from salary, claiming the reimbursements as an employer expense that were not taxable income to the employee.

The IRS disagreed with the claimed tax treatment, pointing out that, for an employee to be reimbursed on a nontaxable basis for the insurance premiums, the employee must first incur the expense. Because the employee paid the premium with pre-tax dollars, and because the law treats the portion of the premium reimbursed as an expense as paid by the employer and not the employee (more on this below), the employer was effectively taking the deduction twice (i.e., “double-dipping”). According to the IRS, the reimbursed amounts must be included in the employees’ income and are also subject to payroll taxes. Later that same year, the IRS summarily rejected two other similar programs, involving advance reimbursements and loans.

In the decade that followed, promoters began to leverage combinations of hospital/fixed indemnity health plans and wellness plans with the same aim of generating material tax savings. A trio of IRS general counsel memoranda issued in 2016 and 2017 examined variations of the double dipping arrangements. The promoters’ focus on hospital indemnity plans was in response to these memoranda. Each new set of arrangements sought to overcome the specific objections articulated by the IRS. In one instance, for example, the proposed arrangement lacked the required risk shifting to qualify as insurance. Promoters responded to the lack of risk shifting. At the same time, the claimed tax savings shifted from income to payroll taxes. Promoters further sought to employ a number of tactics, such as automatic enrollment, very high monthly premiums, direct reimbursement from the insurance carrier, and required health assessments to maximize intended tax savings and/or work around prior IRS guidance.


The memo describes a situation in which an employer provides major medical coverage for its employees through a group health insurance policy. In addition to health coverage, the employer also provides all employees with the ability to enroll in voluntary coverage under a fixed-indemnity health insurance policy. Employees pay monthly $1,200 premiums for the fixed-indemnity health insurance policy by salary reduction through a Section 125 cafeteria plan. The fixed indemnity policy pays $1,000 monthly to employees who participate in the plan and undertake certain health or wellness activities. The fixed-indemnity health insurance policy provides wellness counseling, nutrition counseling and telehealth benefits at no additional cost. The fixed-indemnity health insurance policy also provides a benefit for each day that the employee is hospitalized. Promoters claim that the $1,000 reimbursement is a medical benefit rather than compensation. As a result, payroll taxes do not apply. The memo rejects this assertion.

The memo goes into a detailed analysis of the payroll tax rules. The key issue is that the savings under the hospital indemnity/wellness programs are driven by the promoters who claim that program reimbursements are not subject to payroll taxes. The memo explains that payroll taxes are imposed on “wages,” which includes all remuneration for employment. There are two relevant exceptions to this broad, general rule: payroll taxes are not imposed on medical reimbursements, nor are they imposed on reimbursements of medical or hospitalization expenses in connection with sickness or accident, or disability. The memo takes the position that the $1,000 reimbursement it describes does not qualify under either exception and it is therefore subject to payroll taxes. Thus, according to the memo:

[W]hen 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.

The arrangement described in the memo posits that the monthly reimbursement is paid from the insurance company to the employer, which then pays out the wellness benefit to employees via the employer’s payroll system. The participant reimbursement may be structured in alternate ways in different programs, but this would not void the application of the memo’s reasoning.


Memos prepared by the IRS’s Office of Chief Counsel represent its opinion and recommendations. They cannot be used or cited as precedent. Nevertheless, the opinion of the IRS’s Office of Chief Counsel should never be taken lightly. We have seen our clients presented with a broad variety of these double-dipping arrangements, each varying slightly in design and purported savings, but all with the same goal—to save the employer significant amounts of tax dollars. Employers should look out for these double-dipping arrangements and contact one of the authors or their legal counsel with any questions.