Wellness cash rewards and premium refunds are taxable wages

Plain-English summary

Chief Counsel analyzed employer wellness programs that offered health benefits plus cash rewards, gym-fee payments, or refunds of employee premiums paid through salary reduction. Medical coverage and qualifying medical care could be excluded under IRC §§ 105 and 106. Cash rewards and gym-fee payments were taxable because they were not reimbursements for medical care and did not qualify as excludable fringe benefits. Refunds of premiums previously paid pretax through a § 125 cafeteria plan were also taxable because the employee had already received an exclusion for those premium payments. The taxable amounts were wages subject to income-tax withholding, FICA, and FUTA taxes.

Ruling snapshot

• Question: Could wellness-program cash rewards or refunds of premiums paid pretax through a cafeteria plan be excluded from employees' income?
• Outcome: Advice given, the payments are taxable wages
• Key authorities: IRC §§ 61, 105, 106, 125, 132, 213, 3121, 3306, and 3401; Rev. Rul. 2002-3

Full text (IRS public release)

           Office of Chief Counsel
           Internal Revenue Service
           Memorandum
           Number: 201622031
           Release Date: 5/27/2016
           CC:TEGE:EB
           PRESP-118788-15

 UILC:     105.00-00, 106.00-00

  date:    April 14, 2016

     to:   Mark Ericson
           Senior Attorney
           TEGE Division Counsel

  from:    Stephen Tackney
           Deputy Associate Chief Counsel (Employee Benefits)
           CC:TEGE:EB



subject:   Tax Treatment of Wellness Program Benefits and Employer Reimbursement of
           Premiums Provided Pre-tax Under a Section 125 Cafeteria Plan

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


           ISSUES

           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           the wellness program were originally made by salary reduction through a section 125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?


           CONCLUSION

           An employer may not exclude from an employee’s gross income payments of cash
           rewards for participating in a wellness program.
PRESP-118788-15                             2

An employer may not exclude from an employee’s gross income 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.


FACTS

Situation 1. An employer provides all employees, regardless of enrollment in other
comprehensive health coverage, with certain benefits under a wellness program at no
cost to the employees. In particular, the wellness program provides health screening
and other health benefits such that the program generally qualifies as an accident and
health plan under section 106. In addition to those benefits, employees who participate
in the program may earn cash rewards of varying amounts or benefits that do not qualify
as section 213(d) medical expenses, such as gym membership fees.

Situation 2. An employer provides all employees, regardless of enrollment in other
comprehensive health coverage, with certain benefits under a wellness program.
Employees electing to participate in the wellness program pay a required employee
contribution by salary reduction through a section 125 cafeteria plan. The wellness
program provides health screening and other health benefits such that the program
generally qualifies as an accident and health plan under section 106. In addition to
those benefits, employees who participate in the program may earn cash rewards of
varying amounts or benefits that do not qualify as section 213(d) medical expenses,
such as gym membership fees.

Situation 3. The same as Situation 2, except that one of the benefits available under the
wellness program includes a reimbursement of all or a portion of the required employee
contribution for the wellness plan that the employee made through salary reduction.


LAW AND ANALYSIS

Section 61(a)(1) of the Internal Revenue Code and § 1.61-21(a)(3) of the Income Tax
Regulations provide that, except as otherwise provided in subtitle A, gross income
includes compensation for services, including fees, commissions, fringe benefits, and
similar items.

In general, section 106(a) provides that gross income of an employee does not include
employer-provided coverage under an accident or health plan. Under section 106(a),
an employee may exclude from income premiums for accident or health insurance
coverage that are paid by an employer. Also, under section 105(b), an employee may
exclude amounts received through employer-provided accident or health insurance if
those amounts are paid to reimburse expenses incurred by the employee for medical
care (of the employee, the employee’s spouse, or the employee’s dependents, as well
as children of the employee who are not dependents but have not attained age 27 by
the end of the taxable year) for personal injuries and sickness.
PRESP-118788-15                            3


Sections 3101 and 3111 impose FICA taxes on “wages” as that term is defined in
section 3121(a), with respect to “employment,” as that term is defined in section
3121(b). The term “wages” is defined in section 3121(a) for FICA purposes as all
remuneration for employment, with certain specific exceptions.

Section 3301 imposes FUTA tax on wages paid with respect to employment. The
general definitions of the terms “wages” and “employment” for FUTA purposes are
similar to the definitions for FICA purposes. See section 3306(b) and 3306(c).

Section 3402(a), relating to federal income tax withholding, 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 section 3401(a) for federal income tax withholding purposes
as all remuneration for services performed by an employee for his employer, with
certain specific exceptions.

To the extent amounts are excluded from gross income under sections 105(b) or
106(a), they are also excluded from wages subject to income tax withholding under
section 3401. In addition, amounts paid to reimburse expenses incurred by the
employee for medical care (of the employee, the employee’s spouse, or the employee’s
dependents, as well as children of the employee who are not dependents but have not
attained age 27 by the end of the taxable year) for personal injuries or sickness are
excepted from wages for FICA and FUTA tax purposes under sections 3121(a)(2) and
3306(b)(2), respectively.

Section 3121(a)(5)(G) provides an exception from FICA wages for any payment to or on
behalf of an employee under a cafeteria plan (within the meaning of section 125) if such
payment would not be treated as wages without regard to such plan and it is reasonable
to believe that (if section 125 applied for purposes of section 3121) section 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.

Under § 1.105-2, the exclusion under section 105(b) does not apply to amounts which a
taxpayer would be entitled to receive irrespective of whether or not the taxpayer incurs
expenses for medical care.

Coverage by an employer-provided wellness program that provides medical care as
defined under section 213(d) is generally excluded from an employee’s gross income
under section 106(a), and any section 213(d) medical care provided by the program is
excluded from the employee’s gross income under section 105(b). However, any
reward, incentive or other benefit provided by the medical program that is not medical
care as defined under section 213(d) is included in an employee’s income, unless
excludible as an employee fringe benefit under section 132.
PRESP-118788-15                             4

Section 132(e) defines a de minimis fringe as any property or service the value of which
is (after taking into account the frequency with which similar fringes are provided by the
employer to the employer’s employees) so small as to make accounting for it
unreasonable or administratively impracticable. Under § 1.132-6(c), a cash fringe
benefit (other than overtime meal money and local transportation fare) is never
excludable as a de minimis fringe benefit.

A wellness program that provides employees with a de minimis fringe benefit, such as a
tee-shirt, that would satisfy the requirements to be excluded under section 132(e) would
provide a benefit that would be excluded from an employee’s income notwithstanding
the fact that the de minimis fringe benefit (the tee-shirt) is not medical care under
section 213(d). However, the employer payment of gym membership fees that does not
qualify as medical care as defined under section 213(d) would not be excludible from
the employee’s income, even if provided through a wellness plan or program, because
payment or reimbursement of gym fees is a cash benefit that is not excludable as a de
minimis fringe benefit. Cash rewards received from a wellness program do not qualify
as the reimbursement of medical care as defined under section 213(d) or as an
excludible fringe benefit under section 132, and therefore are not excludible from an
employee’s income.

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 benefits under which are included in income
unless the choice is provided in accordance with the rules under section 125. Under
section 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 section 125, the amount of
an employee’s salary reduction applied to purchase such 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 section 125, the coverage is excludible from gross income under section 106 as
employer-provided accident or health coverage.

Revenue Ruling 2002-3, 2002-3 I.R.B. 316, addresses the situation in which an
employer has an arrangement under which employees may reduce their salaries and
have the salary reduction amounts used to pay health insurance premiums for the
employees. In addition, that employer makes payments to the employees that
reimburse a portion of the amount of health insurance premiums paid by salary
reduction. Revenue Ruling 2002-3 holds that the exclusions under sections 106(a) and
105(b) do not apply to amounts that the employer pays to employees to reimburse the
employees for amounts paid by the employees for health insurance coverage that was
excluded from gross income under section 106(a) (including salary reduction amounts
pursuant to a cafeteria plan under section 125 that are applied to pay for such
coverage). Accordingly, the reimbursement amounts are included in the employee’s
gross income under section 61, and are wages subject to employment taxes under
sections 3121(a), 3306(b), and 3401(a).
PRESP-118788-15                            5


DISCUSSION

In Situations 1, 2, and 3, the coverage provided by the wellness program is excluded
under section 106(a) as coverage under an accident and health program. The health
screenings and other medical care as defined under section 213(d) provided to
employees by the program are excluded from the employees’ income under
section 105(b). If an employee earns a cash reward under the program, the amount of
the cash reward is included in the employee’s gross income under section 61 and is a
payment of wages subject to employment taxes under sections 3121(a), 3306(b), and
3401(a). Similarly, if the employee earns a reward of a benefit not otherwise excludible
from the employee’s income, such as the payment of gym membership fees, the fair
market value of the reward is included in the employee’s gross income under section 61
and is a payment of wages subject to employment taxes under sections 3121(a),
3306(b), and 3401(a).

In addition, in Situation 3, that the payment to employees of reimbursements for all or a
portion of the premiums paid by salary reduction is made through a wellness plan does
not distinguish this arrangement from the arrangement addressed in Revenue Ruling
2002-3. Accordingly, the exclusions under sections 106(a) and 105(b) do not apply to
amounts paid to employees as reimbursements of a portion of the premium for the
wellness program that is excluded from gross income under section 106(a) (including
salary reduction amounts pursuant to a cafeteria plan under section 125 that are applied
to pay for such coverage). Accordingly, the reimbursement amounts are included in the
employee’s gross income under section 61 and are payments of wages subject to
employment taxes under sections 3121(a), 3306(b), and 3401(a).

Please call me at (202) 317-6000 if you have any further questions.