IRS Weighs In on Tax Treatment of Wellness Incentives

Stephen Tackney, deputy associate chief counsel (Employee Benefits) at the Internal Revenue Service (IRS) issued a memorandum concluding that an employer may not exclude from an employee’s gross income payments of cash rewards for participating in a wellness program.

Noting that the advice may not be used or cited as precedent, the memorandum addresses two questions:

• May an employer exclude from an employee’s income under Section 105 or Section 106 [of the Internal Revenue Code] 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106 reimbursements of premiums for participating in a wellness program if the premiums for the wellness program were originally made by salary reduction through a Section 125 cafeteria plan?

Tackney also concluded that 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income reimbursements of premiums for participating in a wellness program if the premiums for the wellness program were originally made by salary reduction through a Section 125 cafeteria plan.

The memorandum notes that Section 61(a)(1) of the Internal Revenue Code and Section 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 for personal injuries and sickness.

NEXT: Applying the law to wellness incentives

Tackney notes that 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. 

He explains that 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 Section 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 tee-shirt would satisfy the requirements to be excluded under Section 132(e); 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, Tackney says. “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,” the memorandum states.

As for reimbursement of premiums, Tackney notes that 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),” he says.