Seemingly lost among the inauguration activities last week was an important Office of Chief Counsel Memorandum from the IRS. The Memorandum states that a fixed indemnity health plan that is employer-paid or purchased on a pre-tax basis through a cafeteria plan will result in taxable income equal to the amount of any benefits paid under the plan.

Fixed indemnity health plans are offered by a number of insurers and pay a fixed dollar amount for certain health-related events such as a doctor’s office visit or a day (or days) in the hospital. The amounts paid are not related to the amount of medical expenses incurred by the employee. Because the amounts paid are not related to medical expenses incurred, the taxation of amounts paid under these plans has always been the subject of some concern, and insurers are usually unwilling to address the tax impact of their fixed indemnity health plans.

According to the Memorandum, when a fixed indemnity health plan is employer-paid or purchased on a pre-tax basis, the usual tax free treatment of benefits paid under Internal Revenue Code section 105 is not available because the amount paid is not a reimbursement of medical care under Code section 213(d). Because the amount paid is not entitled to tax free treatment, any amounts paid under the fixed indemnity health plan are included in the employee’s gross income and wages.

Takeaways

The Memorandum will significantly complicate the current administration of fixed indemnity coverage that is employer-paid or purchased on a pre-tax basis (because existing policies rarely have the ability to tax participants on reimbursements). By way of contrast, payments from a fixed indemnity health plan are still tax free under Code section 104 to the extent that the premiums for such coverage are paid by the employee on an after-tax basis. However, the after-tax nature of the employee premiums may make the fixed indemnity health plan less attractive for employees and employers.

Finally, we also note that the Memorandum treats wellness programs that pay a fixed dollar amount for wellness activities as amounts that are included in the employee’s gross income and wages. However, the wellness programs described in the Memorandum include an employee pre-tax premium to participate in the wellness program. As the pre-tax premium is a highly unusual design element, this appears to be more of an attempt to crack down on traditional fixed indemnity programs masquerading as wellness programs than a serious attack on traditional wellness programs that do not require an employee pre-tax premium.