IRS Denies Tax-Favored Status to Certain “Self-Funding” Health Plans

By James Pieper

The Internal Revenue Service (“IRS”) has issued a memorandum (“Memorandum”) indicating that it will deny tax-favored status to payments received under certain health plans marketed by their promoters as “self-funding.”

The Memorandum indicates that payments made under such plans will be considered “income” on the part of the employee (and thus not excluded from “gross income” for purposes of the income tax), and will be considered “wages” for purposes of the Federal Insurance Contributions Act (FICA) and Federal Unemployment Tax Act (FUTA) taxes paid by the employer.

The Memorandum cites plans being offered by promoters as “fixed indemnity health plans” with associated “wellness plans.”  The benefit promoted is that the plans are “self-funding” because the purported tax benefits will offset the expense, and employees can gain apparently tax-favored payments as a result of the plan while reducing the FICA purportedly owed by the employer.

The key to the plans is that the employee receives a monthly payment, not as income, but as a “health benefit” in return for a simple but voluntary act such as calling a toll-free number to obtain health advice or participating in biometric screening.  So long as the employee undertakes one act per month, then the benefit is paid.  Promoters of such plans contend that the employee receives comparable take-home pay and the employer receives tax benefits, all on a self-funded basis.

The IRS, however, concludes in the Memorandum that the plans do not constitute “insurance” because the “health benefit” is almost certain to be paid, and, on an actuarial basis, the amount of “benefits” is almost certain to exceed the amount paid as “premium.”

Accordingly, the IRS concluded that payments related to the so-called “self-funding” plans will be considered “income” and “wages” – and, therefore, the apparent “self-funding” mechanism obtained via tax-favored treatment is illusory.

Any employers considering any sort of “self-funding” plan should consider the Memorandum as strong evidence that such a plan is not likely to produce the tax benefits promised.

© 2017 Vandenack Weaver LLC
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