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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Supreme Court Decides Severance Payments Are Subject to FICA Tax

The U.S. Supreme Court has reversed a Sixth Circuit Court of Appeals decision by finding that severance payments unrelated to state unemployment insurance that are made to terminated employees are subject to tax under the Federal Insurance Contributions Act (FICA).

 The underlying case involved an employer, Quality Stores, Inc., that entered bankruptcy proceedings in 2001. Prior to and following the bankruptcy petition being filed, the employer made payments to terminated employees pursuant to two employee severance plans. When payments were made, the employer withheld federal income tax and the employee portion of the FICA tax and also paid the employer portion of the FICA tax on the payments. In 2002, the employer filed a claim for refund for the employer and employee FICA taxes paid on the severance payments. The IRS failed to either approve or deny the refund request, so the employer filed an adversary action in the bankruptcy proceeding. The bankruptcy court, district court and Sixth Circuit Court of Appeals all found that the severance payments were not subject to FICA.

The Supreme Court reversed the rulings of the lower courts based on FICA’s broad definition of “wages” which was found to include the severance payments. Following the Supreme Court decision, unemployment benefits other than those provided through state unemployment insurance are now “wages” subject to FICA tax. The Court noted that the IRS has taken the position that state unemployment benefits are not subject to FICA, but the Court reserved its opinion on whether that position is supported by FICA’s broad definition of “wages”.

© 2014 Parsonage Vandenack Williams LLC

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Court Holds Severance Payments Are Not Subject to FICA Taxes

A federal appellate court decision may give employers and laid-off employees a new opportunity to be refunded FICA taxes paid on severance payments. The Sixth Circuit upheld the decision in U.S. v. Quality Stores, Inc. that the employer’s severance payments made to laid-off employees should not have been subject to FICA tax.

The Facts:  Quality Stores, Inc. filed for bankruptcy and laid-off numerous employees from locations that were forced to close. In compliance with plans created both before and after the bankruptcy, Quality Stores made severance payments to laid-off employees. The plan created after the bankruptcy filing was designed to retain current employees and provide a payment that acts as a safety net for laid-off employees. On severance payments, both the employer and employee were subject to FICA tax.  After paying the tax deemed to be owed, Quality Stores filed for a refund of the FICA taxes paid arguing that the severance payments were supplemental unemployment compensation benefit (SUB) payments and should not be subject to FICA taxes. In response the IRS denied the request for a refund and the case went to court to determine if a refund should be issued. The Sixth Circuit Affirmed the determination that Quality Stores’ severance payments should be considered SUB payments for the sake of FICA taxation and the refund was allowed.

For years the issue of whether or not severance payments made to laid-off employees should be subject to FICA taxes has been in dispute. Quality Stores may be the biggest breakthrough since the CSX Corp. case which determined involuntary lay-off payments are exempt from FICA taxes.

What does this mean for current employers and employees? Any employer or laid-off employee who has previously paid FICA taxes on severance payments may now have an opportunity to seek a FICA tax refund. In addition, future severance payments, if compliant with the requirements set forth in U.S. v. Quality Stores, may not be subject to FICA tax.

How can you request a refund? It may be easy to request a refund but doing so successfully is another story. You should contact a tax attorney who is familiar with requests for FICA tax refunds if you believe one may be due. Your time to request a refund is limited, so time is of the essence. Generally, the deadline to file a request for a FICA tax refund is the later of 3 years from the due date of the affected return or 2 years following payment of the tax.

Who can request a refund? Employers and employees who have paid FICA taxes on severance payments within the time period discussed above can request a refund. Employers and employees should consider filing a refund request as soon as possible for the best chance at a refund.

© 2012 Parsonage Vandenack Williams LLC

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