IRS warns employers to beware of the "double dip"
An old tax avoidance strategy is making the rounds again. Employers should be aware so that when it comes knocking, they know how to respond.
The Sales Pitch
A vendor contacts you to set up a wellness, “preventative services,” or other similar program using pre-tax salary reductions. To attract participants, the promotor may offer employees a fixed indemnity insurance product with reoccurring payments for completion of certain wellness activities or might even make the reoccurring “wellness payments” directly to employees. The “wellness” part of the program usually involves participating in activities that are already free, low cost, or reimbursed by another source (such as the employer’s major medical plan). At regular intervals throughout the year, the employee then receives their “tax-free” wellness payment, and their take-home pay is now the same or only slightly less than it was prior to using the wellness salary reductions. In some cases, the vendor might even say they’ll increase take-home pay.
The employer may be promised tax savings, too, by avoiding FICA and other payroll/employment taxes.
Too Good to Be True?
You may be thinking “this sounds great! Where do I sign up?” The problem? It’s too good to be true. In the view of the Internal Revenue Service (IRS), these are not compliant benefit programs. In 2023, the IRS once again issued a memorandum addressing this type of arrangement, concluding that the reimbursements are taxable to the employees (see IRS CCA 202323006). The IRS memo addresses a program much like other so-called “double dip” arrangements the agency has previously disallowed.
While features and promised benefits may vary, these questionable structures have several things in common:
- Employee salary reductions are combined with a promise to return a large portion of the pre-tax contributions to the employee tax free, leaving the employee with “the same” or “better” take-home pay than if no salary reduction had occurred.
- Projections show payroll tax savings beyond what an employer and employee would typically realize with a compliant approach.
Get the Right Advice
Despite multiple IRS rulings and cases over the years, double-dipping arrangements continue to grow. The answer? Be careful of these programs. They might show up disguised as “self-insured medical reimbursement plans.” Or they could be paired with legitimate benefits like an ordinary dental or vision plan. The best way to ensure any program you’re considering complies with applicable law is to review it in depth with experienced employee benefits tax or legal counsel familiar with your specific circumstances.
The Compliant Way to Save
Employers everywhere are struggling to keep their people. A “double dip” offer could look really enticing when many are at their most vulnerable. But there is a compliant way to give your employees (and your organization) a tax break – using a properly administered Section 125 Plan. Section 125 allows payments for qualifying benefits on a pre-tax basis through employee salary reductions. These contributions are used to purchase compliant accident and healthcare coverage which then pays specific benefits or provides reimbursement for specific substantiated medical expenses unique to each employee and in accordance with federal tax rules.
Questionable vs. Compliant Wellness Programs
|
|
Questionable Wellness Program | Compliant Wellness Program |
|
Program is usually funded by the employer |
|
X |
|
Program is typically funded through employee salary reduction |
X |
|
|
Salary reduction reduces the employee’s take home pay |
|
X |
|
The employee receives reoccurring “tax-free” payments not connected with specific substantiated medical expenses of the employee. |
X |
|
|
The employee receives nontaxable wellness incentives such as premium reductions, cost sharing reductions or contributions to an FSA or HRA. |
|
X |
| The employee receives taxable wellness incentives of cash or cash equivalents such as prizes, gift cards, or money for a gym membership. |
|
X |
This blog is up to date as of November 2023 and has not been updated for changes in the law, administration or current events.