By Jen Carsen, JD, Legal Editor

In a new guidance dated April 14, 2016, the IRS states that an employer may not exclude from an employee’s gross income payments of cash rewards for participating in a wellness program.

Additionally, reimbursements of premiums for participating in a wellness program may not be excluded from an employee’s gross income if the premiums were originally made via salary reduction through a section 125 cafeteria plan.

Three scenarios considered

The IRS considered three different scenarios:

Situation 1. An employer provides all employees, regardless of enrollment in other comprehensive health coverage, with certain benefits under a wellness program at no cost to the employees. In particular, the wellness program provides health screening and other health benefits such that the program generally qualifies as an accident and health plan under section 106. In addition to those benefits, employees who participate in the program may earn cash rewards of varying amounts or benefits that do not qualify as section 213(d) medical expenses, such as gym membership fees.

Situation 2. An employer provides all employees, regardless of enrollment in other comprehensive health coverage, with certain benefits under a wellness program. Employees electing to participate in the wellness program pay a required employee contribution by salary reduction through a section 125 cafeteria plan. The wellness program provides health screening and other health benefits such that the program generally qualifies as an accident and health plan under section 106. In addition to those benefits, employees who participate in the program may earn cash rewards of varying amounts or benefits that do not qualify as section 213(d) medical expenses, such as gym membership fees.

Situation 3. The same as Situation 2, except that one of the benefits available under the wellness program includes a reimbursement of all or a portion of the required employee contribution for the wellness plan that the employee made through salary reduction.

IRS analysis: Health insurance is different than health incentives

In general, said the IRS, 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 (of the employee, the employee’s spouse, or the employee’s dependents, as well as children of the employee who are not dependents but have not attained age 27 by the end of the taxable year) for personal injuries and sickness.

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.

Therefore, while the coverage provided by the wellness program (including the health screenings and other medical care) is excluded under section 106(a) as coverage under an accident and health program for all three considered scenarios, the amount of any cash reward under the program must be included in the employee’s gross income under section 61 and is a payment of wages subject to applicable employment taxes.

Similarly, if the employee earns a reward or benefit not otherwise excludible from the employee’s income (such as the payment of gym membership fees), the fair market value of the reward is included in the employee’s gross income under section 61 and is a payment of wages subject to applicable employment taxes.

What about section 125 plans?

What about Situation 3? The IRS noted it had previously determined that payments to employees that reimburse a portion of health insurance premiums paid via salary deduction do not fall under the income exclusions provided by sections 106(a) and 105(b)—including salary reduction amounts pursuant to a section 125 cafeteria plan that are applied to pay for the health insurance coverage.

Accordingly, the reimbursement amounts are included in the employee’s gross income under section 61 and are considered a payment of wages subject to applicable employment taxes.

Bottom line: If it walks like a duck…

While IRS memos like this one do not constitute official precedent, they can be helpful for employers in similar situations who are looking for guidance.

The bottom line here is to not let yourself get distracted by rewards or incentives that happen to be wrapped up in larger health or wellness plans—if you are giving employees actual cash rewards, or incentives (like a gym membership) that go beyond merely de minimis tokens, it’s likely that they need to be included in employees’ gross income.