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February 10th, 2017
This update is part of a Brown & Brown series summarizing new guidance in connection with the Patient Protection and Affordable Care Act (also known as the ACA or Health Care Reform). We are joining forces with our business partner, the law firm of Miller Johnson, to provide these updates to you.
For this addition, we are taking a step back from Health Care Reform and focusing on new IRS guidance concerning the taxation of fixed indemnity benefit payments.
A new IRS Memorandum issued in January 2017 provides that payments under employer-provided fixed indemnity health plans may be taxable. For purposes of this ruling, an employer-provided fixed indemnity health plan is typically a voluntary, employee-paid benefit provided on a fully-insured basis.
The policy pays a flat dollar amount such as $100 or $200 per medical visit or day of hospitalization in the event the employee experiences a serious medical condition like cancer or is admitted to the hospital.
In the past, there has been uncertainty regarding the tax consequences of the benefits paid under such a policy.
On one hand, if the employee could demonstrate that he or she had uninsured health expenses which were reimbursed by the policy, many argued that the benefit should be tax-free.
On the other hand, if the expenses did not reimburse an uninsured health expense, there was a concern that the benefit was taxable. The IRS resolved the issue under the Chief Counsel Advice Memorandum by finding that the tax consequences depend upon how the premium is paid.
Specifically, the IRS says that if the premium is paid by the employer or is paid for by the employee on a pre-tax basis, then any benefits are taxable regardless of whether the participating employee has any uninsured health expenses. On the other hand, if the employee pays the entire premium for the fixed indemnity coverage on a post-tax basis, any benefits paid are tax-free. Because of the income tax and FICA savings for employees and the FICA savings for employers, many of these arrangements have historically called for employees to pay the premiums on a pre-tax basis. While the fixed indemnity benefit may be less attractive to both employees and employers if purchased on an after-tax basis, clearly an after-tax approach is now preferable because it avoids the tax consequences.
It should also be noted that the Office of Chief Counsel Memorandum does not address how the employer should fulfill its withholding and tax reporting obligations if the premiums are pre-tax. In the case of insured disability benefits, there are specific rules on how to handle the withholding and tax reporting obligations between the employer and the insurance carrier. It is very possible that the IRS may issue similar rules here where an employer wants to continue a pre-tax premium arrangement, but at this point there is no such guidance.