No Risk at All

The group benefit space is being inundated with a new product that purports to convert fully taxable employee wages into non-taxable health-related insurance benefits—like water into wine. 

The benefit? Employees reduce their wage income and therefore pay lower FICA, Medicare and income taxes. Employers also reduce their FICA and Medicare taxes along with their unemployment taxes and workers compensation premiums, all of which are calculated based on total taxable wages paid.

The mechanism? A medical indemnity plan funded as part of a cafeteria plan by pre-tax employer contributions (premiums in lieu of salary) that then returns a monthly cash benefit to participating employees. Under the plans we have reviewed, that cash benefit (called a claim) is 95% or more of the monthly amount contributed on their behalf. The premiums can range from $750 to $1,500 per month per employee.

Claims are paid based on the employees’ submission of some sort of documentation verifying that they have participated in one health-related “screening” activity that month (different plans characterize the nature of these activities differently, for example, using “medical event” in place of “screening”). Acceptable activities include going to a doctor; undergoing any medical-related procedure or test; filling out a health-related survey; participating in any wellness activity or event; and caring for a family member for a day. Only one such claim will be paid a month, and the amount paid is the same amount each month. The documentation and marketing materials of all of the plans we have reviewed to date assume that every participating employee will receive one health screening payment for every month they participate in the plan. 

For example, a plan may have a $1,000 monthly premium with a “screening” benefit that pays each eligible employee $970 per month. There is usually a more traditional indemnity component—like a fixed $100 or $200 payment for a hospital stay or doctor visit—that is funded by the $30 balance. Plan promoters use charts to demonstrate the significant tax savings to both employer and employee who each, under this example, save $91 on FICA and Medicare taxes per month alone. That is $91,000 per month for a 1,000-employee employer or $1,092,000 per year for that employer. Real money.

This of course sounds like a terrific deal. So what’s the problem?

First, to qualify for pre-tax treatment under the cafeteria plan rules, payments must be made to programs that have “the effect of accident or health insurance.” In its seminal 1941 decision in Helvering v. Le Gierse, the Supreme Court held that, to qualify as “insurance,” the policy must shift the risk of economic loss arising from a fortuitous event from the insured to the insurer. The IRS, relying on Helvering, has found that “plans” that involve no risk of real loss do not qualify as “insurance” and, because such plans are “not insurance, a third party making the payments of benefits under the[se] plans would have no insurance risk and would be treated as an agent of the employer under the income withholding regulations relating to payments on account of sickness or accident disability.”

Here, the primary program benefit is an assumed and essentially guaranteed monthly payment benefit for participation in any medically related “screening” activity, and the maker of these payments bears no actual insurance risk.

Second and in a similar vein, the IRS may find that these screening plans lack the “economic substance” required to satisfy the prevailing tax rules. Because participation in these screening-based programs leaves both employers and employees in the same economic position as before, if the purported tax benefits are left out of the analysis, they should, by definition, fail this test.

Some “screening” programs appear to attempt to sidestep some of these issues by bolstering the true insurance component of their program either with an expanded menu of more typical indemnification payments ($200 for a medical visit for example) or by adding true claims-based coverage. To the extent that they do the latter, then either they must be offered only in conjunction with a plan that comports with the requirements of the Affordable Care Act—including coverage of all ACA-required “essential benefits” and not limiting any annual or lifetime benefits for “essential benefits” claims—or the screening plans themselves must so comply which, by design, they would never purport to do.

Including a very minor—in terms of percentage of premium—insurance component also is unlikely to overcome the primary “insurance” and economic substance objections, at least for the vast majority of the premiums which are not at risk.

Moreover, even if these relatively small insurance components did allow the plans to qualify as “insurance,” the vast majority of their payments would not be for the direct payment or reimbursement of qualified medical expenses; thus, those payments still would be subject to the full employment tax regime under prevailing IRS authority. As one IRS revenue ruling noted by way of example, “if a fixed indemnity plan…paid $200 for a medical office visit and the covered individual’s unreimbursed medical costs as the result of the visit were $30, $30 would be excluded from gross income…and the excess of $170 would be included in” the employee’s gross wages and subject to all applicable taxes on such wages.

If—or more likely when—these arrangements are challenged by the IRS, participating employers will be confronted with potential liabilities that include their unpaid FICA and Medicare taxes along with penalties and interest. Often in these situations, the employers also will pay their employees’ unpaid taxes, penalties and interest as part of any settlement with the IRS. Not pretty, and it could be worse if the IRS determines that these plans constitute abusive tax avoidance strategies (or tax shelters) for which additional penalties are warranted.

Insurance brokers selling or otherwise promoting these programs also could face their own liability both under the IRS rules and directly to their clients. At a minimum, you should be closely reviewing any such “screening” program proposals to ensure you are satisfied that they are not triggering the litany of concerns outlined above and, most importantly, that you are informing your clients who may be interested in participating in these programs of the potential issues they pose and the potential tax liabilities to which participating employers may be exposed.

If it seems too good to be true, it probably is. I have seen no better recent illustration of that old adage in practice and of its natural corollary—buyer beware.