By continuing to access our website, you agree to our privacy policy and use of cookies.

Skip to Main Content

Press "Enter" to search

Employee Benefits

FICA Tax Avoidance Wellness Program Viewed Unfavorably by 87,000 New IRS Agents

January 19, 2024

Seyfarth Synopsis: Just like a bad penny, schemes promising employers ways to reduce their FICA tax burden, and maybe their employees’ income tax burden at the same time, keep popping up with a slightly different burnish on the coin. The risks of such an approach have concerned tax practitioners and now the IRS has directly and definitively weighed in on the side of confirming there is no free lunch here.

In a recently released Chief Counsel Memorandum, the IRS weighed in on the tax treatment of a frequently marketed “insurance” product designed to reduce employer FICA taxes and employees’ taxable wages. In short, the IRS views payments under a wellness indemnity product as wages, subject to FICA taxes.


Over the last ten years or so, various vendors and insurance carriers have sought to take advantage of the admittedly arcane insurance and tax rules to design a mechanism to convert otherwise taxable income to tax-free benefits. While the products all vary slightly, they generally follow the same playbook:

  1. Employer enrolls employee in a wellness/fixed indemnity insurance product.
  2. Employee pays the product premium (let’s call it $1,200/month) on a pre-tax basis through the employer’s Section 125 cafeteria plan.
  3. On a monthly basis, the employee engages in a low-commitment “wellness” activity (e.g., call a nurse line, take blood pressure, fill out a health risk questionnaire).
  4. The “reward” or “reimbursement” for participating in the wellness activity is a tax-free “reimbursement” in an amount roughly equivalent to the amount the employee paid for the premium (less taxes) (e.g., $1,000). So, the employee nets roughly equal and the employer avoids paying FICA taxes. [Earlier versions of this product also promised to fully reimburse employee for the pre-tax premium, resulting in the amount of the premium payment itself being income tax free.]
  5. The product is usually also paired with a hospital indemnity/fixed indemnity insurance product that pays a set amount based on certain contingencies (e.g., hospitalization).

Over the years, the IRS has issued various memoranda (here, and here) opining that wellness payments are not tax-free simply because they are associated with a wellness plan (i.e., a cash reward is still taxable). While marketers of these products have attempted to circumvent this guidance by arguing this is a bona fide insurance product, recognized by state regulators, Seyfarth has continued to express concern that the payments under these types of products remained, at best, at risk of recharacterization as taxable income (and at worst, an abusive tax shelter).

2023 Memorandum

In its recent guidance, the IRS focused on the FICA/FUTA tax exclusion relied upon by marketers of these products, which exempts “payments on account of sickness or accident disability”. The IRS indicated that even though wellness payments issued from the insurance product may relate to sickness or accident disability, they remain wages subject to FICA/FUTA withholding as they are not made to reimburse medical or hospitalization expenses. The same analysis applies to payments made from the hospital indemnity program.

Similarly, the IRS focused on the income tax exclusion for sick pay and medical benefits, and concluded that payments under these wellness insurance and indemnity programs do not qualify for the exclusion.

The IRS does not address the outcome if the reimbursements were to be applied toward the employee’s unreimbursed medical expenses, and whether they would be subject to FICA/FUTA or income tax withholding. But practically speaking, as proof of medical expenses are not required under this program an employer would have no meaningful way to ascertain how the funds would be applied, which appears to mean the IRS would almost always require the employer to pay (and withhold) FICA/FUTA and income taxes on reimbursements under these programs.

Nail in the Coffin?

While we have no doubt that some variation of this scheme will continue to live on in some form going forward, employers are cautioned to exercise extreme caution in implementing such a design, as the IRS continues to express an unfavorable opinion on the validity of these tax-avoidance arrangements.

The above information does not constitute advice. Always contact your employee benefits broker or trusted advisor for insurance-related questions.

This information was posted with permission from Seyfarth Shaw LLP.

Authored By

Holly Wahl

Holly Wahl

EB Compliance Practice Leader

Holly leads Hylant’s ongoing efforts to provide our clients with exceptional compliance consulting services on new developments as well as ongoing requirements affecting health and welfare plans. She has a deep understanding of federal and state regulations pertaining to employee benefit plans, as well as extensive experience in group benefit plan operation.

Want more like this?

Sign up for our monthly e-newsletter, Fresh Perspectives, and other relevant content.

By entering your contact information and submitting the form, you understand that Hylant may send similar information in the future. You can unsubscribe anytime by using the link at the bottom of any Hylant email.

Related Insights